Chapter 10 — Debt Modifications and Exchanges

10.5 Modifications and Exchanges Involving Third-Party Intermediaries

10.5.1 Background

Sometimes, debtors involve a third-party intermediary to arrange or facilitate a debt modification or exchange with the entity’s creditors. For example, if a debtor wishes to replace existing debt for new debt, it might engage a bank to seek out holders of the existing debt and offer them the new debt. The accounting analysis of a debt modification or exchange that involves an intermediary depends on whether the intermediary is considered a principal to the transaction or the debtor’s agent. If the issuer concludes that the intermediary is acting as its agent, ASC 470-50 requires the issuer to “look through” the intermediary by treating the intermediary’s actions as its own (i.e., the intermediary’s transactions with other parties would be considered the debtor’s own transactions). If the issuer determines that the intermediary is acting as a principal, the issuer would not look through the intermediary but would instead view the intermediary as a third-party creditor (i.e., the intermediary’s transactions with other parties would be considered transactions among debt holders to which the debtor is not a party; see Section 10.2.8).

The next section addresses how to determine whether an intermediary should be viewed as a principal or an agent under ASC 470-50. Section 10.5.3 discusses the accounting for modifications or exchanges involving an intermediary.

10.5.2 Principal-Versus-Agent Analysis

10.5.2.1 Background

ASC 470-50

55-7 Transactions between a debtor and a third-party creditor should be analyzed based on the guidance in paragraph 405-20-40-1 and the guidance in this Subtopic to determine whether gain or loss recognition is appropriate. Application of the guidance in this Subtopic may require determination of whether a third-party intermediary is an agent or a principal and consideration of legal definitions may be helpful in making that determination. Generally, an agent acts for and on behalf of another party. Therefore, a third-party intermediary is an agent of a debtor if it acts on behalf of the debtor. In addition, an evaluation of the facts and circumstances surrounding the involvement of a third-party intermediary should be performed. . . .

Generally, an intermediary is considered the debtor’s agent if it “acts for and on behalf of” the debtor. For example, an intermediary would be viewed as the debtor’s agent if the intermediary’s actions are for the debtor’s benefit and under the debtor’s discretion and control. ASC 470-50-55-7 suggests that in evaluating whether an intermediary is acting as a principal or an agent, a debtor may find it helpful to consider legal definitions. Further, ASC 470-50-55-7 provides a list of indicators that a debtor must evaluate when determining whether a third-party intermediary is acting as a principal or agent:

Indicators	Factors Suggesting That Intermediary Is Acting as Principal	Factors Suggesting That Intermediary Is Acting as Debtor’s Agent	Roadmap Section
Intermediary’s exposure to risk of loss	Places its own funds at risk	Indemnified by the debtor for any losses	10.5.2.2
Intermediary’s level of commitment	Firmly committed	Best efforts	10.5.2.3
Debtor’s power to direct the intermediary’s transactions	Intermediary directs transactions and is subject to loss	Debtor directs intermediary’s transactions	10.5.2.4
Intermediary’s compensation	Varies on the basis of debt gains and losses	Preestablished fee	10.5.2.5

10.5.2.2 Intermediary’s Exposure to Risk of Loss

ASC 470-50

55-7 . . . The following indicators should be considered in that evaluation:

If the intermediary’s role is restricted to placing or reacquiring debt for the debtor without placing its own funds at risk, that would indicate that the intermediary is an agent. For example, that may be the case if the intermediary’s own funds are committed and those funds are not truly at risk because the intermediary is made whole by the debtor (and therefore is indemnified against loss by the debtor). If the intermediary places and reacquires debt for the debtor by committing its funds and is subject to the risk of loss of those funds, that would indicate that the intermediary is acting as principal. . . .

If an intermediary places its own funds at risk (i.e., it is exposed to the risk of changes in the value of the debt), this suggests that the intermediary is acting as a principal in its transactions with the debtor and investors. In this circumstance, the intermediary’s transactions with investors represent transactions among debt holders (see Section 10.2.8), which do not affect the debtor’s accounting. If the intermediary does not place its own funds at risk, this suggests that the intermediary is acting as the debtor’s agent in its transactions with investors.

