CAC and Wiley E Coyote

Collective Action Clauses

Collective Action Clauses (CAC’s henceforth) or Majority Action Clause have a long and varied history. According to Buchheit & Gulati[1] they were first introduced in English law by Palmer (1879). Their introduction served and serves a very real purpose and need. That of facilitating the restructuring or the amendment the (T)erms & (C)onditions of a Bond by the majority of Noteholders and to avoid rogue or malevolent holders of bonds holding at ransom both the debtor and other creditors.?What are CAC’s (see Appendix for an example) and what purpose do they serve??Let me start with an example of how it might work.

Suppose that ACME a company that manufactures futuristic technology gadgets finds itself in the position of having a severe cashflow problem as one of its major clients Mr W.E.Coyote has not paid in time. ACME is unable to pay its bond liabilities at the agreed time. Consider further that most bondholders believe, after careful analysis of ACME’s product range, that the main business is sound and given time and perhaps some reorganization of the company’s management and client focus ACME would thrive and pay in full its bond liabilities. All that it needs is to amend some of the T&C of the bond, perhaps extend the maturity or move some coupons in the future and ACME would survive. One bondholder, Mrs R.Runner for reasons of personal benefit or other, things differently. When ACME got into trouble Mrs Runner bought some of the bonds at discount with a view to either force ACME into liquidation or force a management change or simply to extract more money. Mrs Runner can do so since ACME bonds need the consent of 100% of Noteholders as there are no CAC’s that allow for the will of the majority to prevail. If on the other hand, ACME bonds included right from the start CAC’s specifying that a 75% majority is binding for all bondholders Mrs Runner would have needed at least 25% of the outstanding ACME bonds to see her sinister plans materialize.

As always, however, there is another side to the ACME story. It could be that the real villain is ACME and the victim is the unsuspecting small bondholder. ACME purposefully, introduced (at the start) CAC’s with a low majority threshold, say 50% (simple majority) with a view to make non-payment or restructuring fast and easy. ACME colluded with some bondholders to haircut the bond’s principal by 50%. Then ACME found some other way to compensate (recapitalize or sweeten) its friendly creditors.?

Thus, CAC’s have two sides. Striking a balance between the real need to restructure a company and with the moral hazard it introduces is a fine art. Ultimately, any dispute in the motives would have to be resolved by courts. In fact, there have been cases where the majority has been overturned as it was not deemed to serve the interests of all bondholders. This means that even though CAC’s allow for the majority view to prevail, the minority bondholders cannot be ignored completely. After all, the original bond documentation contains an “unconditional promise to pay”.?

One argument against the introduction of CAC’s in the bond documentation has to do with price and liquidity. Studies have concluded that the introduction of CAC’s in less creditworthy countries (lower rating) have an adverse effect on the price and liquidity. Namely, creditors demand a higher yield as they view the CAC’s from the moral hazard point of view. For borrowers of high rating CAC’s are viewed as a safety feature.?

[1] Lee C. Buchheit,G. Mitu Gulati, 2002, SOVEREIGN BONDS AND THE COLLECTIVE WILL

Appendix A. Example of CAC from Greek Bond XS0357333029

MEETINGS OF NOTEHOLDERS AND MODIFICATION

The Agency Agreement contains provisions for convening meetings of Noteholders to consider matters affecting their interests, including modification by Extraordinary Resolution of these Terms and Conditions or the provisions of the Agency Agreement. Such a meeting may be convened by the Republic and shall be convened by the Republic at any time upon the request in writing of the holder or holders of ten per cent. or more in principal amount of the Notes for the time being outstanding. The quorum for any meeting convened to consider an Extraordinary Resolution shall be one or more persons holding or representing not less than 66 2/3 per cent. of the aggregate principal amount of the Notes for the time being outstanding, or 25 per cent. of the aggregate principal amount of the Notes for the time being outstanding at any adjourned meeting. However, at any meeting, the business of which is to: (i) change the due date for the payment of the principal, premium (if any) or any installment of interest on the Notes;

(ii) reduce or cancel the principal amount or redemption price or premium (if any) of the Notes;

(iii) reduce the portion of the principal amount which is payable upon acceleration

?f the maturity of the Notes;

(iv) reduce the interest rate on the Notes or any premium payable upon redemption of the Notes;

(v) change the currency in which interest, premium (if any) or principal will be paid or the places at which interest, premium (if any) or principal of Notes is payable;

(vi) shorten the period during which the Republic is not permitted to redeem Notes, or permit the Republic to redeem Notes if, prior to such action, the Republic is not permitted to do so;

(vii) reduce the proportion of the principal amount of the Notes whose vote or consent is necessary to modify, amend or supplement the Agency Agreement or the Terms and Conditions of the Notes;

(viii) reduce the proportion of the principal amount of the Notes whose vote or consent is necessary to make, take or give any request, demand, authorisation, direction, notice, consent, waiver or other action provided to be made in the Agency Agreement or the Terms and Conditions of the Notes;

(ix) change the obligation of the Republic to pay additional amounts with respect to the Notes;

