Concurrent Rights Offerings by Chapter 11 Debtors

The 4(2) Offering was designed to satisfy the Section 4(a)(2) exemption generally and Rule 506 of Regulation D in particular. Kodak limited the 4(2) Offering to accredited investors and qualified institutional buyers, and filed a Form D with the SEC. Compliance with the principally/partly test is not required for a private placement of securities pursuant to Section 4(a)(2) or Rule 506; however, such securities are restricted securities for purposes of Rule 144 under the Securities Act, and investors must therefore be prepared to bear the risk of their investment for the applicable Rule 144 holding period.

The SEC also had issued guidance with respect to concurrent public and private offerings in 2007. See Revisions of Limited Offering Exemptions in Regulation D, Securities Act Release No. 33-8828, 72 Fed. Reg. 45,116, 45,129 (Aug. 10, 2007) (noting that whether a registration statement should be considered a general solicitation or general advertising that affects the availability of the Section 4(a)(2) exemption with respect to a concurrent private offering depends on whether investors in the private placement were solicited through the registration statement or by “some other means that would otherwise not foreclose the availability of the Section 4(2) exemption”; for instance, if an investor becomes interested in a concurrent private placement through a substantive, pre-existing relationship with the company, the prior filing of the registration statement “generally would not impact the potential availability of the Section 4(2) exemption for that private placement”).

Some debtors seeking to rely on private placement exemptions under the Securities Act to conduct a Chapter 11 rights offering have distributed “seeker letters” to potentially eligible stakeholders in order to establish a limited universe of eligible participants prior to the commencement of the rights offering. Seeker letters generally request that a recipient confirm its eligibility to participate in a private placement by certifying that it satisfies the conditions for accredited investor or qualified institutional buyer status, along with other applicable requirements (e.g., holding claims against the debtor of a certain class), and must be submitted before the debtor distributes solicitation materials. Following receipt of the certifications, the debtor makes the private offering only to the qualifying institutions and individuals.

Cognizant of the legal implications associated with conducting a private placement in reliance on Section 4(a)(2) concurrently with a public offering in reliance on Section 1145 ' juxtaposed against a competing mandate to devise a strategy that would allow the broadest possible qualified creditor participation in the 4(2) Offering ' Kodak, working closely with the Creditors' Committee and the Backstop Parties, designed a 4(2) Offering in which creditor participation was limited only to a creditor that could certify that it:

• qualified as an accredited investor, or as a qualified institutional buyer;
• held a minimum face amount of unsecured claims ($100,000 for qualified institutional buyers and $500,000 for accredited investors), for purposes of establishing a pre-existing substantive relationship with Kodak as a creditor of the company and, for accredited investors in particular, an appropriate level of familiarity with and an ability to bear the risk of an investment in Kodak; and
• held the minimum claim amount prior to the announcement of the rights offerings. This requirement was designed to ensure that the creditor's substantive relationship with Kodak pre-dated any publicity concerning the rights offerings and that the potential investors in the private offering were found independently of such publicity, thus confirming that no general solicitation of, or general advertising to, those investors had taken place.

Following Kodak's public announcement of the rights offerings, it distributed a certification letter to creditors it identified as potentially eligible participants. Subscription materials for the 4(2) Offering were distributed only to those creditors that properly certified their eligibility (i.e., their status as accredited investors or qualified institutional buyers, and their ownership of the minimum claim amount as of the relevant date).

As a consequence of the prohibition on general solicitation and general advertising and Kodak's measures to ensure compliance, a number of unsecured creditors ' in particular, creditors who acquired claims in the requisite minimum amount only after Kodak's announcement of the rights offerings ' were precluded from participating in the 4(2) Offering. Absent the prohibition on general solicitation and general advertising, the 4(2) Offering could have been made accessible to creditors who purchased claims in the market after the announcement, thus increasing the number of eligible investors and the liquidity of Kodak claims.

Implications of New Rule 506(c) Under the Securities Act

On July 10, 2013, the SEC adopted final amendments to Rule 506 of Regulation D including the addition of new Rule 506(c). Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Securities Act Release No. 33-9415, 78 Fed. Reg. 44,771 (July 10, 2013).