The following factors, if present, would suggest that the intermediary is not placing its own funds at risk and, therefore, is the debtor’s agent:

The period during which the intermediary holds any new debt it acquires from the debtor before it resells it to investors is not sufficient to expose it to a significant risk of loss from changes in the debt’s value.
The period during which the intermediary holds any outstanding debt it acquires from investors before it resells it to the debtor is not sufficient to expose it to a significant risk of loss from changes in the debt’s value.
The intermediary obtains purchase commitments from investors before buying new debt from the debtor.
The intermediary obtains sale commitments from investors before it commits to sell outstanding debt to the debtor.
The intermediary obtains soft bids from investors before buying new debt from the debtor (see also Section 10.5.3.4).
The debtor reimburses the intermediary for any losses (or hedging costs) it incurs as a result of changes in the debt’s value in the short period during which it holds debt.

The debtor cannot assume that an intermediary is acting as a principal under ASC 470-50-55-7 even if the intermediary is firmly committed to purchasing new debt securities from the debtor at a specified price and the debtor is under no obligation to indemnify the issuer against any loss. Other facts and circumstances that may affect whether the intermediary’s own funds are at risk must also be considered. If the intermediary obtains soft bids from investors before it commits to purchasing debt securities from the debtor, the intermediary’s risk of loss may be reduced to such a degree that the intermediary should be viewed as the debtor’s agent.

In a speech at the 2003 AICPA Conference on Current SEC Developments, then SEC Professional Accounting Fellow Robert Comerford discussed the application of the indicators in ASC 470-50-55-7 to a modified remarketable put bond transaction (see Section 10.5.3.4). In Mr. Comerford’s example, the intermediary (an investment bank) has a call option that permits it to buy the debtor’s debt securities from investors. If the intermediary calls the debt securities, it will attempt to resell them to new investors at a reset interest rate. Mr. Comerford suggested that if the intermediary obtains soft bids from prospective investors before calling the existing debt securities, the intermediary may be acting as the debtor’s agent in exercising the call option and reselling the modified debt securities to new investors.

Other factors may also affect the analysis, including the debtor’s creditworthiness and the length of time between the intermediary’s purchase of the debt from the issuer and its sale thereof to investors. Entities should evaluate all facts and circumstances associated with the transaction when assessing whether an intermediary is acting as an agent or a principal.

10.5.2.3 Intermediary’s Level of Commitment

ASC 470-50

55-7 . . . The following indicators should be considered in that evaluation: . . .

b. In an arrangement where an intermediary places notes issued by the debtor, if the placement is done under a best-efforts agreement, that would indicate that the intermediary is acting as agent. Under a best-efforts agreement, an agent agrees to buy only those securities that it is able to sell to others; if the agent is unable to remarket the debt, the issuer is obligated to pay off the debt. The intermediary may be acting as principal if the placement is done on a firmly committed basis, which requires the intermediary to hold any debt that it is unable to sell to others. . . .

If an intermediary is firmly committed to executing transactions with the debtor irrespective of whether it is able to arrange offsetting transactions, this suggests that the intermediary is acting as a principal in its transactions with the debtor. For example, the fact that the intermediary is required to hold any new debt that it acquires from the debtor and is unable to sell to other investors suggests that the intermediary is acting as a principal. If the intermediary is required to execute transactions with the debtor only if it is able to arrange offsetting transactions with investors, this indicates that the intermediary is acting as the debtor’s agent. For example, the intermediary is likely to be viewed as the debtor’s agent if (1) the intermediary is required to purchase debt from the debtor only if it is able to sell it to investors or (2) the debtor is required to repurchase any debt securities it has sold to the intermediary if the intermediary is unable to sell it to investors.

10.5.2.4 Debtor’s Power to Direct the Intermediary’s Transactions

ASC 470-50

55-7 . . . The following indicators should be considered in that evaluation: . . .

c. If the debtor directs the intermediary and the intermediary cannot independently initiate an exchange or modification of the debt instrument, that would indicate that the intermediary is an agent. The intermediary may be a principal if it acquires debt from or exchanges debt with another debt holder in the market and is subject to loss as a result of the transaction. . . .

If the debtor directs the specific purchase or sale transactions that the intermediary executes with investors, this suggests that the intermediary is the debtor’s agent. If the intermediary makes its own independent decisions regarding whether to execute purchase or sale transactions involving the debt with investors and it is exposed to gains and losses on such transactions, this suggests that the intermediary is a principal.

