On May 24, 2019, Vice Chancellor Laster of the Delaware Court of Chancery issued a memorandum opinion addressing the effects of an indenture provision allowing for the amendment of the indenture to conform it to the terms of the offering memorandum. In AG Oncon, LLC et al. v. Ligand Pharmaceuticals Inc.,1 the Vice Chancellor held that Ligand Pharmaceuticals’ use of such a provision to amend the indenture was appropriate even when holders of the securities issued under the indenture had not had access to the offering memorandum and were thus not aware of its terms.
In August 2014, Ligand Pharmaceuticals sold and issued convertible senior notes in a private offering, marketing the convertible notes through a confidential offering memorandum dated August 12, 2014. The offering memorandum explained that the conversion rate of the notes, the “Daily Share Amount,” would be based on a conversion formula wherein the daily conversion value would be divided by the daily “VWAP,” generating a value-equivalent number of shares for that day. Once the share amount was determined, Ligand could pay the value of the shares in any combination of cash or stock. The general effect of this conversion formula was that a $1,000 note could be converted into 13.3251 shares of Ligand Pharmaceuticals stock under the capital structure in effect at the issuance of the notes.
The offering closed four days after the issuance of the offering memo, at which time Ligand issued approximately $245 million in principal amount of convertible notes. The indenture was executed at the time of closing. The conversion formula in the indenture did not match the conversion formula in the offering memorandum. Specifically, instead of using the daily VWAP, the indenture used the defined term “Daily Principal Proportion” instead; the effect of this change in denominator was to increase the value of the notes upon conversion to approximately $3.8 billion. The indenture also contained a fairly customary provision authorizing Ligand Pharmaceuticals to amend the indenture to conform its terms to the description of the notes in the offering memorandum without the consent of any noteholders.
After the initial offering was complete, the notes traded on the secondary markets, in which the plaintiffs acquired approximately 95% of the issued and outstanding notes. In acquiring the notes, the plaintiffs relied on the indenture’s conversion formula and were not aware of the offering memorandum or its terms.2 In February 2018, Ligand exercised its right under the indenture to conform its terms to the offering memo and amended the indenture, correcting the conversion formula by swapping out the term “Daily Principal Proportion” to daily “VWAP” in the Daily Share Amount, so that it was consistent with the terms of the initial offering memorandum.
The plaintiffs brought suit on July 27, 2018, seeking to enforce the original terms of the indenture. They argued that: (a) the indenture represented the “complete agreement” of the parties, and that incorporating terms of the offering memorandum undermined the indenture; (b) the amendment was “material and adverse” to the noteholders, and so noteholder consent was required; and (c) the amendment violated the Trust Indenture Act.3 Ligand Pharmaceuticals moved to dismiss the complaint for failure to state a claim.
The Court of Chancery Analysis
Vice Chancellor Laster granted Ligand’s motion to dismiss, holding that none of the plaintiffs arguments presented “a litigable challenge” to the amendment of the indenture.4 He examined each of the plaintiffs’ arguments.
The Complete Agreement Claim
The plaintiffs claimed that the indenture constituted the “complete and final agreement governing the notes,” citing language in the indenture as well as common law to the effect that the indenture controls when a prospectus and indenture conflict. The Vice Chancellor noted that the indenture itself contained a provision expressly permitting amendment to conform to the terms of the offering memorandum. Accordingly, the amendment was not the result of a conflict between the two documents, but was instead made in reliance on the specific terms of the indenture. The plaintiffs further argued that the global certificate issued for the notes only referred to the indenture and not to the offering memorandum, and that the New York Uniform Commercial Code limits the terms of a certificated security to those stated on the certificate. The Vice Chancellor looked to his previous analysis and pointed out that the reference to the indenture included a reference to the indenture provisions permitting amendment to conform to the offering memorandum. Accordingly, he rejected the plaintiffs’ argument, and significantly held that the conforming amendment was made entirely under the authority of the applicable indenture provisions, so that the amendment was not seen as in any way contradicting or undermining the indenture.