As directed by the Jumpstart Our Business Startups (JOBS) Act, enacted in April 2012, new Rule 506(c) allows an issuer to offer and sell securities by means of general solicitation or general advertising in reliance on the Regulation D safe harbor, provided certain conditions are met. Among other conditions, all purchasers of such securities must be accredited investors within the meaning of Regulation D and the issuer must take “reasonable steps” to verify the accredited investor status of all purchasers.

Rule 506(c) indicates several non-exclusive “safe harbor” methods of verification with respect to natural persons who are deemed to satisfy the verification requirement, but any reasonable verification method can be used. Pursuant to the SEC's final release, issuers should consider the facts and circumstances of each purchaser and transaction, including: 1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be (e.g., individual or institution); 2) the amount and type of information that the issuer has about the purchaser; and 3) the nature and terms of the offering, including the manner in which the purchaser was solicited to participate and any limiting factors, such as a minimum purchase amount.

Under the new rule, a debtor-issuer may now conduct a rights offering pursuant to a plan of reorganization in reliance on the “private placement” exemption provided by Rule 506(c) of Regulation D without having to limit participation to investors that have a substantive relationship with the debtor prior to any public announcements or other communications that could be regarded as a general solicitation or general advertising. Several of the restrictions on creditor participation in Kodak's 4(2) Offering, designed to ensure the availability of the private placement exemption, might now be eliminated in reliance on Rule 506(c), thus allowing expanded participation by creditors.

It should be noted that an issuer conducting a private placement in reliance on Section 4(a)(2) of the Securities Act but outside Rule 506(c) will remain subject to the prohibition on general solicitation and general advertising. A debtor that engages in activity that could be regarded as general solicitation or general advertising must comply with Rule 506(c), and will not be able to rely on Section 4(a)(2) otherwise.

Compliance with Regulation D also may be necessary under state blue sky laws, especially if general solicitation or general advertising has occurred. Finally, Rule 144A under the Securities Act has been amended to allow securities sold pursuant to Rule 144A to be offered by means of general solicitation or general advertising, so long as such securities are sold only to a qualified institutional buyer or a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer. Such a sale may be made absent verification that each purchaser is a qualified institutional buyer. The Rule 144A exemption, however, is not available for a sale by the issuer itself, and must involve an intermediary. See id. at 44,786.

Importantly, to comply with Rule 506(c), the debtor will need to ensure that reasonable steps are taken to verify the accredited investor status of all purchasers. This issue should be carefully considered in the context of a bankruptcy, given the potentially significant number of eligible creditors, including individuals or other investors about whom little is known and who may be unsophisticated. Self-certification by purchasers of their accredited investor status will continue to be an important step in this process, but may not be sufficient to satisfy the verification requirement.

It should be noted that the steps that will be “reasonable” to verify accredited investor status will depend on the facts and circumstances of each offering, including available information about the purchasers, the type of accredited investor the purchaser claims to be, and the issuer's other requirements for eligibility to participate in the offering. Accordingly, a debtor-issuer must carefully consider the factors outlined by the SEC in order to develop a procedure that includes “reasonable steps” to verify a participant's accredited investor status.

For example, a purchaser's ability to meet a minimum investment requirement for participation in a Rule 506(c) offering may be considered by an issuer in evaluating a purchaser's accredited investor status. An issuer also is deemed to satisfy the verification requirement under Rule 506(c) by obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months. The person or entity should also have determined that such purchaser is an accredited investor; or, with respect to a natural person, by reviewing a copy of an IRS form that reports income (e.g., Form W-2). In some cases, a debtor may have significant information about its creditors, or some of them, which could be an important factor in determining whether its verification methods are reasonable.

In devising future rights offerings under Rule 506(c), debtors may wish to consider seeking a judicial determination from the bankruptcy court that the manner in which the debtor is verifying purchasers' accredited investor status is reasonable. For example, a Debtor might require each participant to file a declaration with the bankruptcy court, under penalty of perjury, certifying as to its accredited investor status, and append to its declaration evidence documenting that status.

While self-certification alone may not satisfy the verification requirement, an augmented self-certification procedure of this kind, when combined with other factors, such as a minimum investment requirement and information available to the debtor about its existing creditors, may be a helpful tool for debtors in complying with the new verification requirement.

