2.4 Debt
2.4.1 Restrictions
Examples of SEC Comments
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We note your disclosure [of] the Term Loan Facility covenants. Please tell us whether these covenants restrict the ability of your subsidiaries to transfer funds to you in the form of loans, advances or cash dividends without the consent of the lenders. If so, please tell us: (i) the amount of restricted net assets of consolidated subsidiaries and your equity in the undistributed earnings of investments accounted for by the equity method as of the most recent balance sheet date and how you computed the amount; (ii) your consideration of providing the disclosures required by Rule 4-08(e)(3)(i) and (ii) of Regulation S-X; and (iii) your consideration of providing the condensed financial information prescribed by Rule 12-04 of Regulation S-X in accordance with Rule 5-04 of Regulation S-X.
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[Y]ou disclose that you are largely dependent on the receipt of distributions and dividends or other payments from your subsidiaries and joint ventures for cash to fund all your operations and expenses. Please address if there are any restrictions on your ability to declare dividends and discuss the potential impact on your liquidity, financial condition and results of operations, including the disclosures required by Rule 4-08(e) of Regulation S-X. Please also tell us what consideration you gave to the need for parent only financial statements under Rules 5-04 and 12-04 of Regulation S-X.
The SEC staff may comment on restrictions that limit a registrant’s ability to pay
dividends or transfer funds within a consolidated group. When the transfer of assets (cash or other
funds) to the parent company/registrant from its subsidiary (or subsidiaries) or equity method investee
is materially restricted, limited, or in need of a third party’s approval, Regulation S-X, Rules 4-08(e), 5-04,
and 12-04, may require:
- Footnote disclosure of the restriction or limitation (Rule 4-08(e)).
- Presentation of condensed parent-company financial data in a financial statement schedule (i.e., Schedule I).
- Both footnote and Schedule I disclosures.
Rule 4-08(e) disclosures are intended to inform investors of restrictions on a registrant’s ability to pay
dividends or transfer funds within a consolidated group. Such restrictions may result from a contractual
agreement (e.g., a debt agreement) or a regulatory body. Without appropriate disclosure of such
restrictions, an investor may presume that the registrant (at the parent or subsidiary level) has more
discretion to transfer funds or pay cash dividends than is actually the case.
If Rule 4-08(e) applies, registrants must disclose in the notes to the financial
statements a description of “the most significant restrictions on the payment of
dividends by the registrant, indicating their sources, their pertinent
provisions, and the amount of retained earnings or net income restricted or free
of restrictions.”
Disclosure is also required under Rule 4-08(e)(3) if such disclosure would be considered material.
Disclosures required under Rule 4-08(e)(3) consist of the following:
- The “nature of any restrictions on the ability of consolidated subsidiaries and unconsolidated subsidiaries to transfer funds to the registrant in the form of cash dividends, loans or advances.”
- Separate disclosure of “the amounts of such restricted net assets for unconsolidated subsidiaries and consolidated subsidiaries as of the end of the most recently completed fiscal year.”
In addition, to give investors separate information about the parent company, registrants are required
under Rule 5-04 to file Schedule I “when the restricted net assets [of the registrant’s] consolidated
subsidiaries exceed 25 percent of consolidated net assets as of the end of the most recently completed
fiscal year.”
The calculations under Rule 4-08(e) may be different from those under Rule 5-04,
which governs Schedule I; consequently,
registrants must consider both rules to determine
what is required. Given the materiality-based
threshold for footnote disclosures under Rule
4-08(e), if Schedule I is required, footnote
disclosures under Rule 4-08(e) may also be
required. However, if Rule 4-08(e) disclosures are
required, Schedule I may not be required. In
addition, a registrant’s filing of Schedule I does
not necessarily mean that the registrant has
satisfied the disclosure requirements of Rule
4-08(e), which are separate and distinct.
2.4.2 Financial Covenant Disclosures
Examples of SEC Comments
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We note that [Company A] was in compliance with the terms of their financial covenants in the Credit Agreement and Purchase Agreement as of December 31, [fiscal year 1] and June 30, [fiscal year 2]. You disclose that due to the low commodity price environment, it is possible that the total leverage ratio financial covenant may not be met at some point during [fiscal year 2] without further action. Please revise your disclosure to explain the reasonably likely impact of any breach on your financial condition or operating performance and identify any alternate sources of funding.
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We note your credit facilities include certain affirmative and negative covenants that impose restrictions on your financial and business operations. For each class of debt, please tell us whether you were in compliance with the covenants as of the reporting date.
It is important for a registrant to consider providing disclosures about covenant compliance in MD&A to
illustrate its financial condition and liquidity. These disclosures may include a discussion of (1) the terms
of the most severe covenants and how the registrant has complied with those covenants, (2) waivers
obtained from lenders and the likelihood of failing a covenant or obtaining a waiver in the future, and
(3) the impact of noncompliance on the registrant’s financial condition and liquidity. In addition, a
registrant may present a table that compares its most material actual debt covenant ratios as of the
latest balance sheet date with the minimum and maximum amounts permitted under debt agreements.
Such transparent disclosures will enable investors to better understand the risk of future covenant
noncompliance by the registrant.
For additional discussion of liquidity, see Section
3.1.3.
2.4.3 Classification as Debt or Equity
Examples of SEC Comments
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Please provide us with a detailed analysis explaining how you determined that the preferred interests issued in [year 1] and [year 2] should not be classified as debt in accordance with ASC 480.
- Please elaborate on why you believe the decision by your Board of Directors to either exchange the common units and Class B shares for Class A shares or to redeem them for cash is within your control. In doing so, tell us how you considered the guidance in paragraph 7 of ASC 480-10-S99-3A.
- We . . . understand that you believe that ASC 480-10-S99-3A does not apply to the classification and presentation of your contingently redeemable preferred stock. As you have filed financial statements with the Securities and Exchange Commission in preparation for the sale of securities you are subject to the provisions of GAAP that apply to public entities including ASC 480-10-S99-3A. Please revise to present your contingently redeemable preferred stock outside of permanent equity.
Under ASC 480, certain financial instruments that embody an obligation of the
issuer should be accounted for as liabilities even
if their legal form is that of equity or they
involve obligations to repurchase or issue the
entity’s equity shares. In addition, the guidance
in ASC 480-10-S99-3A(2) states, in part, that “ASR
268 requires preferred securities that are
redeemable for cash or other assets to be
classified outside of permanent equity if they are
redeemable (1) at a fixed or determinable price on
a fixed or determinable date, (2) at the option of
the holder, or (3) upon the occurrence of an event
that is not solely within the control of the
issuer.” ASC 480-10-S99-3A also notes the SEC
staff’s belief that ASR 268 can be applied
analogously to other redeemable equity
instruments.
Consequently, the SEC staff frequently asks registrants with redeemable securities — including
registrants undergoing IPO transactions — to support the basis for their classification of such securities
as debt, temporary (mezzanine) equity, or permanent equity. In addition, the staff often asks registrants
about the accounting for conversion features in convertible instruments, including convertible preferred
securities.
See Section 2.16
for more information about redeemable
noncontrolling interests. See Section
2.8.1 for considerations related to
embedded conversion features.
Other
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