10.5.2.5 Intermediary’s Compensation

ASC 470-50

55-7 . . . The following indicators should be considered in that evaluation: . . .

d. If the only compensation derived by an intermediary from its arrangement with the debtor is limited to a preestablished fee, that would indicate that the intermediary is an agent. If the intermediary derives gains based on the value of the security issued by the debtor, that would indicate that the intermediary is a principal.

If the debtor has agreed to any of the following fee or other compensation arrangements with the intermediary, this suggests that the intermediary is the debtor’s agent:

The intermediary’s compensation is limited to a predetermined fee and the intermediary is not exposed to gains or losses from its transactions with investors.
The intermediary’s compensation includes reimbursement by the debtor of any losses the intermediary incurs as a result of changes in the debt’s value or other hedging costs during the period in which it holds debt.
The intermediary’s compensation includes a premium to compensate it for potential losses and therefore its own funds are not substantively at risk.

If the intermediary is exposed to fluctuations in the debt’s value during the period in which it holds the debt, this suggests that the intermediary is acting as a principal.

10.5.3 Accounting for Modifications or Exchanges Involving an Intermediary

10.5.3.1 Background

The accounting for a debt modification or exchange involving an intermediary depends on whether the intermediary is acting as a principal (see the next section) or the debtor’s agent (see Section 10.5.3.3). At the 2003 AICPA Conference on Current SEC Developments, the SEC staff highlighted certain considerations related to the principal-agent analysis that apply to soft bids and remarketable put bond transactions (see Section 10.5.3.4).

10.5.3.2 Intermediary Acting as Principal

ASC 470-50

40-20 In transactions involving a third-party intermediary acting as principal, the intermediary should be viewed as a third-party creditor similar to any other creditor in order to determine whether there has been an exchange of debt instruments or a modification of terms between a debtor and a creditor. Stated another way, if a third-party intermediary acts as principal, the analysis should not look through the intermediary.

55-5 In transactions involving a third-party investment banker acting as principal, the investment banker is considered a debt holder like other debt holders. Thus, if the investment banker acting as principal acquires debt instruments from other parties, the acquisition by the investment banker does not impact the accounting by the debtor, and exchanges or modifications between the debtor and the investment banker shall follow the guidance in this Subtopic.

If an intermediary is considered a principal under ASC 470-50, the debtor treats any purchase or sale transactions that it executes with the intermediary as transactions with a creditor. Accordingly:

The intermediary’s purchases and sales of the debtor’s debt with parties other than the debtor are treated as transactions among holders of the debt (see Section 10.2.8) and, accordingly, do not affect the debtor’s accounting as long as funds do not pass through the debtor.
The debtor evaluates whether exchanges of its outstanding debt for new debt with the intermediary (including transactions with the intermediary that involve a contemporaneous cash exchange, settlement of the original debt, and issuance of new debt) should be accounted for as an extinguishment or modification under ASC 470-50. The debtor should consider the relevant facts and circumstances to determine whether the settlement of the old debt is contemporaneous with the issuance of any new debt to the intermediary.
If the intermediary purchases the debtor’s new debt from the debtor for cash and does not contemporaneously settle outstanding debt with the debtor, the debtor treats the sale of new debt to the intermediary as a new debt issuance.
If the intermediary settles the debtor’s outstanding debt with the debtor for cash and does not contemporaneously purchase new debt from the debtor, the debtor treats the settlement as an extinguishment of the outstanding debt under ASC 405-20-40-1 (see Section 9.2).

10.5.3.3 Intermediary Acting as Agent

ASC 470-50

40-19 In transactions involving a third-party intermediary acting as agent on behalf of a debtor, the actions of the intermediary shall be viewed as those of the debtor in order to determine whether there has been an exchange of debt instruments or a modification of terms between a debtor and a creditor. Stated another way, if a third-party intermediary acts as agent, the analysis shall look through the intermediary.

