Virtually all public indentures contain provisions allowing the issuer to cure ambiguities and make other technical changes to the debt documentation without debtholder consent. When the purported ambiguities have substantive consequences, however, issuers may not be able to get away with an amendment that lacks debtholder approval. InGSO Coastline Credit Partners L.P. v. Global A&T Electronics Ltd. (NY App. Div. 1st Dept. May 3, 2016), a New York lower court bought into a “cure of ambiguity” argument and on that basis granted a motion to dismiss. The Appellate Division would have none of it, and in a summary, unsigned opinion reversed. Along the way, both the lower and the appellate courts addressed a number of other issues of interest.
In 2007, Global A&T Electronics Limited (“GATE”), a provider of semiconductor test and assembly services for integrated circuits, entered into two senior credit facilities totaling $775 million and two junior credit facilities totaling $475 million, both maturing on October 30, 2015. In February 2013, GATE issued $625 million in notes pursuant to an indenture and used the proceeds to prepay the two senior credit facilities. The notes, due to mature in February 2019, were equal in payment priority to the junior credit facilities but were secured by a first lien on GATE’s assets — that is, with lien priority over the junior credit facilities.
Experiencing some financial pressures, in September 2014, GATE conducted an exchange pursuant to which it issued approximately $502 million of additional notes under the notes indenture, which were swapped for the obligations under the two junior credit facilities. The result was that the erstwhile holders of the junior credit facility debt exchanged obligations with a second lien on GATE’s assets for the additional notes having a first lien on those same assets. Among the holders of the junior credit facility debt that participated in the exchange was an entity called Costa Esmeralda Investments Limited, an affiliate of one of the two controlling shareholders of GATE.
Four different groups of holders of the original notes, most of which purchased following the exchange but some of which did so prior to the transaction, sued to invalidate the exchange.
The Issues and the Courts’ Analysis
Among plaintiffs’ causes of action was a claim for breach of Section 4.16 of the indenture, which prohibited GATE from amending the intercreditor agreement between the holders of first and second lien debt without the consent of the holders of the majority of the senior notes. The intercreditor agreement defined “second priority obligations” to include any debt used to retire second priority obligations. The issuer amended the intercreditor agreement so as to provide that any additional notes would be designated as “first priority agreement” obligations and not second priority obligations. GATE maintained that this was an amendment intended to “cure [an] ambiguity, omission, defect or inconsistency in any creditor agreement.” The lower court agreed with the issuer that the change was corrective and not substantive. Since additional notes had the same status as original notes under the intercreditor agreement, the court reasoned, without the correction additional notes used to refinance second lien indebtedness would constitute at the same time both first and second priority obligations under the intercreditor agreement. (The lower court also relied on a second provision of the indenture allowing the issuer to amend the intercreditor agreement to “make provisions for securing additional notes to rank, pari passu, with the security [for] the notes on the collateral.”) Without in-depth analysis the appellate court held that the amendment to the intercreditor agreement was not permitted under Section 4.16 of the indenture. It found no inconsistency or ambiguity in the intercreditor agreement and held that the exchange indebtedness represented by additional notes remained subject to the priority scheme of the intercreditor agreement. What constituted a technical fix in the eye of the lower court, to the appellate court was an end run around a lien hierarchy intended to keep junior credit agreement debt forever in a second priority position with respect to the collateral.
The appellate court also found that GATE had violated Section 4.18 of the indenture, which prohibited it from materially impairing the original notes’ security interest and collateral. To reach this result, the reviewing court determined that the additional notes did not benefit from the permitted lien basket allowing for liens in favor of the notes, because on its reading of the intercreditor agreement, the pari lien in favor of the additional notes breached the priority scheme of the intercreditor agreement. The intercreditor agreement, the court observed, resolved conflicts between the indenture and the intercreditor agreement in favor of the intercreditor agreement. Notwithstanding any arguments that could be raised under the indenture allowing for a lien in favor of the additional notes, those arguments would necessarily fail.
Another interesting ruling of the appellate court applied to the affiliate transactions covenant. An affiliate of the issuer held a significant minority position in the junior credit agreement debt and participated in the exchange. The lower court had reasoned that the affiliate transaction covenant was not implicated, because the exchange was open equally to all holders of the junior debt. The appellate court disagreed and allowed the plaintiffs to go forward with their claim that the exchange was not an arm’s-length transaction.
Finally, the appellate division addressed the plaintiffs’ tortuous interference claim. As noted, two of the defendants were substantial equity holders in GATE, with an affiliate of one of them holding junior debt of the issuer. The tortuous interference alleged against these defendants was the harm to plaintiffs for breach of the indenture and the intercreditor agreement. The lower court, consistent with its other rulings, held that the indenture and intercreditor agreement had not been breached, so there was no injury. However, even if there had been a breach, the alleged interference would not have been improper because the defendants had an economic interest in GATE, the breaching party. Quoting New York case law, the court stated, “New York courts regularly dismiss claims for tortuous interference with contract at the pleading stage when a defendant has an economic or legal interest in the breaching party and the plaintiffs fail to allege malice or illegal means.” Here, the court reasoned, the defendants had an economic interest in GATE as controlling shareholders. Surprisingly, the appellate court held that the controlling shareholder defendants could not rely on the economic interest defense, because rather than acting to protect their equity interests, as the lower court found, the defendants were motivated to protect the interests of the affiliate of one of them that owned the junior debt.
There were a number of points on which the appellate court let stand the rulings of the lower court. Plaintiffs had challenged the exchange as failing to comply with the definition of “permitted refinancing indebtedness” under the debt covenant. As is typical, refinancing indebtedness was permitted only if the priority of the refinancing debt vis-a-vis the original debt remained unchanged. Plaintiffs argued that the exchange debt enjoyed a superior lien position with respect to the junior credit facility debt that it financed. The court disagreed, distinguishing between payment subordination and lien subordination. Here, there was no change in the payment priority of the debt, but only in the lien priority. Since the permitted refinancing basket addressed only payment priority, the plaintiffs’ claim under the refinancing basket failed as a matter of law. In the last cause of action, plaintiffs who purchased their notes prior to the exchange pointed to statements of the issuer that it intended to refinance the junior debt through an initial public offering. This, the plaintiffs claimed, was a fraudulent misrepresentation on which they relied to their detriment in purchasing the notes. Both the lower and the appellate courts disagreed, holding that statements of future intent were not actionable.
GSO v. GATE presents a cornucopia of issues arising under standard indenture clauses. Unfortunately, the appellate division issued its rulings in a summary decision devoid of much reasoning and analysis. There are, however, a number of things to be learned, at least on a cautionary basis. First, beware of seemingly technical amendments to indentures that have substantive consequences. Notwithstanding the standard clauses that allow unilateral amendment in cases of ambiguity, substantive ambiguities may not be curable except through the full amendment process. Second, where intercreditor agreements recite that they trump other transactional documentation, courts will respect the override of the intercreditor agreement. Third, transactions between an issuer and a controller will not necessarily pass muster under an affiliate transactions covenant merely because the benefits provided to the controller are also afforded to other, nonaffiliated security holders. Fourth, the appellate court’s ruling with respect to tortuous interference — that the interest of a controlled affiliate is unavailing to a controller seeking to defeat a tortuous interference claim — is surprising and may not hold up under subsequent case law. But there is at least a yellow flag here, and tortuous interference will likely continue to be part of the tool kit of debtholders claiming improper conduct by the equity controllers of their issuer. Finally, the distinction between payment subordination and lien subordination is alive and well under New York indentures. Drafters intending to preclude a reordering of lien priority upon a refinancing had better express their intent to do so explicitly.