BearingPoint and the Risk of Late SEC Filings

Companies that are late in filing their financial statements with the SEC may simultaneously trigger default provisions under their credit agreements and indentures. Accounting problems from practices such as the backdating of stock options make it difficult for companies to get auditors to sign off on their financial statements, resulting not only in a failure to meet SEC reporting deadlines but also a default under their loan agreements and cross-defaults under other agreements. This problem is widespread, with over 150 companies affected by the options backdating scandals and over 1300 companies in 2005 alone filing restatements of their financial statements with the SEC (see Securities Law Daily, Oct. 30, 2006). Failure to file periodic reports with the indenture trustee within a short time of the SEC filing date creates a default under many indentures and leads to a cascading series of adverse consequences for the issuer.

BearingPoint

Credit agreements and indentures typically include a reporting requirement covenant that obligates the company to file SEC reports with the creditors or indenture trustees. By delaying a required SEC filing, a company is likely to be unable to file its financials with its creditors or trustees on time. As a result, it would breach the reporting covenant and be in default under the agreement, giving its lenders the opportunity to accelerate payment of the entire debt or negotiate more onerous terms. BearingPoint, Inc., a NYSE-traded global management and technical consulting firm, experienced this problem first hand. Due to various accounting concerns, BearingPoint failed to timely file its Annual Report on Form 10-K with the SEC, as well as certain quarterly reports on Form 10-Q. Consequently, it also failed to file these periodic reports with the indenture trustee. However, BearingPoint's only duty under its indenture was to file a copy of the annual and quarterly reports with the indenture trustee within 15 days after filing the same with the SEC. [Section 5.02. SEC and Other Reports. The Company shall file with the Trustee, within 15 days after it files such annual and quarterly reports, information, documents and other reports with the SEC, copies of its annual report and of the information, documents and other reports (or copies of such portions of any of the foregoing as the SEC may by rules and regulations prescribe) which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act. The company shall comply with the other provisions of TIA Section 314(a)'.]

On Sept. 18, 2006, a New York state court ruled in The Bank of New York v. BearingPoint, Inc. that BearingPoint was in default under its indenture because it had breached reporting covenants by failing to file its SEC reports on time with the indenture trustee. Even though the indenture clearly stated that BearingPoint was required to deliver copies of its periodic reports to the indenture trustee 15 days after it filed them with the SEC, the court soundly rejected BearingPoint's arguments that it therefore had no duty to file with the indenture trustee until it filed its reports with the SEC. The court held that the indenture was unambiguous in obligating Bearing-Point to make the required SEC filings and provide copies to the trustee. The court dismissed as 'tortured' BearingPoint's interpretation that its obligation to the Trustee depended on whether or not it chose to file with the SEC and said that such an interpretation would vitiate the clear purpose of the indenture to provide information to the investors so that they may protect their investment.

The court also pointed to Section 314(a) of the Trust Indenture Act, which specifically obligates an issuer of bonds to provide the indenture trustee with copies of the periodic reports required to be filed with the SEC. The court interpreted that to mean that Bearing Point had to provide the 'required SEC filings,' which BearingPoint plainly had not done.

Thus, companies that are late in filing 10-Ks or 10-Qs as a result of accounting problems cannot rely on any technical argument to claim that no default has occurred under their indenture reporting covenants. This case is significant because the failure to file periodic SEC reports with the indenture trustee will constitute a default under the typical indenture, notwithstanding standard indenture language that suggests that the issuer does not have to file copies with the indenture trustee until after filing with the SEC.

As most credit agreements and indentures are governed by New York law, the New York court's interpretation of a common indenture agreement provision may have several other important practical implications.

Defaults and Cross-Defaults

Delayed filings of 10-Ks and 10-Qs with the SEC and the creditor or trustee cause a default under an indenture or a bank loan agreement, and may result in the acceleration of payment obligations thereunder. That default, in turn, may result in the company's cross-defaulting on its other material agreements, resulting in the acceleration of payment obligations under those agreements as well.

