Beijing FrankFurt Hong kong London Los angeLes MunicH new York singapore tokYo wasHington, dc
Please feel free to discuss any aspect of this Client Alert with your regular Milbank contacts or with any of the members of our Corporate Governance Group, whose names and contact information are provided at the end of this alert. In addition, if you would like copies of our other Client Alerts, please visit our website at www.milbank.com and choose the “Client Alerts & Newsletters” link under “Newsroom/Events.” This Client Alert is a source of general information for clients and friends of Milbank, Tweed, Hadley & McCloy LLP. Its content should not be construed as legal advice, and readers should not act upon the information in this Client Alert without consulting counsel. © 2010 Milbank, Tweed, Hadley & McCloy LLP. All rights reserved. Attorney Advertising, prior results do not guarantee a similar outcome.
Corporate Governance Group
Client Alert
SECOND CIRCUIT RULES THAT
AMERICAN DEPOSITARY
RECEIPTS ARE NOT EQUIVALENT
TO COMMON STOCK FOR
PURPOSES OF INDENTURE
CONVERSION RIGHTS
Court Adheres to “Plain Meaning” of Disputed Term
and Refuses to Recognize “Custom and Usage” as
Supporting an Alternative Interpretation
In Law Debenture Trust Co. of New York v. Maverick Tube Corp.,1 the United States
Court of Appeals for the Second Circuit recently was asked to consider an issuer’s refusal to recognize the exercise of conversion rights by noteholders following the issuer’s
merger with a third party. In affirming dismissal of an indenture trustee’s complaint,
the Court ruled that the conversion rights were not triggered because New York Stock Exchange-traded American depositary receipts representing the right to obtain the third party’s common stock do not, for purposes of the governing indenture, constitute “a class of common stock traded on a United States national securities exchange.” The Second Circuit’s decision is an apt reminder that courts are generally reluctant to
look beyond the four corners of an agreement in order to find ambiguity in a disputed
contract provision whose plain meaning otherwise seems clear. This is particularly the case where the agreement, read in its entirety, illustrates that the parties could have addressed the disputed issue during the drafting stage, but neglected to do so.
Background
In 2004, Maverick Tube Corp., a manufacturer of tubing used in the oil and gas industry, issued new notes in exchange for outstanding notes previously sold to raise needed capital. Pursuant to the Indenture governing the new notes, special conversion rights are triggered by a “Public Acquirer Change of Control.” The Indenture
defines “Public Acquirer Change of Control” as “any Non-Stock Change of Control involving a Public Acquirer,”
and “Non-Stock Change of Control” as “any merger … for consideration ‘other than’ common stock traded on
a United States national securities exchange.” “Public Acquirer” is defined as “a Person who (i) acquires … the
Company … in a … merger … and (ii) has a class of common stock traded on a United States national securities
exchange.” Notably, the term “common stock” is not defined.2 The Indenture further provides that after a Public
Acquirer Change of Control, each noteholder has “a right to convert the notes into cash and the acquirer’s common
stock referred to in the Public Acquirer definition.” Accordingly, even if publicly-traded common stock is not
being issued by a Public Acquirer of Maverick as consideration in a merger, the noteholders are nevertheless entitled, under the terms of the Indenture, to convert their notes post-merger into cash and the publicly-traded common stock of the Public Acquirer.
In 2006, Maverick and Tenaris S.A., a Luxembourg joint stock corporation, announced that they had entered into a merger agreement whereby Tenaris would acquire all of Maverick’s common stock at a price of $65 per share, payable in cash. As is the case with many non-U.S. issuers, Tenaris’s ordinary shares (in effect, its common stock) are not traded on a U.S. stock exchange. Instead, Tenaris deposited a number of its ordinary shares with a depositary, which in turn issued American Depositary Receipts evidencing American Depositary Shares (“ADSs”) that are traded on the New York Stock Exchange. Each ADS represents the right to receive a number of Tenaris ordinary shares. In its public announcement of the merger, Maverick stated that Tenaris does not qualify as a “Public Acquirer” because its ordinary shares (as opposed to its ADSs) are not traded on a U.S. national securities exchange. Despite this announcement, several noteholders tendered their notes for conversion into cash and Tenaris ordinary shares, based on their belief that Tenaris does in fact qualify as a Public Acquirer by virtue of the trading of its ADSs on the NYSE. Consistent with its public stance, Maverick refused to recognize these conversions.