55-4 In transactions involving a third-party investment banker acting as agent on behalf of the debtor, the activity of the investment banker is treated as if it were the activity of the debtor. Thus, if the investment banker acquires debt instruments from holders for cash, the debtor has an extinguishment even if the investment banker subsequently transfers a debt instrument with the same or different terms to the same or different investors. If the investment banker acting as agent on behalf of the debtor acquires instruments from holders by exchanging those instruments for new debt, the guidance in this Subtopic shall be applied. If the investment banker acquires debt instruments from holders for cash and contemporaneously issues new debt instruments for cash, an extinguishment has occurred only if the two debt instruments have substantially different terms, as defined in Section 470-50-40.

If an intermediary is considered the debtor’s agent under ASC 470-50, the debtor treats the intermediary’s purchases and sales of the debtor’s securities as if they had been executed by the debtor itself. Accordingly:

If the intermediary purchases the debtor’s outstanding debt from an investor for cash and does not contemporaneously sell new debt of the debtor to the same investor, the guidance in ASC 470-50 does not apply even if the intermediary issues new debt to other investors that did not own the old debt. Instead the debtor would treat the intermediary’s purchase of the outstanding debt as an extinguishment of that debt under ASC 405-20-40-1 (see Section 9.2). The debtor should consider the relevant facts and circumstances to determine whether the settlement of the old debt is contemporaneous with the issuance of any new debt to the same investor.
If the intermediary exchanges the debtor’s outstanding debt for new debt with the same investor (including transactions that involve a contemporaneous cash exchange, settlement of the original debt, and issuance of new debt to the same investor), the debtor applies ASC 470-50 to determine whether the intermediary’s exchange of debt with the investor should be accounted for as a modification or extinguishment of its outstanding debt.
If the intermediary purchases debt from the debtor or settles the debtor’s outstanding debt with the debtor, those transactions do not affect the debtor’s accounting (however, such transactions may suggest that the intermediary is acting as a principal). Only the intermediary’s transactions with other investors on behalf of the debtor affect the debtor’s accounting for the debt.

If (1) some of the new debt is issued to investors that held the old debt, (2) some of the new debt is issued to new investors, and (3) the settlement of the old debt is contemporaneous with the issuance of new debt, the debtor would be required under ASC 470-50-55-3 to determine what portion of the new debt is acquired by investors that held the old debt (see Section 10.3.2.2). ASC 470-50 applies to those investors that held the old debt that was replaced by the new debt, and extinguishment accounting would apply to the portion of the old debt that has been replaced by new debt held by new investors. However, in some cases, it would be acceptable for the issuer to treat an issuance of new debt as a transaction that is separate from the redemption of any existing debt, even if some investors hold both the old and new debt and the transactions are contemporaneous (see Section 10.2.13).

Example 10-13

Debt Settlement by the Debtor’s Agent

Entity K restructured its debt facilities. Bank A, acting as an agent of K, paid off K’s old debt and was immediately reimbursed with proceeds from a new K debt offering that it arranged. Because A is an agent of K, the activity of A is treated as if it were the activity of K. If A acquires old debt instruments from investors for cash and contemporaneously issues new debt instruments to the same investors for cash, K would apply the guidance in ASC 470-50 to determine whether it should record an extinguishment of the old debt or account for the transactions as a modification of its old debt.

Example 10-14

Debt Settlement by the Debtor’s Agent

On December 1, 20X0, Entity L issues five-year nonconvertible debt at par for total proceeds of $11 million. Investor Y obtains debt with a principal amount of $6 million, and Investor Q obtains debt with a principal amount of $5 million. The debt pays 10 percent interest annually.

On December 1, 20X2, L engages a bank to act as an agent in the repurchase of L’s debt with Y and Q and to help it place new nonconvertible debt. The bank repurchases the original debt held by Y and Q for a total cash payment of $11.567 million, of which $6.309 million is paid to Y and $5.258 million is paid to Q. Simultaneously, the bank places new five-year debt of L with Q and Investor Z, a new investor, at par for total proceeds of $18 million. Investor Q purchases $5 million of the new debt, and Z purchases $13 million of the new debt. The new debt pays 8 percent interest annually.

Entity L should apply extinguishment accounting to the $6 million of original debt repurchased from Y since Y is not a continuing creditor and the debt has been extinguished for cash equal to $6.309 million. This component of the transaction is outside the scope of ASC 470-50.

