Recent Decision Highlights the Perils for Hedge Fund Managers of Failing to Understand Early Redemption Provisions in Bond Indentures

If not carefully understood, early redemption rights contained in bond indentures can become a source of dispute and litigation, as demonstrated by an action recently brought in federal court by an issuer seeking to enforce its right to redeem its notes early and at par.  Although the parties in the case were the issuer and the indenture trustee, the court’s decision nonetheless impacted at least one hedge fund that purchased the notes, possibly believing that the period for the issuer to redeem the notes early at par had elapsed.  This article summarizes the factual background of the case and the court’s decision.  In such scenarios, in addition to the fact that the issuer may, in its discretion, have the right to redeem notes early and at par under issuer-favorable conditions, hedge funds and other investors may suffer other adverse economic consequences.  For example, in early, at-par redemption scenarios, a redeemed hedge fund may have difficulty reinvesting amounts previously invested in the notes at equally attractive entry prices and interest rates.  However, the goals and incentives of hedge funds that invest in fixed income depend on the facts and circumstances of the investment.  Sometimes, for example, managers may want an issuer to redeem depreciated notes at par.  See, e.g., “U.S. Supreme Court Declines to Review District Court Decision Holding that Collective Action by Hedge Funds in Pressing Issuer to Redeem Its Long-Term Notes at Par Did Not Violate Antitrust Laws,” Hedge Fund Law Report, Vol. 6, No. 23 (Jun. 6, 2013).

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