Investor Action

The BearingPoint ruling may also initiate a trend in which bond investors seeking to make an early profit take aggressive action against companies that are late in filing SEC reports. Investors may be encouraged to orchestrate action against companies by using the enforcement of reporting requirement covenants and other covenants previously considered minor or labeled as 'technical,' such as the standard 'compliance with laws' covenant, in order to force early termination of the credit agreement and acceleration of full payment obligations. This certainly compounds concerns for the many companies that have delayed filings with the SEC due to stock option backdating or other problems. In addition, actions against companies late in reporting to the SEC may cause even further delays in reporting. For instance, BearingPoint has stated that it does not expect to be current with its filings until spring of 2007, since litigation arising out of its failure to make timely filings has caused uncertainty in its financial status.

Controlling Influence of Debt Holders

Hedge funds and other bondholders may now have greater leverage in negotiations with companies that default due to late SEC filings. During debt restructure negotiations, hedge funds and other bondholders may be able to demand more favorable results such as higher interest rates, increased control over company operations, an equity stake in the company or other onerous provisions. Hedge funds own millions of dollars of debt of many large companies and have recently been aggressive in taking action. One hedge fund holds 8.5% of UnitedHealth Group's notes due in 2036, and such fund has filed suit against UnitedHealth, claiming that it defaulted on its debt by failing to file audited second quarter 10-Q reports with the SEC. The same hedge fund also stated that it would seek the immediate repayment from Affiliated Computer Services ('Affiliated') of $260 million in notes that were due in 2015, claiming it defaulted when it failed to file its annual report with the SEC due to an ongoing internal investigation over stock issuance problems. This statement prompted Affiliated to file a lawsuit in Federal court last month seeking a formal ruling on whether it is actually in default. In addition, the same hedge fund recently bought approximately one-third of computer chip maker Vitesse Semiconductor's $100 million of convertible bonds, only to later claim that Vitesse defaulted on the terms of the bonds after it delayed its regulatory filings due to a federal investigation over securities violations. The BearingPoint ruling is likely to make it difficult for companies such as UnitedHealth, Affiliated and Vitesse, which are targets of aggressive hedge fund action, to defend their position that they are not in default.

Ratings Downgrades

The BearingPoint ruling may alarm investors in companies that are parties to indentures and have a history of tardy reporting to the SEC. Standard & Poor's recent downgrading of BearingPoint's rating from 'hold' to 'sell' demonstrates that the recent ruling and its consequences have tarnished the company's reputation in the eyes of analysts, which in turn affects the opinion of investors and ultimately the stock prices. Moody's Investors Service, a credit rating agency, downgraded BearingPoint Inc. from a B1 rating to a B2 rating, which is a rating assigned to speculative corporate bonds with relatively high probability of default and loss, and put BearingPoint on review for further possible downgrade, citing delayed SEC filings as a factor in this decision. Similarly, Standard & Poor's cut its credit rating for Affiliated Com-puter Services Inc. with the possibility of more downgrades to come after the company failed to file its annual report with the SEC as a result of an ongoing review of its options granting practices.

Delisting

A late filing with the SEC may also create problems with securities markets such as the New York Stock Exchange and NASDAQ. Generally, the NYSE's listing standards require the commencement of suspension and delisting proceedings if a company fails to file its annual reports within a year of the due date. However, the SEC has recently approved a NYSE proposal that would allow it more flexibility and discretion depending on the circumstance. The NYSE will now have the ability to evaluate its decision every three months in order to decide whether trading should continue. In order to make this decision, the NYSE will look into various factors such as the financial well-being of the company and whether the company can be reasonably expected to meet filing deadlines in the future. With the SEC approval of this proposal, the risk of delisting and trading suspension on the NYSE due to late filings has somewhat decreased.

NASDAQ listing standards also require timely reports to be filed with the SEC. Unlike the NYSE rules, NASDAQ does not allow a one-year grace period for filing reports and a late filing automatically results in a delisting letter sent to the company. Apple Computer, Inc. recently failed to file its Form 10-Q financial report filing with the SEC due to stock option accounting problems, and NASDAQ sent Apple a formal notice of delisting from the stock exchange. If NASDAQ determines to delist a company's securities, the company may accept the delisting or appeal the decision to a NASDAQ Listing Qualifications Hearing Panel.

Damages

Issuers that are late filing their required financial statements may also risk incurring damages to their creditors. For example, Bearing-Point's bondholders sought $21
million in damages based on breach of contract. The plaintiff, The Bank of New York in its capacity as Indenture Trustee, further alleged that the indenture granted the holders of the Series B Debentures the remedy of acceleration as well as any available remedy to collect the payment of the principal amount of the securities and any accrued and unpaid interest.