Rule 506(c) should give debtor-issuers new flexibility in conducting securities offerings under a plan of reorganization. Subject to necessary evaluation of relevant securities law issues in light of the facts and circumstances of each case, appropriate use of the new Rule 506(c) exemption has the potential to expand access to investment in a reorganized debtor for appropriate investors, and to enable creditors and other stakeholders to unlock additional value in the restructuring process.

Finally, notwithstanding the adoption of Rule 506(c), Kodak's approach ' conducting two separate rights offerings concurrently ' is likely to set the standard for bankruptcy rights offerings in Chapter 11. A public offering under Section 1145 allows a debtor to raise capital by offering freely tradable, unrestricted securities, while making additional restricted securities available through a separate offering pursuant to Regulation D, thus enhancing potential participation by qualified creditors, all consistent with the Bankruptcy Code's antidiscrimination provisions. This approach allows the debtor to raise more capital than would otherwise be permitted under the principally/partly test, but also permits a debtor to offer new securities to its stakeholders more broadly than would be permitted in a restricted private placement alone by simultaneously taking advantage of the Section 1145 exemption.

Michael Torkin is a partner in the General Practice Group at Sullivan & Cromwell LLP, specializing in Bankruptcy & Restructuring matters. He represents clients in complex Chapter 11 reorganizations and out-of-court restructurings. Chiansan Ma is an associate in the General Practice Group at the firm.

Last month, we discussed how Eastman Kodak Company conducted the first-ever parallel rights offerings in connection with its Chapter 11 plan of reorganization. The structure was designed to raise capital for Kodak's emergence from Chapter 11 through a public offering and a separate private placement of reorganized Kodak equity to a pool of Kodak's eligible unsecured creditors, without requiring that the offerings be registered with the Securities and Exchange Commission (SEC) pursuant to the Securities Act. The discussion continues herein.

Structuring the 4(2) Offering

In order to comply with the requirements of the Rule 506 safe harbor under Regulation D in the context of its concurrent public and private rights offerings, Kodak could not and did not engage in general solicitation or general advertising in connection with the 4(2) Offering. Under Regulation D as in effect at the time of the offerings, an issuer could not conduct a Rule 506 exempt offering by means of any form of general solicitation or general advertising.

The 4(2) Offering was designed to satisfy the Section 4(a)(2) exemption generally and Rule 506 of Regulation D in particular. Kodak limited the 4(2) Offering to accredited investors and qualified institutional buyers, and filed a Form D with the SEC. Compliance with the principally/partly test is not required for a private placement of securities pursuant to Section 4(a)(2) or Rule 506; however, such securities are restricted securities for purposes of Rule 144 under the Securities Act, and investors must therefore be prepared to bear the risk of their investment for the applicable Rule 144 holding period.

The SEC also had issued guidance with respect to concurrent public and private offerings in 2007. See Revisions of Limited Offering Exemptions in Regulation D, Securities Act Release No. 33-8828, 72 Fed. Reg. 45,116, 45,129 (Aug. 10, 2007) (noting that whether a registration statement should be considered a general solicitation or general advertising that affects the availability of the Section 4(a)(2) exemption with respect to a concurrent private offering depends on whether investors in the private placement were solicited through the registration statement or by “some other means that would otherwise not foreclose the availability of the Section 4(2) exemption”; for instance, if an investor becomes interested in a concurrent private placement through a substantive, pre-existing relationship with the company, the prior filing of the registration statement “generally would not impact the potential availability of the Section 4(2) exemption for that private placement”).

Some debtors seeking to rely on private placement exemptions under the Securities Act to conduct a Chapter 11 rights offering have distributed “seeker letters” to potentially eligible stakeholders in order to establish a limited universe of eligible participants prior to the commencement of the rights offering. Seeker letters generally request that a recipient confirm its eligibility to participate in a private placement by certifying that it satisfies the conditions for accredited investor or qualified institutional buyer status, along with other applicable requirements (e.g., holding claims against the debtor of a certain class), and must be submitted before the debtor distributes solicitation materials. Following receipt of the certifications, the debtor makes the private offering only to the qualifying institutions and individuals.

