Publications

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The battering of the financial markets on a daily basis is getting to be old news. What is not old for many public companies is their inability to raise capital quickly and cost-effectively due to the volatility in the capital markets.

Public companies with a need to access the capital markets quickly for a sizeable infusion of capital have limited options if they desire or need to utilize their common stock (either directly or via convertible securities) in such transactions because of the requirement to obtain prior shareholder approval, which could take months.

One option recently used by some public companies listed on the New York Stock Exchange or the Nasdaq is the financial viability exception.¹ This exception to the exchanges’ shareholder approval rules, while not the only factor a board of directors should consider, may provide a ray of hope to public companies facing an urgent need to access the capital markets.

Analysis of the Exception to the Shareholder Approval Rule

NYSE Rule 312.03(c) and Nasdaq Rule 4350(i)(1)(D) generally require a listed company to obtain prior shareholder approval if a transaction, or a series or transactions, results in the issuance of a certain percentage or more of the listed company’s outstanding common stock.² NYSE Rule 312.03(c) requires prior shareholder approval if the listed company intends to issue common stock, or securities convertible or exercisable for common stock, in any transaction or series of transactions if: (a) the common stock to be issued has, or will have upon issuance, voting power equal to or in excess of 20 percent of the voting power outstanding before the issuance of such stock or of securities convertible into or exercisable for common stock; or (b) the number of shares of common stock to be issued is, or will be upon issuance, equal to or in excess of 20 percent of the number of shares of common stock outstanding before the issuance of the common stock or of securities convertible into or exercisable for common stock. Nasdaq Rule 4350(i)(i)(D) has similar provisions for transactions not involving a public offering.³

The NYSE and Nasdaq each have an exception to their respective shareholder approval rules and permit listed companies to avoid prior shareholder approval upon written application when the delay in obtaining shareholder approval would “seriously jeopardize the financial viability” of the company.⁴ Both the NYSE and Nasdaq exceptions require the company’s audit committee to expressly approve the company’s reliance on the exception and to notify its shareholders not later than 10 days before the issuance of the securities of its reliance on the exception.⁵

Once a company decides to rely on the exception, the first step is to engage either the NYSE or the appropriate division of the Nasdaq in a discussion of the proposed transaction and the company’s timing.⁶ A company listed on the NYSE should contact either the NYSE’s Office of General Counsel or financial compliance group,⁷ while a company listed on the Nasdaq generally begins with a call either to the company’s Listing Qualification Analyst, or sometimes to the appropriate person at Nasdaq Corporate Governance Interpretations.⁸ It is possible to obtain approval from the NYSE within a matter of days after submitting the application. The Nasdaq, however, generally requires more time; it is not unusual for the application process to take a few days.⁹ In both cases, listed companies should consider filing a written application and obtaining prior approval from the applicable exchange.

The application must specifically address the reasons why a delay in closing a transaction - due to the time it would take to seek shareholder approval - would have a significant detrimental impact on the company’s financial viability. The application must describe the proposed transaction in considerable detail and, if possible, should include the identity of the investors.

Examples of factors that a company could address in its application include:

• describing the facts and circumstances that preceded the company’s application, including describing other alternatives pursued by the company to obtain financing on other terms;
• explaining why the delay in closing the proposed transaction as a result of the time required to obtain shareholder approval would require the company to seek bankruptcy protection;
• explaining the impact on the company’s operations due to the time required to obtain shareholder approval;
• discussing the company’s ability to service its current obligations, such as payroll, lease payments and debt service if the proposed transaction is not completed;
• describing whether the proposed transaction will satisfy the company’s financial needs for the next several months and, if possible, including projected financial forecasts for several months;
• explaining whether the company will be able to satisfy the continued listing requirement of the exchange over the next several months; and
• explaining whether there will be any disparate voting power or other preferences between the existing shareholder and the investors.

Recent Applications of the Exception

Recently, Thornburg Mortgage,¹⁰ JPMorgan Chase,¹¹ Bear Stearns Companies,¹² and MoneyGram International,¹³ have relied upon the NYSE exception as part of a variety of transactions including capital raising, acquisitions and restructurings. Other companies have not relied on the exception; one example is Washington Mutual, which recently issued convertible preferred stock and warrants for common stock and subsequently is seeking shareholder approval.¹⁴

In addition, the financial viability exception has also been used by Delta Airlines and DayStar Technologies in certain restructuring efforts as follows:

Restructuring Plans

In mid-2004, Delta Airlines was rumored to be on the brink of bankruptcy. In November 2004, Delta implemented an out-of-court restructuring plan that included adopting new employee incentive programs and granting non-qualified stock options to approximately 57,000 employees. Approximately 63 million shares of Delta common stock were subject to the stock options. Delta also issued approximately 12 million shares of its common stock to certain debt holders who agreed to defer certain near-term debt and to leaseholders of its aircrafts. At that time, Delta issued a press release indicating that the Audit Committee had approved the use of the NYSE exception so that Delta could issue up to 75 million shares of its common stock as part of the restructuring plan and that the NYSE had accepted Delta’s reliance on the exception.¹⁵ Continental Airlines also relied upon this exception to issue stock options to its employees for approximately 10 million shares as part of certain pay and benefit reductions it undertook in early 2005.¹⁶