Company Options

In order to avoid defaulting on debts due to late filings, a company may have several options:

Filing Incomplete Financials. Companies waiting on accountants to approve and sign off on financial statements may elect to file reports with the SEC without outside accountant review, in order to be able to assert that the filing, even if arguably deficient, has occurred. However, this tactic will be futile if the financing agreement itself requires that the company's financial statements be reviewed by an independent accountant or if the agreement requires that reports be filed timely with the SEC rather than simply 'delivered' to the SEC. Although such an approach may allow a company to avoid being in default under its financing agreements, the SEC may take the position that such a filing is not a timely filing, and an incomplete filing may cause other problems with the SEC, such as possibly foregoing the eligibility to file a Form S-3 registration statement in the future. Companies should thus carefully weigh the costs and benefits of making such a filing.

Grace Periods and Cure Periods. A company should try to negotiate covenants so that filings with the indenture trustee may be delayed until such reports are actually filed with the SEC. If this is not possible, another option is to specify longer grace periods after filings with the SEC are due. BearingPoint has stated that it has amended the terms of a $150 million credit facility to extend the filing deadlines for its 10-K annual report and several 10-Q reports.

It may also be important for companies to negotiate longer 'cure periods' for reporting requirement covenants wherever possible, so that a company receiving a notice of default for failure to provide timely reports will have an adequate amount of time to both file with the SEC and cure any resulting default with the indenture trustee. This will not be helpful for those companies that need several months to catch up with their filings.

Less Costly Remedies. Companies will also need to re-think the remedies available to creditors and bondholders under financing agreements. If a company breaches the reporting requirement or compliance with laws covenant, acceleration may be far too harsh a remedy. Companies should seek to negotiate less severe and costly remedies for breaches of covenants that are technical in nature, such as interest rate adjustments, penalty fees or more restrictive covenant terms.

Negotiating Better Terms. Auditors have become tougher and more demanding. Auditors are less willing to issue their reports unless they are satisfied that even immaterial items are properly reported. The result, of course, is that auditor concerns are more likely than ever to force issuers to restate their financials or to file their financials late. This is a major reason why issuers should press their lenders to allow leeway such as grace periods and cure periods in respect of late filing violations. Unfortunately, banks typically have greater leverage when negotiating a financing agreement (and perhaps will have even greater leverage in the aftermath of the BearingPoint ruling).

It is important to modify other technical covenants in the agreement that relate to the reporting requirement covenants. Covenants such as the standard 'compliance with laws' covenant must be modified and narrowed in scope so that violations of reporting requirements are not covered. Both the reporting requirement and compliance with laws covenants should make clear exactly what types of delays are considered 'material' and will constitute a breach.

Waivers. If the failure to file SEC reports is due to a technical or immaterial problem, companies may be able to obtain extensions or waivers of reporting requirements from bondholders if such a delayed filing is expected. If obtaining such a waiver is not possible, another option is to obtain a waiver of the remedy of acceleration by offering to pay penalty fees to the holders rather than the full accelerated payment obligations. BearingPoint announced on Friday, Nov. 3 that it has reached an agreement with its Series A and Series B Debenture bondholders that waives the requirement that BearingPoint file reports with the SEC. In exchange, the agreement provides for the interest rate on the company's bonds to increase by an amount ranging from 10 to 85 basis points. The agreement is contingent on a group of the company's bondholders dropping its lawsuit.

Conclusion

Delayed SEC filings may well invite a host of problems and concerns for the company making such filings. Corporate treasurers and CFOs of companies dealing with accounting issues stemming from practices such as stock option backdating should certainly keep this in mind when considering the impact that a late
filing of SEC reports will have on financing agreements, and should make every effort to avoid the possibility of default under any such agreements.

Joshua P. Agrons (jagrons@fulbright. com) and Richard P. Bourgeois ([email protected]) are partners in the Corporate, Banking and Business section of Fulbright & Jaworski L.L.P. They practice in the Houston and New York offices, respectively. Natasha S. Chowdhury ([email protected]) is an associate in the Corporate, Banking and Business section and also practices in the firm's Houston office.