Cognizant of the legal implications associated with conducting a private placement in reliance on Section 4(a)(2) concurrently with a public offering in reliance on Section 1145 ' juxtaposed against a competing mandate to devise a strategy that would allow the broadest possible qualified creditor participation in the 4(2) Offering ' Kodak, working closely with the Creditors' Committee and the Backstop Parties, designed a 4(2) Offering in which creditor participation was limited only to a creditor that could certify that it:

• qualified as an accredited investor, or as a qualified institutional buyer;
• held a minimum face amount of unsecured claims ($100,000 for qualified institutional buyers and $500,000 for accredited investors), for purposes of establishing a pre-existing substantive relationship with Kodak as a creditor of the company and, for accredited investors in particular, an appropriate level of familiarity with and an ability to bear the risk of an investment in Kodak; and
• held the minimum claim amount prior to the announcement of the rights offerings. This requirement was designed to ensure that the creditor's substantive relationship with Kodak pre-dated any publicity concerning the rights offerings and that the potential investors in the private offering were found independently of such publicity, thus confirming that no general solicitation of, or general advertising to, those investors had taken place.

Following Kodak's public announcement of the rights offerings, it distributed a certification letter to creditors it identified as potentially eligible participants. Subscription materials for the 4(2) Offering were distributed only to those creditors that properly certified their eligibility (i.e., their status as accredited investors or qualified institutional buyers, and their ownership of the minimum claim amount as of the relevant date).

As a consequence of the prohibition on general solicitation and general advertising and Kodak's measures to ensure compliance, a number of unsecured creditors ' in particular, creditors who acquired claims in the requisite minimum amount only after Kodak's announcement of the rights offerings ' were precluded from participating in the 4(2) Offering. Absent the prohibition on general solicitation and general advertising, the 4(2) Offering could have been made accessible to creditors who purchased claims in the market after the announcement, thus increasing the number of eligible investors and the liquidity of Kodak claims.

Implications of New Rule 506(c) Under the Securities Act

On July 10, 2013, the SEC adopted final amendments to Rule 506 of Regulation D including the addition of new Rule 506(c). Eliminating the Prohibition Against General Solicitation and General Advertising in Rule 506 and Rule 144A Offerings, Securities Act Release No. 33-9415, 78 Fed. Reg. 44,771 (July 10, 2013).

As directed by the Jumpstart Our Business Startups (JOBS) Act, enacted in April 2012, new Rule 506(c) allows an issuer to offer and sell securities by means of general solicitation or general advertising in reliance on the Regulation D safe harbor, provided certain conditions are met. Among other conditions, all purchasers of such securities must be accredited investors within the meaning of Regulation D and the issuer must take “reasonable steps” to verify the accredited investor status of all purchasers.

Rule 506(c) indicates several non-exclusive “safe harbor” methods of verification with respect to natural persons who are deemed to satisfy the verification requirement, but any reasonable verification method can be used. Pursuant to the SEC's final release, issuers should consider the facts and circumstances of each purchaser and transaction, including: 1) the nature of the purchaser and the type of accredited investor that the purchaser claims to be (e.g., individual or institution); 2) the amount and type of information that the issuer has about the purchaser; and 3) the nature and terms of the offering, including the manner in which the purchaser was solicited to participate and any limiting factors, such as a minimum purchase amount.

Under the new rule, a debtor-issuer may now conduct a rights offering pursuant to a plan of reorganization in reliance on the “private placement” exemption provided by Rule 506(c) of Regulation D without having to limit participation to investors that have a substantive relationship with the debtor prior to any public announcements or other communications that could be regarded as a general solicitation or general advertising. Several of the restrictions on creditor participation in Kodak's 4(2) Offering, designed to ensure the availability of the private placement exemption, might now be eliminated in reliance on Rule 506(c), thus allowing expanded participation by creditors.

It should be noted that an issuer conducting a private placement in reliance on Section 4(a)(2) of the Securities Act but outside Rule 506(c) will remain subject to the prohibition on general solicitation and general advertising. A debtor that engages in activity that could be regarded as general solicitation or general advertising must comply with Rule 506(c), and will not be able to rely on Section 4(a)(2) otherwise.

