Key Notes:

  • Congress is considering amending the Trust Indenture Act (TIA)
  • The amendment is being considered in the context of an omnibus spending bill, not as standalone legislation
  • The amendment centers on Section 316(b) of the TIA and would impact corporate trustee duties and liabilities if passed
  • The amendment would implicate corporate restructuring, bankruptcies and the rights of minority bondholders

Congress is currently considering amending the Trust Indenture Act (TIA), according to news reports this week. While the legislative situation remains fluid in Washington as legislators negotiate a roughly $1.1 trillion omnibus spending bill under deadline, it is clear that when the dust settles, the TIA, which has long set guidelines for the issuance of a significant portion of corporate debt in the United States, may be changed in a way that stands to impact corporate trustees.

Initially passed in 1939 to protect unsophisticated “mom and pop” bondholders from unfair practices, the TIA has rarely been amended in its 76-year lifespan. Currently, however, the corporate trust industry is keeping a close eye on the proposed amendment, which proponents say is harmless and merely meant to clarify an ambiguity in the TIA and overturn recent outlier court decisions requiring unanimous bondholder decisions. Opponents say the amendment would make it more difficult for a minority bondholder to contest issuer restructuring actions.

Background

Section 316(b) of the TIA, the central focus of attempts to amend the TIA in Congress, has been litigated recently in federal courts in New York. This provision is meant to prevent the impairment of a bondholder’s right to payment of principal and interest absent unanimous consent[i]. Historically, this section had been read narrowly to protect bondholders from any impairment in the procedural sense (i.e., barring a bondholder’s right to sue). New York Federal District Court Judge Scheindlin, however, applied a broad interpretation to this provision and ruled in favor of minority bondholders in June 2015 in Marblegate Asset Management v. Education Management Corp. (known also as Marblegate II)[ii]. Judge Scheindlin held that the TIA was violated by eliminating a parent guarantor that would, in effect, leave the issuer, Education Management Corp. (EDMC), assetless and deprive the bondholders of future payments. This holding required unanimous bondholder approval despite the fact that the release of the parent guarantor was expressly permitted under the relevant indenture and a majority of bondholders had consented to the release.

The current legislative consideration of an amendment to the TIA is not the first to flow from Marblegate II. From a political standpoint, the defendant in Marblegate II, EDMC, is opposed by many pro-student organizations and lobbying groups. EDMC is a for-profit college organization that has been accused of predatory practices and deceptive recruiting.[iii] As a result, when an amendment to the TIA (which would have limited Section 316(b)’s reach to procedural impairments only[iv]) was proposed in a federal transportation bill several days ago, it did not come as a surprise when pro-student lobbying groups rallied against it and succeeded in removing the amendment from the bill altogether. This reaction was fueled by the concern that the amendment to the TIA would translate to a bailout for EDMC and assist EDMC in avoiding bankruptcy (by circumventing Judge Scheindlin’s ruling).

Although it seemed as if EDMC had lost the legislative fight, a substantively similar amendment has now made its way into discussions surrounding the federal omnibus spending bill this week (although one source indicates that the amendment now explicitly carves out EDMC). Also implicated in this amendment is the casino giant Caesars Entertainment, whose operating company is currently in bankruptcy. Caesars has been similarly sued by minority bondholders in connection with a parent guarantor release[v]. The involvement of both of these controversial entities and cases has only served to solidify opponents’ belief that this amendment is a special interest push quietly (or not so quietly) tucked away in a massive bill.

Future Implications

Regardless of the political drive behind this amendment, its approval would have significant consequences for minority bondholders’ rights. The narrowing of Section 316(b) of the TIA could mean that out-of-court restructurings could go unchecked by the courts and leave minority bondholders with an “empty right” to recovery. The limitations on out-of-court restructurings may, in turn, increase bankruptcies.

Although the “mom and pop” bondholders the original TIA was designed to protect are rarely seen in the current landscape, the underlying concern remains relevant for any remaining minority bondholders. Eighteen law professors wrote Congress warning of the perils of amending the TIA in the harried context of the spending bill instead of through separate, adequate deliberation.[vi] The deadline to pass the spending bill was originally December 11th but has been extended to December 16th.