Companies that are late in filing their financial statements with the SEC may simultaneously trigger default provisions under their credit agreements and indentures. Accounting problems from practices such as the backdating of stock options make it difficult for companies to get auditors to sign off on their financial statements, resulting not only in a failure to meet SEC reporting deadlines but also a default under their loan agreements and cross-defaults under other agreements. This problem is widespread, with over 150 companies affected by the options backdating scandals and over 1300 companies in 2005 alone filing restatements of their financial statements with the SEC (see Securities Law Daily, Oct. 30, 2006). Failure to file periodic reports with the indenture trustee within a short time of the SEC filing date creates a default under many indentures and leads to a cascading series of adverse consequences for the issuer.

BearingPoint

Credit agreements and indentures typically include a reporting requirement covenant that obligates the company to file SEC reports with the creditors or indenture trustees. By delaying a required SEC filing, a company is likely to be unable to file its financials with its creditors or trustees on time. As a result, it would breach the reporting covenant and be in default under the agreement, giving its lenders the opportunity to accelerate payment of the entire debt or negotiate more onerous terms. BearingPoint, Inc., a NYSE-traded global management and technical consulting firm, experienced this problem first hand. Due to various accounting concerns, BearingPoint failed to timely file its Annual Report on Form 10-K with the SEC, as well as certain quarterly reports on Form 10-Q. Consequently, it also failed to file these periodic reports with the indenture trustee. However, BearingPoint's only duty under its indenture was to file a copy of the annual and quarterly reports with the indenture trustee within 15 days after filing the same with the SEC. [Section 5.02. SEC and Other Reports. The Company shall file with the Trustee, within 15 days after it files such annual and quarterly reports, information, documents and other reports with the SEC, copies of its annual report and of the information, documents and other reports (or copies of such portions of any of the foregoing as the SEC may by rules and regulations prescribe) which the Company is required to file with the SEC pursuant to Section 13 or 15(d) of the Exchange Act. The company shall comply with the other provisions of TIA Section 314(a)'.]

On Sept. 18, 2006, a New York state court ruled in The Bank of New York v. BearingPoint, Inc. that BearingPoint was in default under its indenture because it had breached reporting covenants by failing to file its SEC reports on time with the indenture trustee. Even though the indenture clearly stated that BearingPoint was required to deliver copies of its periodic reports to the indenture trustee 15 days after it filed them with the SEC, the court soundly rejected BearingPoint's arguments that it therefore had no duty to file with the indenture trustee until it filed its reports with the SEC. The court held that the indenture was unambiguous in obligating Bearing-Point to make the required SEC filings and provide copies to the trustee. The court dismissed as 'tortured' BearingPoint's interpretation that its obligation to the Trustee depended on whether or not it chose to file with the SEC and said that such an interpretation would vitiate the clear purpose of the indenture to provide information to the investors so that they may protect their investment.

The court also pointed to Section 314(a) of the Trust Indenture Act, which specifically obligates an issuer of bonds to provide the indenture trustee with copies of the periodic reports required to be filed with the SEC. The court interpreted that to mean that Bearing Point had to provide the 'required SEC filings,' which BearingPoint plainly had not done.

Thus, companies that are late in filing 10-Ks or 10-Qs as a result of accounting problems cannot rely on any technical argument to claim that no default has occurred under their indenture reporting covenants. This case is significant because the failure to file periodic SEC reports with the indenture trustee will constitute a default under the typical indenture, notwithstanding standard indenture language that suggests that the issuer does not have to file copies with the indenture trustee until after filing with the SEC.

As most credit agreements and indentures are governed by New York law, the New York court's interpretation of a common indenture agreement provision may have several other important practical implications.

Defaults and Cross-Defaults

Delayed filings of 10-Ks and 10-Qs with the SEC and the creditor or trustee cause a default under an indenture or a bank loan agreement, and may result in the acceleration of payment obligations thereunder. That default, in turn, may result in the company's cross-defaulting on its other material agreements, resulting in the acceleration of payment obligations under those agreements as well.