If the transaction qualifies as a market issuance of new debt to replace old debt (see Section 10.2.13), L would be permitted to treat the issuance of new debt to Q as a transaction that is separate from the redemption of the existing debt held by Q. In addition, L would apply extinguishment accounting to the $5 million of original debt repurchased from Q.

If the transaction does not qualify as a market issuance of new debt to replace old debt, L should determine under ASC 470-50 whether to account for the exchange with Q of $5 million of original debt for $5 million of new debt as a modification or an extinguishment of the original debt held by Q. While Q has exchanged original debt with a principal amount of $5 million for a cash payment equal to $5.528 million, it has simultaneously bought new debt from L for cash equal to $5 million. Entity L would determine whether the change in terms is significant by assessing whether the change in present value is greater than 10 percent. To do so, it would take the following steps:

Determine the present value of the cash flows of the new debt instrument:
1. Investor Q will receive interest payments at 8 percent annually for five years ($400,000 per year).
2. Investor Q will receive a principal repayment of $5 million in five years.
3. Currently, Q receives $5,257,710 for the original debt and pays $5 million for the new debt. The net amount of $257,710 ($5,257,710 – $5,000,000) received by Q is added to the cash flows of the new debt instrument and used to perform the 10 percent cash flow test.
4. The discount rate is the effective interest rate, for accounting purposes, of the original debt instrument, which is 10 percent.
5. The present value of the interest and principal payments on the new debt discounted at 10 percent is $4,620,921.
6. Under the 10 percent cash flow test, the cash flows of the new debt instrument include all cash flows of the new debt instrument plus any amounts paid by the debtor to the creditor, less any amounts received by the debtor from the creditor as part of the exchange. Accordingly, the total present value attributable to the new debt is $4,878,631 ($4,620,921 + $257,710).
Determine the present value of the remaining cash flows of the original debt instrument:
1. Investor Q would have received interest payments at 10 percent annually for three years ($500,000 per year).
2. Investor Q would have received a principal repayment of $5 million in three years.
3. The discount rate is the effective interest rate, for accounting purposes, of the original debt instrument, which is 10 percent.
4. Accordingly, the present value of the cash flows of the original debt instrument is $5 million.
Determine the percentage of change in the present value of the debt:
1. The change in present value is $121,369 ($5,000,000 – $4,878,631).
2. The change as a percentage of the old debt is 2.43 percent ($121,369 ÷ $5,000,000).

Because the change is less than 10 percent and the debt does not contain any conversion features before or after the modification or exchange, the debt instruments would not be considered substantially different (see Section 10.3). Accordingly, L would apply modification accounting to the exchange of debt with Q (see Section 10.4.3). Investor Z is a new creditor and, accordingly, the issuance of debt to Investor Z is outside the scope of ASC 470-50 and should instead be accounted for as a new debt issuance.

10.5.3.4 Modified Remarketable Put Bond Transactions

At the 2003 AICPA Conference on Current SEC Developments, then SEC Professional Accounting Fellow Robert Comerford provided an example of the application of ASC 470-50 to a modified remarketable put bond transaction. Mr. Comerford’s remarks suggest that an intermediary may perform a dual role in certain transactions involving the contemporaneous repurchase and reissuance of debt. In his example, the intermediary acts both (1) in a principal capacity by (a) exercising a call option attached to the debt that permits it to purchase the debt at a specified price from third-party investors and (b) selling the debt to the debtor and (2) as the debtor’s agent by selling modified debt to investors:

Assume that a company issues a 5-year bond for $1,000, which is also the bond’s face value. Two years later, the issuer’s investment bank may call the bond from its holder for $1,000, reset the interest rate on the bond according to a predetermined formula and then sell the bond bearing this new interest rate to new investors for the bond’s then-current fair value. The predetermined formula has a fixed component plus a newly determined spread reflecting the credit risk of the issuer as of the reset date. If the investment bank does not call the bond the original investor must sell the bond back to the issuer for $1,000. The issuer’s participation on the reset date is limited to either of the following scenarios. If the investment bank exercises its call option and remarkets the bond the issuer must pay the bond’s new interest rate until the bond’s final maturity date. If the investment bank does not exercise its call, the issuer must repurchase the bond from the original investor. . . .