The Material and Adverse Amendment Claim
The plaintiffs’ second argument was that the conforming amendment did not comply with sections of the indenture requiring noteholder consent for any amendment that “materially and adversely” affected noteholders’ rights. In the plaintiffs’ view, because the conforming amendment had such a material and adverse effect on the value of the notes at conversion, such sections of the indenture requiring consent should control or otherwise restrict Ligand’s right to effect an amendment conforming the indenture to the offering memorandum. The Vice Chancellor, “reviewing the Indenture as a whole,” determined that Ligand Pharmaceuticals could rely on the conforming amendment provision to effectuate the amendment. Finding that the “Indenture’s terms recognized that the Description of the Notes section in the Offering Memorandum established the baseline terms for the notes,” the Vice Chancellor determined that Section 9.02, which required noteholder consent for material and adverse changes, was intended to “limit midstream amendments” that would alter such baseline terms, but that the indenture provisions permitting conforming amendments governed changes to conform “the baseline terms” of the notes. That is, while the conforming amendment provision allowed for an amendment to the indenture, it was not a means to effect an amendment of the deal.5 The Vice Chancellor also specifically noted that the indenture did not contain any terms that expressly subordinated the provisions governing conforming amendments to the provisions requiring noteholder approval for certain amendments (e.g., the indenture could have specified that noteholder approval was required for certain amendments “notwithstanding” any of the other terms of the indenture, or could have made the conforming amendment provisions “subject to” the restrictions on amendments).
The plaintiffs’ also argued that the conforming amendment violated Section 6.07 of the indenture, which stated that “Notwithstanding any other provision of the Indenture, the right of any Holder to bring suit for the enforcement of payment of principal, accrued and unpaid interest . . . on or after the respective due dates, or the right to receive consideration due upon conversion of Notes . . . shall not be impaired or affected without the consent of such Holder.” The Vice Chancellor noted that this provision, because of its use of the word “notwithstanding,” would control over the provision allowing for conforming amendments. However, this provision, common in indentures, protects only the “right to sue, not the underlying economic right,” and “does not independently protect the conversion rights from amendment.” Accordingly, Section 6.07 was not applicable to the question of whether the conforming amendment was properly entered into.
The Trust Indenture Act
Lastly, the plaintiffs argued that the amendment violated Section 316(b) of the Trust Indenture Act. This section provides that, notwithstanding any provision of any indenture qualified under the Trust Indenture Act, nothing shall impair or affect the right of a security holder under such a qualified indenture to receive payment of principal or interest, when due, or to sue to enforce such rights. Vice Chancellor Laster first noted that, because the indenture was not qualified under the Trust Indenture Act (which is required for indenture securities that will be registered under the Securities Act6), Section 3.16(b) did not apply.7 The plaintiffs further argued that the indenture incorporated the terms of the Trust Indenture Act, making Section 316(b) applicable even if it would not otherwise have applied, pointing to specific language in the indenture indicating that every supplemental indenture executed should comply with the Trust Indenture Act. Looking at the indenture as a whole, however, the Vice Chancellor rejected this argument. Rather, he found that the indenture included only specific provisions of the Trust Indenture Act and that this language did not make the indenture subject to Section 316(b). Finally, Vice Chancellor Laster found that “[t]he plain language of Section 316(b) does not extend to consideration received under a conversion right.”8 Accordingly, even if Section 316(b) applied to the indenture, it would not prohibit the conforming amendment.