Investor Action

The BearingPoint ruling may also initiate a trend in which bond investors seeking to make an early profit take aggressive action against companies that are late in filing SEC reports. Investors may be encouraged to orchestrate action against companies by using the enforcement of reporting requirement covenants and other covenants previously considered minor or labeled as 'technical,' such as the standard 'compliance with laws' covenant, in order to force early termination of the credit agreement and acceleration of full payment obligations. This certainly compounds concerns for the many companies that have delayed filings with the SEC due to stock option backdating or other problems. In addition, actions against companies late in reporting to the SEC may cause even further delays in reporting. For instance, BearingPoint has stated that it does not expect to be current with its filings until spring of 2007, since litigation arising out of its failure to make timely filings has caused uncertainty in its financial status.

Controlling Influence of Debt Holders

Hedge funds and other bondholders may now have greater leverage in negotiations with companies that default due to late SEC filings. During debt restructure negotiations, hedge funds and other bondholders may be able to demand more favorable results such as higher interest rates, increased control over company operations, an equity stake in the company or other onerous provisions. Hedge funds own millions of dollars of debt of many large companies and have recently been aggressive in taking action. One hedge fund holds 8.5% of UnitedHealth Group's notes due in 2036, and such fund has filed suit against UnitedHealth, claiming that it defaulted on its debt by failing to file audited second quarter 10-Q reports with the SEC. The same hedge fund also stated that it would seek the immediate repayment from Affiliated Computer Services ('Affiliated') of $260 million in notes that were due in 2015, claiming it defaulted when it failed to file its annual report with the SEC due to an ongoing internal investigation over stock issuance problems. This statement prompted Affiliated to file a lawsuit in Federal court last month seeking a formal ruling on whether it is actually in default. In addition, the same hedge fund recently bought approximately one-third of computer chip maker Vitesse Semiconductor's $100 million of convertible bonds, only to later claim that Vitesse defaulted on the terms of the bonds after it delayed its regulatory filings due to a federal investigation over securities violations. The BearingPoint ruling is likely to make it difficult for companies such as UnitedHealth, Affiliated and Vitesse, which are targets of aggressive hedge fund action, to defend their position that they are not in default.

Ratings Downgrades

The BearingPoint ruling may alarm investors in companies that are parties to indentures and have a history of tardy reporting to the SEC. Standard & Poor's recent downgrading of BearingPoint's rating from 'hold' to 'sell' demonstrates that the recent ruling and its consequences have tarnished the company's reputation in the eyes of analysts, which in turn affects the opinion of investors and ultimately the stock prices. Moody's Investors Service, a credit rating agency, downgraded BearingPoint Inc. from a B1 rating to a B2 rating, which is a rating assigned to speculative corporate bonds with relatively high probability of default and loss, and put BearingPoint on review for further possible downgrade, citing delayed SEC filings as a factor in this decision. Similarly, Standard & Poor's cut its credit rating for Affiliated Com-puter Services Inc. with the possibility of more downgrades to come after the company failed to file its annual report with the SEC as a result of an ongoing review of its options granting practices.

Delisting

A late filing with the SEC may also create problems with securities markets such as the New York Stock Exchange and NASDAQ. Generally, the NYSE's listing standards require the commencement of suspension and delisting proceedings if a company fails to file its annual reports within a year of the due date. However, the SEC has recently approved a NYSE proposal that would allow it more flexibility and discretion depending on the circumstance. The NYSE will now have the ability to evaluate its decision every three months in order to decide whether trading should continue. In order to make this decision, the NYSE will look into various factors such as the financial well-being of the company and whether the company can be reasonably expected to meet filing deadlines in the future. With the SEC approval of this proposal, the risk of delisting and trading suspension on the NYSE due to late filings has somewhat decreased.

NASDAQ listing standards also require timely reports to be filed with the SEC. Unlike the NYSE rules, NASDAQ does not allow a one-year grace period for filing reports and a late filing automatically results in a delisting letter sent to the company. Apple Computer, Inc. recently failed to file its Form 10-Q financial report filing with the SEC due to stock option accounting problems, and NASDAQ sent Apple a formal notice of delisting from the stock exchange. If NASDAQ determines to delist a company's securities, the company may accept the delisting or appeal the decision to a NASDAQ Listing Qualifications Hearing Panel.

Damages

Issuers that are late filing their required financial statements may also risk incurring damages to their creditors. For example, Bearing-Point's bondholders sought $21
million in damages based on breach of contract. The plaintiff, The Bank of New York in its capacity as Indenture Trustee, further alleged that the indenture granted the holders of the Series B Debentures the remedy of acceleration as well as any available remedy to collect the payment of the principal amount of the securities and any accrued and unpaid interest.