Restructuring of an Outstanding Convertible Note

DayStar Technologies restructured an outstanding convertible note and undertook a private placement of its common stock pursuant to the Nasdaq exception in February 2007.¹⁷ Pursuant to the terms of the restructuring, the note was sold by the original note holder to a purchaser who agreed that DayStar could defer payments of interest and principal on the note for a period of thirty days. DayStar agreed to issue 825,181 shares of its common stock to the original note holder in full payment of outstanding principal and interest and a warrant to purchase an additional 317,394 shares of its common stock. DayStar and the note purchaser agreed to amend the note so that it would automatically convert, subject to certain conditions, into shares of DayStar common stock based upon the unpaid principal and interest. Concurrently with the debt restructuring, DayStar also entered into a securities purchase agreement with several new investors to sell an additional 2.5 million shares of its common stock. The Nasdaq accepted Daystar’s reliance on the exception for this restructuring of its convertible note.

Challenges in Obtaining the Exception

The financial viability exception is by no means an easy avenue for listed companies to quickly raise capital in today's markets. The company must obtain the approval of the NYSE or Nasdaq - not an easy threshold to cross. – But a company and its board of directors must also consider several other factors even before pursuing this avenue.¹⁸ For example, the board of directors should consider:

(a) the impact of the disclosure about the company’s reliance that this alternative will have on the company’s stock price and investor relations,
(b) the dilutive effect of any issuance on its existing shareholders,
(c) the structure of the proposed transaction and potential impact on the company’s operations, (d) the timing of the proposed transaction, and
(e) whether the proposed transaction could lead to a change-in-control of the company.

The views of company's other constituents, such as creditors, must also be taken into account. Finally, the directors must be mindful that such an alternative is indeed a prudent exercise of their fiduciary duties.

With all this in mind, however, the financial viability exception is a real possibility for companies with a strong and immediate need for substantial capital and should be certainly considered when evaluating capital-raising strategies.

An earlier version of this article appeared in the May-June 2008 issue of Deal Lawyers.

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¹ NYSE Listed Company Manual, Rule 312.05 and Nasdaq Manual, Nasdaq Rule 4350(i)(2).

² Each of NYSE Rule 312.03 and Nasdaq Rule 4350(i) include detailed procedures for the circumstances in which a listed company is required to seek shareholder approval prior to issuing securities, including, for example, transactions involving a director, officer or substantial shareholder. The financial viability exception described herein is equally applicable to all such circumstances.

³ See Nasdaq Corporate Governance FAQs, at http://www.nasdaq.com/about/LegalComplianceFAQs.stm#corpgov for interpretive guidance on this rule.
⁴ NYSE Rule 312.05 and Nasdaq Rule 4350(i)(2).

⁵ The Nasdaq requires that the mailing and the related press release cannot be made until after the exception is granted and must state that the company is relying on the exception. The NYSE also has a similar requirement.

⁶ See e.g., Current Report on Form 8-K filed by Manhattan Pharmaceuticals, Inc. February 28, 2008 (noting that the company intended to voluntarily delist its common stock from the AMEX, since it had not successfully obtained AMEX approval to its request for reliance on the exception and its financial condition was such that it needed to complete a proposed transaction immediately.)

⁷ The NYSE has not published any interpretive guidance on the content of such an application. However, a company should consider addressing the points here in its application.

⁸ The Nasdaq also requires the filing of a listing of additional share applications and has specific requirements as to when such an application is due. See http://www.nasdaq.com/about/listing_information.stm#forms.

⁹ A principal item in Nasdaq’s inquiry relates to protecting the retail investors.

¹⁰ See Current Report on Form 8-K filed by Thornburg Mortgage Inc. on April 1, 2008.

¹¹ See Current Report on Form 8-K filed by JPMorgan Chase Co. March 24, 2008.

¹² See Current Report on Form 8-K filed by The Bear Stearns Companies Inc. on March 24, 2008.

¹³ See Current Report on Form 8-K filed by MoneyGram International Inc. on March 18, 2008.

¹⁴ See Current Report on Form 8-K filed by Washington Mutual, Inc. on April 9, 2008.

¹⁵ See Current Report on Form 8-K filed by The Bear Stearns Companies Inc. on March 24, 2008.

¹⁶ See Current Report on Form 8-K filed by Delta Air Lines, Inc. November 10, 2004.

¹⁷ See Current Report on Form 8-K filed by Continental Airlines, Inc. February 28, 2005.

¹⁸ See Current Report on Form 8-K filed by DayStar Technologies, Inc. February 7, 2007.

¹⁹ Depending on the circumstances, a company may also have to take into account other NYSE or Nasdaq rules as well. See e.g., Nasdaq Rule 4351.