In December 2006, the Trustee under the Indenture filed suit, on behalf of the noteholders, in the
United States District Court for the Southern District of New York, claiming breach of contract and seeking (in addition to other relief) a “declaratory judgment that the acquisition constituted a Public Acquirer Change of Control.” All parties moved for summary judgment. The District Court sided with Tenaris and Maverick,
ruling “that the unambiguous terms of the contract demonstrate that ADSs are not included in the definition of ‘common stock’ for purposes of the Public Acquirer definition.” The Trustee appealed this decision to the Second Circuit, which affirmed the lower court’s ruling.3
2 As opposed to “Common Stock,” which is defined in the Indenture as Maverick’s common stock.
3 Because the Court affirmed the dismissal of the Trustee’s breach of contract claim, the Trustee’s claim of tortious interference with contract also
The Court’s Analysis
The Court began its analysis by noting that, under New York law,4 the initial question is “whether the
contract is unambiguous with respect to the question disputed by the parties.” If a court finds no ambiguity,
then interpretation of the disputed term becomes a question of law for a court to determine rather than one of fact. According to the Court, “[a]n ambiguity exists where the terms of the contract ‘could suggest more than one meaning when viewed objectively by a reasonably intelligent person who has examined the context of the entire integrated agreement and who is cognizant of the customs, practices, usages and terminology as generally understood in the particular trade or business.’” Moreover, if “the parties have used contract terms which are ‘in
common use in a business or art’ and have ‘a definite meaning understood by those who use them,’ but which
‘convey no meaning to [t]hose who are not initiated into the mysteries of the craft,’ … the court ‘must be informed of the meaning of the language as generally understood in that business, in the light of the customs and practices of the business.’” The Court further pointed out, however, that [p]roof of custom and usage does not mean proof of the parties’ subjective intent, for ‘[e]xtrinsic evidence of the parties’ intent may be considered only if the agreement is ambiguous.’” Rather, “proof of custom and usage consists of proof that the language in question
‘is ‘fixed and invariable’ in the industry in question.’”
Applying this analysis to the facts before it, the Court agreed with the lower court that the term “common
stock” as used in the Indenture (albeit without definition) is not ambiguous, and that its use in the phrase
“common stock traded on a United State national securities exchange” unambiguously does not include
Tenaris’s ADSs. The Court also pointed out that although “common stock” is not defined in the Indenture, the Indenture does contain several direct and indirect references to ADSs in other defined terms. For instance, “Capital Stock” is defined as “any and all shares (including ordinary shares or American depositary shares).”5
The Court then observed that if the parties had intended to define “common stock traded on a United States
national securities exchange” to include ADSs that are so traded, they “could easily have included in the
Indenture a definition of common stock in general with a parenthetical phrase expressly including ADSs, such as the parenthetical in the definition of ‘Capital Stock’; or they could have included such a parenthetical after
‘common stock’ in the ‘a class of common stock traded on a United States national securities exchange’ clause
of the Public Acquirer definition. They did neither.” Thus, according to the Court, “the Indenture as a whole does not suggest that the undefined term ‘common stock’ in the Public Acquirer definition … includes ADSs…”
Despite the absence of such a definition, the Trustee argued that “common stock traded on a United States
national securities exchange” should be “deemed to include American Depositary Shares that trade on such an exchange because, as a matter of custom and usage, the trading of ADSs is a form of trading common stock.” In support, the Trustee cited an SEC Release in which the term “ADR” is used to “refer to either the physical
certificate or the security evidenced by such certificate.”6 The Court rejected this argument, stating that proof of
custom and usage must establish a ‘uniform and unvarying,’ ‘general and not personal’ custom so well established
that the parties must be presumed to have meant the term ‘common stock’ in the Public Acquirer definition to
include ADSs.” In the Court’s opinion, the portion of the SEC Release cited by the Trustee “falls well short” of the level of proof necessary to “support the proposition that a contractual reference to common stock must be presumed to encompass a reference to ADSs.”