Company Options

In order to avoid defaulting on debts due to late filings, a company may have several options:

Filing Incomplete Financials. Companies waiting on accountants to approve and sign off on financial statements may elect to file reports with the SEC without outside accountant review, in order to be able to assert that the filing, even if arguably deficient, has occurred. However, this tactic will be futile if the financing agreement itself requires that the company's financial statements be reviewed by an independent accountant or if the agreement requires that reports be filed timely with the SEC rather than simply 'delivered' to the SEC. Although such an approach may allow a company to avoid being in default under its financing agreements, the SEC may take the position that such a filing is not a timely filing, and an incomplete filing may cause other problems with the SEC, such as possibly foregoing the eligibility to file a Form S-3 registration statement in the future. Companies should thus carefully weigh the costs and benefits of making such a filing.

Grace Periods and Cure Periods. A company should try to negotiate covenants so that filings with the indenture trustee may be delayed until such reports are actually filed with the SEC. If this is not possible, another option is to specify longer grace periods after filings with the SEC are due. BearingPoint has stated that it has amended the terms of a $150 million credit facility to extend the filing deadlines for its 10-K annual report and several 10-Q reports.

It may also be important for companies to negotiate longer 'cure periods' for reporting requirement covenants wherever possible, so that a company receiving a notice of default for failure to provide timely reports will have an adequate amount of time to both file with the SEC and cure any resulting default with the indenture trustee. This will not be helpful for those companies that need several months to catch up with their filings.

Less Costly Remedies. Companies will also need to re-think the remedies available to creditors and bondholders under financing agreements. If a company breaches the reporting requirement or compliance with laws covenant, acceleration may be far too harsh a remedy. Companies should seek to negotiate less severe and costly remedies for breaches of covenants that are technical in nature, such as interest rate adjustments, penalty fees or more restrictive covenant terms.

Negotiating Better Terms. Auditors have become tougher and more demanding. Auditors are less willing to issue their reports unless they are satisfied that even immaterial items are properly reported. The result, of course, is that auditor concerns are more likely than ever to force issuers to restate their financials or to file their financials late. This is a major reason why issuers should press their lenders to allow leeway such as grace periods and cure periods in respect of late filing violations. Unfortunately, banks typically have greater leverage when negotiating a financing agreement (and perhaps will have even greater leverage in the aftermath of the BearingPoint ruling).

It is important to modify other technical covenants in the agreement that relate to the reporting requirement covenants. Covenants such as the standard 'compliance with laws' covenant must be modified and narrowed in scope so that violations of reporting requirements are not covered. Both the reporting requirement and compliance with laws covenants should make clear exactly what types of delays are considered 'material' and will constitute a breach.

Waivers. If the failure to file SEC reports is due to a technical or immaterial problem, companies may be able to obtain extensions or waivers of reporting requirements from bondholders if such a delayed filing is expected. If obtaining such a waiver is not possible, another option is to obtain a waiver of the remedy of acceleration by offering to pay penalty fees to the holders rather than the full accelerated payment obligations. BearingPoint announced on Friday, Nov. 3 that it has reached an agreement with its Series A and Series B Debenture bondholders that waives the requirement that BearingPoint file reports with the SEC. In exchange, the agreement provides for the interest rate on the company's bonds to increase by an amount ranging from 10 to 85 basis points. The agreement is contingent on a group of the company's bondholders dropping its lawsuit.

Conclusion

Delayed SEC filings may well invite a host of problems and concerns for the company making such filings. Corporate treasurers and CFOs of companies dealing with accounting issues stemming from practices such as stock option backdating should certainly keep this in mind when considering the impact that a late
filing of SEC reports will have on financing agreements, and should make every effort to avoid the possibility of default under any such agreements.

Joshua P. Agrons (jagrons@fulbright. com) and Richard P. Bourgeois ([email protected]) are partners in the Corporate, Banking and Business section of Fulbright & Jaworski L.L.P. They practice in the Houston and New York offices, respectively. Natasha S. Chowdhury ([email protected]) is an associate in the Corporate, Banking and Business section and also practices in the firm's Houston office.