Compliance with Regulation D also may be necessary under state blue sky laws, especially if general solicitation or general advertising has occurred. Finally, Rule 144A under the Securities Act has been amended to allow securities sold pursuant to Rule 144A to be offered by means of general solicitation or general advertising, so long as such securities are sold only to a qualified institutional buyer or a purchaser that the seller and any person acting on behalf of the seller reasonably believe is a qualified institutional buyer. Such a sale may be made absent verification that each purchaser is a qualified institutional buyer. The Rule 144A exemption, however, is not available for a sale by the issuer itself, and must involve an intermediary. See id. at 44,786.

Importantly, to comply with Rule 506(c), the debtor will need to ensure that reasonable steps are taken to verify the accredited investor status of all purchasers. This issue should be carefully considered in the context of a bankruptcy, given the potentially significant number of eligible creditors, including individuals or other investors about whom little is known and who may be unsophisticated. Self-certification by purchasers of their accredited investor status will continue to be an important step in this process, but may not be sufficient to satisfy the verification requirement.

It should be noted that the steps that will be “reasonable” to verify accredited investor status will depend on the facts and circumstances of each offering, including available information about the purchasers, the type of accredited investor the purchaser claims to be, and the issuer's other requirements for eligibility to participate in the offering. Accordingly, a debtor-issuer must carefully consider the factors outlined by the SEC in order to develop a procedure that includes “reasonable steps” to verify a participant's accredited investor status.

For example, a purchaser's ability to meet a minimum investment requirement for participation in a Rule 506(c) offering may be considered by an issuer in evaluating a purchaser's accredited investor status. An issuer also is deemed to satisfy the verification requirement under Rule 506(c) by obtaining written confirmation from a registered broker-dealer, an SEC-registered investment adviser, a licensed attorney or a certified public accountant that such person or entity has taken reasonable steps to verify that the purchaser is an accredited investor within the prior three months. The person or entity should also have determined that such purchaser is an accredited investor; or, with respect to a natural person, by reviewing a copy of an IRS form that reports income (e.g., Form W-2). In some cases, a debtor may have significant information about its creditors, or some of them, which could be an important factor in determining whether its verification methods are reasonable.

In devising future rights offerings under Rule 506(c), debtors may wish to consider seeking a judicial determination from the bankruptcy court that the manner in which the debtor is verifying purchasers' accredited investor status is reasonable. For example, a Debtor might require each participant to file a declaration with the bankruptcy court, under penalty of perjury, certifying as to its accredited investor status, and append to its declaration evidence documenting that status.

While self-certification alone may not satisfy the verification requirement, an augmented self-certification procedure of this kind, when combined with other factors, such as a minimum investment requirement and information available to the debtor about its existing creditors, may be a helpful tool for debtors in complying with the new verification requirement.

Rule 506(c) should give debtor-issuers new flexibility in conducting securities offerings under a plan of reorganization. Subject to necessary evaluation of relevant securities law issues in light of the facts and circumstances of each case, appropriate use of the new Rule 506(c) exemption has the potential to expand access to investment in a reorganized debtor for appropriate investors, and to enable creditors and other stakeholders to unlock additional value in the restructuring process.

Finally, notwithstanding the adoption of Rule 506(c), Kodak's approach ' conducting two separate rights offerings concurrently ' is likely to set the standard for bankruptcy rights offerings in Chapter 11. A public offering under Section 1145 allows a debtor to raise capital by offering freely tradable, unrestricted securities, while making additional restricted securities available through a separate offering pursuant to Regulation D, thus enhancing potential participation by qualified creditors, all consistent with the Bankruptcy Code's antidiscrimination provisions. This approach allows the debtor to raise more capital than would otherwise be permitted under the principally/partly test, but also permits a debtor to offer new securities to its stakeholders more broadly than would be permitted in a restricted private placement alone by simultaneously taking advantage of the Section 1145 exemption.

Michael Torkin is a partner in the General Practice Group at Sullivan & Cromwell LLP, specializing in Bankruptcy & Restructuring matters. He represents clients in complex Chapter 11 reorganizations and out-of-court restructurings. Chiansan Ma is an associate in the General Practice Group at the firm.