Vice Chancellor Laster’s opinion provides significant guidance concerning the interplay between indentures and offering documents. Several key takeaways are:
- The importance of a conforming provision in an indenture. First and foremost, the Vice Chancellor was able to resolve this case at the motion to dismiss stage because of clear contractual language incorporating the terms of the offering memorandum. In the absence of such a provision, a clear typographical error in the indenture could have had a disastrous effect—not only would it have radically increased the value of the notes at issue here, but it would have meant that Ligand’s disclosure about the offering was wrong, subjecting Ligand to additional securities law claims. Even if a court were to ultimately hold that the disclosure in the offering documents controlled, without a clear indenture provision to this effect such determination could involve lengthy and costly litigation.
- An acknowledgement of the fact that, in a securities offering, the deal is established in the disclosure documents. Most securities offerings are negotiated through the drafting and agreement upon disclosure documents such as offering memoranda. Only after the terms are set and sufficient investor demand is found is an indenture drafted—and it usually is drafted specifically to incorporate the terms of the disclosure documents. The Vice Chancellor’s opinion here recognizes the practical effects of this process (so long as appropriate savings language is incorporated into the indenture).
- A conforming provision in an indenture will be given effect even when looking at the rights of security holders who never received or reviewed non-public disclosure documents. Many indentures contain a provision similar to the provision at issue in the Ligand notes, allowing an issuer to amend its indenture to conform it to the terms of the relevant disclosure documents. An investor considering purchasing notes with such a provision on the open market should attempt to obtain the initial disclosure documents, because such documents may allow for significant amendments to the indenture, even if adverse to the noteholders and not apparent on a thorough review of the public materials.
- The effect of subordinating language (“notwithstanding,” etc.). Finally, AG Oncon, LLC et al. v. Ligand Pharmaceuticals Inc. provides an excellent example of the effect of subordinating language within a contract (such as an indenture). Use of words such as “notwithstanding,” “subject to,” and similar terms can provide significant clarity in resolving apparently contradictory provisions. As with the Vice Chancellor here, courts will tend to defer to the hierarchy of interpretation established within any contract and give provisions marked as superseding the other terms of the contract their intended effect.
1 C.A. No. 2018-0556-JTL (May 24, 2019). All quotations herein not otherwise attributed are to this case.
2 This case was decided at the motion to dismiss stage; accordingly, all facts pleaded by the plaintiffs were assumed to be true, including their reliance on the indenture formula and ignorance of the offering memorandum terms. It is worth noting, however, that the Vice Chancellor did remark upon the fact that the plaintiffs were “sophisticated bond traders.”
3 The Trust Indenture Act of 1939, as amended.
4 Because the motion to dismiss was made under Delaware Rule 12(b)(b), in conducting its analysis the Vice Chancellor was required to “(i) accept as true all well-pleaded factual allegations in the complaint, (ii) credit vague allegations if they give the opposing party notice of the claim, and (iii) draw all reasonable inferences in favor of the plaintiffs.” The application of the standard means that “dismissal is inappropriate unless the plaintiff would not be entitled to recover under any reasonably conceivable set of circumstances susceptible of proof” (citations omitted).
5 The Vice Chancellor made it clear that “[i]f Ligand had attempted to depart from the original deal, then Section 9.02(d) would have applied and required noteholder consent.”
6 The Securities Act of 1933, as amended.
7 In addition, the plaintiffs argued that the indenture should have been registered under the Trust Indenture Act. Whether registration is required under the Trust Indenture Act is a complicated question, but is addressed by the Vice Chancellor’s conclusion that “A transaction not involving a public offering is not subject to qualification.”
8 Recent courts, including the district court in Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 75 F. Supp. 3d 592 (S.D.N.Y. 2014), had expanded the analysis of Section 316(b) into whether an amendment affects the “core terms” of an indenture instead of limiting the section to rights to obtain principal and interest when due and to sue to enforce such rights. On appeal, the circuit court in Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Fin. Corp., 846 F.3d 1 (2d Cir. 2017) vacated this opinion and held that Section 316(b) “prohibits only non-consensual amendments to an indenture’s core payment terms.” While the Vice Chancellor’s opinion is only binding in Delaware, it provides additional support for a limited reading of the restrictions imposed by such section.