“Render unto Caesar the things that are Caesar’s, and unto [CEC] the things that are [CEC’s] [?]” – Matthew 22:21 (as revised)

Last week, Judge Shira Scheindlin issued a much-awaited decision in the pending litigation over the so-called “parent guarantee” in connection with the Caesars bankruptcy case.  We discuss the decision in a two-part series beginning today.  But before we go any further, the short, short version:

  • The Trust Indenture Act (TIA) prohibits certain nonconsensual impairment of certain noteholders rights.
  • Courts are divided regarding what kind of impairment violates the TIA.
  • Judge Scheindlin (S.D.N.Y.) held that the applicable provision of the TIA bars impairment of the right to payment, as well as the right to bring suit, but only with respect to nonconsensual (i) amendments to core terms of a debt instrument or (ii) out of court debt reorganizations.
  • Judge Scheindlin further held that any alleged impairment must be evaluated as of the date that a payment becomes due, rather than the date of the transaction ultimately giving rise to the alleged impairment.
  • Judge Scheindlin certified questions regarding the interpretation of the TIA to the Second Circuit.
  • The Caesars “parent guarantee” litigation is far from over.

The Caesars parent guarantee litigation has been hotly contested and closely followed.  In brief, it arises from an action against Caesars Entertainment Corporation (CEC), the Caesars nondebtor parent entity, which guaranteed approximately $7 billion in notes issued by Caesars Entertainment Operating Company (CEOC), which, in January 2015, commenced a voluntary chapter 11 case in the United States Bankruptcy Court for the Northern District of Illinois.

The indenture trustee for those notes asserted that the commencement of that chapter 11 case triggered CEC’s guaranty obligations and demanded payment by CEC.  CEC, on the other hand, argued that its guaranty was terminated and no longer enforceable, as a result of three transactions by CEC and CEOC between May and August 2014, the effect of which was (arguably) a release of CEC’s guarantee obligations, thereby leaving the CEOC noteholders without a right to payment from CEC.  The specifics of those transactions are, of course, important to the Caesars litigation, but, at this point, they do not bear directly on whether a release of the CEC guarantee is void pursuant to the TIA.  Additional information regarding those transactions is available in Judge Scheindlin’s decision, available here.

The indenture trustee subsequently commenced an action against CEC in the United States District Court for the Southern District of New York and moved for partial summary judgment, seeking a determination that the alleged release of the CEC guarantee violated section 316(b) of the Trust Indenture Act (TIA).  That section of the TIA protects minority noteholders, restricting “majority action clauses,” whereby holders of a majority of the notes would otherwise be able to change certain key terms of an indenture, to the detriment of minority holders.  It provides, in short, that an issuer cannot – except in bankruptcy – alter its obligations to make payments of principal or interest on its notes without the consent of each bondholder.  In other words, a majority of bondholders cannot force minority bondholders to accept a debt restructuring outside of a formal bankruptcy proceeding.

In a prior decision, on January 15, 2015, and following two prior decisions of other judges in the Southern District of New York, Judge Scheindlin had already concluded that section 316(b) of the TIA “protects more than simply formal, explicit modification of the legal right to receive payment” which would allow a sufficiently clever issuer to gut the [TIA]’s protections” (internal quotations omitted).  In this case, however, a series of open questions remained to be answered, even after Judge Scheindlin’s prior decision. Namely:

What kinds of impairment violate section 316(b) the TIA? Did the TIA bar CEOC from releasing the CEC guarantee without first obtaining the consent of each noteholder?

The indenture trustee argued that any nonconsensual impairment of a security holder’s right to receive payment necessarily violates section 316(b) of the TIA.  In response, CEC argued that section 316(b) only applies to “core terms” of the debt instrument or to a “restructuring of the noteholders’ debt.”  CEC further argued that any alleged impairment must be evaluated as of the time of the challenged transaction – in other words, the termination of the CEC guarantee would only have been improper if CEOC was insolvent at the time that the guarantee was terminated (because if CEOC had been solvent, termination of the guarantee would not have constituted an impairment).  Similarly CEC argued that the CEC guarantee was never intended to provide value to noteholders, so the termination of the guarantee did not actually impair the noteholders.  And lastly, CEC argued that (at a minimum), there were material issues of fact regarding whether the challenged transactions constituted a “restructuring” of CEOC’s debt and summary judgment was therefore inappropriate.

In denying the indenture trustee’s motion for summary judgment, Judge Scheindlin agreed with CEC in certain respects, but rejected its arguments in other respects.

Did the Termination of the Guarantee Constitute an Impairment of the Notes?

The court began its substantive analysis by rejecting CEC’s argument that the guarantee was not a material term of the notes, but was simply a “regulatory device” to comply with SEC regulations.  Looking to the plain language of the indenture, the court observed that CEC had “irrevocably and unconditionally guarantee[d]. . . the full and punctual payment when due” of the notes.  Consequently, extrinsic evidence was not appropriate, given that there was no ambiguity regarding the unconditional nature of the guarantee.  The court similarly rejected CEC’s argument that the release provision in the indenture created an ambiguity regarding the nature of the guarantee because, even if that provision did permit CEC to be released from the guarantee under certain circumstances, any such release did nothing to change the fact that CEC had – in the first instance – provided the noteholders with a meaningful guarantee.  Finally, the court noted that even if the release provision had been triggered by CEOC’s conduct (which the court has yet to decide), such release is of no effect if it violates the TIA because (i) the indenture specifically states that the TIA governs in the event of any conflict and (ii) in any event, the release would be inherently invalid if that provision, on its face, violated the TIA.