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Turns out that Friday the 13th is also unlucky for toxic convertible note-holders! I have been warning the toxic convertible note industry that there was going to be a reckoning with regard to how they lend money to microcap OTC Markets companies, and now, it seems that the chickens are coming home to roost. Several months ago COR Clearing decided to make it near impossible to clear any stock derived through convertible notes coming from OTC Market issuers.  That decision was based largely on several issues, they key being that a convertible note is not a security that would allow an opinion to clear stock under a Rule 144 exemption.  I won’t get into the legalities of this here other than to say to look up both the New Earthshell v. Jakoobit case in the US District Court for the Southern District of New York, as well as the Reves v Ernst & Young US Supreme Court case. In the end, COR Clearing made a good decision – but not good for toxic convertible note holders. In fact, I had a well-known lenders counsel from Florida send me an article he wrote that tried to counter the courts decisions – that was a massive FAIL!  Well, as of Friday, April 13, 2018, one of the last major clearing houses, ALPINE, is going to make it near impossible to process stock from convertible notes from issuers trading sub-penny (most are sub-penny after being pummeled by toxic convertible notes). Turns out that Friday the 13th is also unlucky for note-holders! Now-what note-holders?  Your sometimes arrogant and greedy attitudes in dealing with small undercapitalized issuers needs to change and it needs to change quickly if you are going to save all that money on the street - instead of being worth 5 times that amount, being worth less than half of its principle value and in some instance, worth nothing.

Here’s how I see it – The options are limited:

Sell the note to a third party– Good luck with that.  That was a viable alternative when the third party could easily benefit from tacking provisions from the date of the original transaction, but now the challenge is finding a clearinghouse, on shore, that would clear that stock. If you think someone will buy the note just to collect the principle and stated interest, think again. Not likely as most of your borrowers don’t have sufficient assets to take should your successor ever get a judgment. The only way to get rid of that note now is to sell it at a substantial discount to its face value, and again, good luck with that, you will be throwing money away if your lucky to find someone stupid enough to buy it.

Wait for Maturity then Get a Judgment– Good luck with that also. Most of the issuers have limited assets and limited revenues and it’s highly unlikely that you would ever collect. Plus, you will incur legal fees to commence, litigate, adjudicate, secure and collect on a judgment (if you can). On a note under $50,000.00, it’s just not worth it. That would just be throwing good money after bad. Almost every toxic note lender I come across has not been able to collect on judgments they obtain in either state or federal court relying instead on the tactic that once they get a judgment the issuer will fold and settle and fork over cash and/or free trading stock. In some cases litigation forces the companies out of business. They will probably just start all over again without you.

A 3(a)(10) Court Approved Settlement– Possibly, but the courts are starting to catch on to this end-around and have been denying approving such settlements.  Also, the costs and documentation to get a 3(a)(10) settlement is almost prohibitive, but it is an option provided your issuer agrees to it.  Based on the first two options the issuers may hurt their chances of doing a real deal that could benefit both sides, if they agreed to a 3(a)(10) settlement too early.

Give up and let the Loan Sit- Always an option.  Many issuers experience a toxic note-holder who will sit on its' hands and wait it out, sometimes for years, hoping the company’s stock price improves or the issuer somehow is able to bring its' financial reporting requirements current, or better yet, some magical mystery investor that will hand over cash to pay off the notes. There are only a handful of lenders, mostly out of New York, Chicago and Massachusetts that will try on litigation to force you to settle or come up with money to pay them off. Usually, they want to force issuance of shares or they want a new deal for more shares – either way, its back to the prior discussed problems of clearing the stock. They may even try suing the CEO personally under some BS fraud claim and as we know now under the Jakoobit case, a convertible note may not be a security and if it’s not a security, there can be no securities fraud claims.  Then its simple state based fraud claim and in most states, if there is a breach of contract claim, the fraud claim against the CEO personally usually fails.


I have seen how entrenched these toxic note-holders are in how they have previously approached some of my clients. The funny thing is that every time we contest litigation based on certain usury statutes under state law, they jump up and down claiming that the notes are investments instead of loans.  Well, ALL of the courts are now finding that these transactions all start out as loans. But the point here is that they “claim” they are investments even though the investment decision is made when they convert months after the original loan is made. So if they are an “investor” from the beginning, that means by definition they are taking a “risk” in the company’s success – yea, right. We all know the true and sole motivation of providing these types of loans and it certainly is NOT based on the success of the issuer but rather, on trading price and volume of the issuers public stock.

The cold hard reality is that from an economic position, the note-holders have just lost a tremendous amount of leverage and some of you CEO’s whose company stocks have been crippled by these transactions and those who have been tortured by message board posters would instinctively want to take revenge and put the screws to them.  BUT WAIT! There is a solution that makes sense that is legal and puts both the issuer and the lender on better footing. The plan for a new class of convertible preferred equity designed solely to allow the convertible note holder to actually use the booked liability to really “invest”, short term, into the company. My group has been using this method of debt remediation rather successfully with no issues other than some lender pushback. Now with APLINE’s Friday the 13th massacre, I think that will change as well. The lender eventually gets what it wants out of the deal; the issuer gets the liabilities removed from its balance sheet allowing them to go out and raise more traditional capital; the company reserves a right of redemption that will allow the company to redeem the class of equity for cash; the pressure on the stock is alleviated, no more lawsuits, no more angst, its really a win-win for both sides. Less booked liabilities, more capital is available improving the company’s financial outlook, and in 6 or 12 months, the former lender, and now shareholder, can either be redeemed out of the security or convert it into common at such future date. 

In discussing Apline’s newest position with one of my clients CEO’s, Bob Silzer of DSG Global, Inc., a great company that is revolutionizing the golf information industry, we agreed that most OTC Markets companies should consider a fair and reasonable restructuring that can clean up their books, eliminate booked liabilities yet provide a similar return to their note-holders under a fair program where both sides win. It’s very hard to try to convince someone that their business model needs to change, but if change provides you with a similar or same return, then why all the pushback? The days of lenders forcing their position seem to be quickly coming to an end because the major clearing houses will not clear stock from convertible notes and the sooner these lenders realize that convertible preferred stock arrangement can allow them to realize similar returns while helping the companies they “invest” in to focus on their business to make it more successful can benefit everyone including its shareholders. 

It could very well be that the current landscape for convertible notes is changing and I can only suggest that the lenders quickly, post-haste, contact their issuers now to work out a deal in which everyone wins. I also encourage the issuers, no matter how mad you are at the note-holders, to be receptive and deal with them fairly and provide them with a real investment structure to help them realize a return on the monies loaned to your company. At the end of the day its not only about the deal you make, but rather, being part of the solution that is way more rewarding than being the actual problem.

Mark R. Basile, Esq. is a nationally known corporate restructuring and workout attorney and is a member of The Basile Law Firm P.C.

The Firm represents numerous OTC and Pink Sheet companies in litigation and corporate restructurings. Mr. Basile is also director of OTCWORKOUTS LLC

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