4 The parties agreed that New York law governs interpretation of the Indenture.
5 The term “Capital Stock” is used in the definition of “Fundamental Change,” which in turn triggers a right of the noteholders to require
Maverick to purchase their notes for cash.
In further support of its position, the Court noted that the SEC Release also states that “for purposes of the Securities Act, ADRs and deposited securities are considered separate securities” and “listed ADRs are not the securities of the foreign issuer but rather of the legal entity created by the depositary.” The Court also pointed out several potential differences between ADSs and the common stock represented thereby, including voting rights and relative trading prices. Finally, the Court refused to recognize that a “so-called admission” in Tenaris’s
regular SEC filings, in which it “repeatedly acknowledged that its ordinary shares … are ‘traded on the NYSE,’”
established “an industry custom that other persons must be presumed to adopt in their contracts.”
Conclusion
Simply because the Second Circuit, based on its reading of the entire Indenture, found the disputed term “common stock” to be unambiguous does not mean that ADSs will not be found to be equivalent to common stock in other circumstances. Of course, different facts could lead to a different result. However, the Second Circuit’s
reluctance “to rewrite the Indenture’s Public Acquirer definition” serves as a strong reminder of the importance of careful drafting of contract terms; courts continue to be loathe to look beyond the plain meaning of a signed
agreement when ruling on a disputed contract provision. Once a contract provision is found by a court to be
unambiguous, it will be exceedingly difficult for a dissatisfied party to introduce proof of a contrary custom and
Beijing
Units 05-06, 15th Floor, Tower 2
China Central Place, 79 Jianguo Road, Chaoyang District Beijing 100025, China
Anthony Root +86-10-5969-2777 [email protected] Edward Sun +86-10-5969-2772 [email protected]
Frankfurt
Taunusanlage 15
60325 Frankfurt am Main, Germany
Norbert Rieger +49-69-71914-3453 [email protected]
Hong Kong
3007 Alexandra House, 18 Chater Road Central, Hong Kong
Anthony Root +852-2971-4842 [email protected] Joshua Zimmerman +852-2971-4811 [email protected]
London
10 Gresham Street
London EC2V 7JD, England
Stuart Harray +44-20-7615-3083 [email protected] Thomas Siebens +44-20-7615-3034 [email protected]
Los Angeles
601 South Figueroa Street Los Angeles, CA 90017
Ken Baronsky +1-213-892-4333 [email protected] Neil Wertlieb +1-213-892-4410 [email protected]
Munich
Maximilianstrasse 15 (Maximilianhoefe) 80539 Munich, Germany
Peter Nussbaum +49-89-25559-3636 [email protected]
New York
One Chase Manhattan Plaza New York, NY 10005
Scott Edelman +1-212-530-5149 [email protected] Roland Hlawaty +1-212-530-5735 [email protected] Thomas Janson +1-212-530-5921 [email protected] Robert Reder +1-212-530-5680 [email protected] Alan Stone +1-212-530-5285 [email protected] Douglas Tanner +1-212-530-5505 [email protected]
Singapore
30 Raffles Place, #14-00 Chevron House
Singapore 048622
David Zemans +65-6428-2555 [email protected] Naomi Ishikawa +65-6428-2525 [email protected]
Tokyo
21F Midtown Tower, 9-7-1 Akasaka, Minato-ku Tokyo 107-6221 Japan
Darrel Holstein +813-5410-2841 [email protected]
Washington, DC
International Square Building, 1850 K Street Washington, DC 20006