Posted by & filed under Debt, Equity-Linked Transactions.

Conventional convertible debt is a technical definition. To be considered conventional convertible debt, the holder may only realize the value of the conversion option by exercising the option and receiving the entire proceeds in a fixed number of shares or the equivalent amount of cash determined at the discretion of the issuer. Additionally, the ability of the holder to exercise the conversion option must be based on the passage of time (immediately convertible would qualify) or the occurrence of a contingent event. This definition permits standard anti-dilution that serve merely to maintain the value of the conversion option are permitted. Provisions that are sometimes referred to as ‘anti-dilution’ but that are actually price protection provisions are NOT permitted.

Mandatorily redeemable preferred stock that meets the above requirements would also qualify as conventional convertible debt if it is considered more akin to debt than equity (refer back to the nature of the host contract analysis performed previously).

Any provisions in the instrument that either 1) changes the number of shares issuable upon conversion from the number issuable at inception other than standard anti-dilution provisions or 2) alters the amount of cash, would violate the conventional convertible debt definition. In other words, the number of shares issuable must be set at inception and must not change for any reason other than the standard anti-dilution adjustments. So, for example, if accrued interest is convertible to shares under the conversion feature and the interest rate is fixed, then the number of shares issuable is determined at inception and the definition is met. However, if the interest rate floats with the market, or if the interest rate is contingent on some event (e.g., an event of default), then the number of shares is variable and the definition is not met.

Additionally, any provisions that would alter the settlement alternatives or give the holder the ability to choose settlement alternatives would violate the definition. The definition allows for either settlement entirely in shares or settlement entirely in cash at the discretion of the entity, but not a combination of the two and not at the discretion of the holder.

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