(x) change this definition, the definition of “outstanding” contained in the Agency Agreement or the definition of “Written Resolution” set out below;

(xi) change the governing law provision of the Notes;

(xii) change the courts to the jurisdiction of which the Republic has submitted, its obligation under the Agency Agreement or the Terms and Conditions of the Notes to appoint and maintain an agent for service of process or the waiver of immunity in respect of actions or proceedings brought by any holder based upon a Note; or

(xiii) appoint a committee to represent Noteholders after an event of default occurs; (each a “Reserved Matter”), the necessary quorum will be one or more persons holding or representing not less than 75 per cent. of the aggregate principal amount of the Notes for the time being outstanding or not less than 50 per cent. of the aggregate principal amount of the Notes for the time being outstanding at any adjourned meeting. Resolutions may be duly passed as an Extraordinary Resolution at any meeting of the Noteholders or by Written Resolution and will be binding on all the Noteholders (whether or not they are present at such meeting and whether or not they may sign the Written Resolution) and on all Couponholders. An “Extraordinary Resolution” means a resolution passed at a meeting of the Noteholders duly convened and held in accordance with the provisions above by or on behalf of the holders of: (i) in the case of a Reserved Matter, at least 75 per cent. Of the aggregate principal amount of the Notes for the time being outstanding or at least 50 per cent. at any adjourned meeting of aggregate principal amount of the Notes for the time being outstanding, or (ii) in the case of a matter other than a Reserved Matter, at least 66 2/3 per cent. of the aggregate principal amount of the Notes for the time being outstanding or at least 25 per cent. at any adjourned meeting of the aggregate principal amount of the Notes for the time being outstanding. A “Written Resolution” means a resolution in writing signed by or on behalf of the holders of: (i) in the case of a Reserved Matter, at least 75 per cent. of the aggregate principal amount of the Notes for the time being outstanding, or (ii) in the case of a matter other than a Reserved Matter, at least 66 2/3 per cent. of the aggregate principal amount of the Notes for the time being outstanding. Any Written Resolution may be contained in one document or several documents in the same form, each signed by or on behalf of one or more Noteholders.

The Republic and the Agent may, without the vote or consent of any holder of the Notes, amend the Agency Agreement or the Notes for the purpose of: (i) adding to Republic’s covenants for the benefit of the holders of the Notes; or

(ii) surrendering any right or power conferred upon the Republic; or

(iii) securing the Notes; or

(iv) curing any ambiguity or curing, correcting or supplementing any defective provision in the Notes or the Agency Agreement; or

(v) amending the Agency Agreement or any of the Notes in any manner which

the Republic and the Agent may determine and which is not inconsistent with the Notes and does not in the opinion of the Republic adversely affect the interest of any holder of the Notes; or

(vi) correcting in the opinion of the Republic a manifest error of a formal, minor or technical nature; or

(vii) complying with mandatory provisions of law or any other modification provided that such modification is not in the opinion of the Republic materially prejudicial to the interests of the Holders. Any such modification, waiver or authorisation shall be binding on the Noteholders and any such modification unless the Agent otherwise requires, shall be notified by the Agent to the Noteholders as soon as practicable thereafter. For the purposes of (i) ascertaining the right to attend and vote at any meeting of Noteholders, (ii) Condition 10 (Meetings of Noteholders and Modification) of the Offering Circular and Schedule 3 of the Agency Agreement (Provisions for Meetings of Noteholders) and (iii) Condition 7 (Events of Default) and for purposes of determining whether the required percentage of holders of the Notes are present at a meeting for quorum purposes, or has consented to or voted in favour of any request,

demand, authorisation, direction, notice, consent, waiver, amendment, modification or supplement to the Notes or the Agency Agreement, or whether the required percentage of holders has delivered a notice of acceleration of the Notes, any Notes that the Republic owns or controls directly or indirectly will be disregarded and deemed not to be outstanding. For this purpose, Notes owned, directly or indirectly, by the Bank of Greece or any of the Republic’s local authorities and other local authorities’ entities will not be regarded as, or deemed to be, owned or controlled, directly or indirectly by the Republic. “Control” means the power, directly or indirectly, through the ownership of voting securities or other ownership interests or otherwise, to direct the management of or elect or appoint a majority of the board of directors or other persons performing similar functions in lieu of, or in addition to, the board of directors of a corporation, trust, financial institution or other entity. Before any request is made or notice is delivered or Written Resolution is signed by any Noteholder in accordance with the provisions of this Condition 10 or Condition 7, the relevant Noteholder must deposit its Notes with the Paying Agent and obtain two copies of an acknowledgment of receipt (an “Acknowledgment”) signed and dated by the Paying Agent and certifying the nominal amount of Notes so deposited. Any request so made, notice so given or Written Resolution so signed by any Noteholder must be accompanied by an Acknowledgment issued to the Noteholder. Notes so deposited will not be released until the earlier of (i) the thirtieth day after the date of deposit and (ii) the request, notice or Written Resolution becoming effective in accordance with these Terms and Conditions, and will only be released against surrender of a relevant Acknowledgment.