[Some] issuers have considered increasing the face value of their . . . remarketed bonds [and reducing] the interest rate on the bonds to a market-based rate appropriate to 3-year debt of the issuer. This matching of the remarketed bond’s new face value with its expected issuance price has the potential to reduce the credit spread demanded by the new investors, thus reducing the issuer’s overall cost of funds.

However, as is often the case with structured transactions, the little changes that I have mentioned may have unintended consequences for the issuer. Because increasing the remarketable put bond’s face value and reducing its coupon to a market-based rate is not contemplated in the original terms of the bond, these modifications require evaluation under the guidance contained in [ASC 470-50]. . . .

The Staff believes that a thorough analysis of the modified remarketing transaction that I have described causes the investment bank to be viewed as playing a dual role in the transaction. The investment bank may be viewed as that of a principal in the first component of the transaction involving the acquisition of the bond from the original investor, the resetting of the bond’s interest rate pursuant to the bond’s original terms and the subsequent tendering of these instruments back to the issuer at a price in excess of the instrument’s face value. Once the issuer has increased the principal amount and decreased the coupon of the replacement bond, the investment bank’s role is that of the issuer’s agent conducting the placement of a modified bond to a new investor.

The Implementation Guidelines in [ASC 470-50] list four indicators to consider when evaluating whether an intermediary is acting as a principal or as the issuer’s agent. . . . I would like to walk through those indicators as they pertain to the investment bank’s role in placing the modified bonds with new investors. [Footnote omitted]

The first indicator involves the risk of loss, if any, that the intermediary is exposed to. Investment banks typically obtain “soft bids” for the replacement bond prior to, or concurrent with, making the decision to exercise their call option on the old bond. By obtaining soft bids the investment bank can determine whether demand for the replacement bond is sufficient to ensure its successful placement. This significantly reduces the investment bank’s exposure to market risk associated with the remarketed instruments, thus pointing towards the investment bank’s role being that of an agent.
The second indicator examines whether the investment bank is placing the modified bond on a best efforts or a firmly committed basis. Facts and circumstances could lead one to build an argument either way.
The third indicator considers whether the issuer directs the intermediary’s actions. Although the issuer may not have conceived the idea of increasing the face amount of the bond and decreasing the coupon, these actions require the issuer’s active involvement and ultimately its approval. Therefore, we believe the issuer essentially directs the investment bank’s actions, which suggests the investment bank is an agent.
The final indicator relates to whether the intermediary’s compensation is limited to a pre-established fee or is derived from gains based on the value of the security to be issued by the issuer. In its capacity as placement agent for the modified bond, the investment bank typically is compensated by a pre-established fee. This further points towards the investment bank’s role being that of the issuer’s agent.

We believe that this analysis provides a firm basis for concluding that the investment bank acts as the issuer’s agent in the debt placement component of these modified remarketing transactions. Because this amounts to the transaction being the issuer’s acquisition of its own bonds from one investor coupled with the issuance of a modified bond to a new investor, [ASC 470-50] requires that this transaction be accounted for as the extinguishment and de-recognition of the old bond and the recognition of the new bond at its fair value with the difference between these two amounts recognized in the income statement as an extinguishment loss.

Mr. Comerford’s remarks highlight that a contemporaneous debt repurchase and reissuance should be analyzed as a debt extinguishment under ASC 405-20 and not as a modification or exchange under ASC 470-50 if the intermediary is acting as a principal in the debt repurchase and as the debtor’s agent in the debt reissuance. The intermediary’s purchase of debt securities from investors is considered a transfer among debt holders that does not affect the debtor’s accounting since the intermediary is acting as a principal in a transaction to which the debtor is not a party (see Section 10.2.8). However, the debtor’s repurchase of debt from the intermediary would be analyzed as a debt extinguishment because the debtor is viewed as having repurchased debt from one investor (the intermediary) by using proceeds from debt issued to other investors (since the intermediary is acting as an agent in the debt placement. If the intermediary instead had acted as the debtor’s agent in both the purchase and reissuance of debt to the same investors, those transactions would have been analyzed as a debt modification or exchange under ASC 470-50 (see Section 10.2.2).

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This publication provides comprehensive guidance; however, it does not address all possible fact patterns, and the guidance is subject to change. Consult a Deloitte & Touche LLP professional regarding your specific issues and questions.