No-action clauses — those standard provisions of indentures that prohibit individual bondholders from undertaking enforcement actions unless a prescribed series of steps are observed — continue to be of interest. In June 2014, the New York Court of Appeals in Quadrant Structured Products, LTD v. Vertin, 23 N.Y. 3d 549 (N.Y. 2014), strictly construed a no-action clause and held that noteholders could proceed with common law causes of action relating to the subject notes. The court observed that the indenture there limited the no-action restrictions to “the indenture and rights thereunder,” and therefore did not reach common law causes of action that might arise in respect of the notes. Recently, a case in the Southern District of New York had occasion to revisit a long-running question of the extent to which no-action clauses apply to suits against the trustee of an indenture. In BlackRock Core Bond Portfolio v. U.S. Bank National Association (S.D.N.Y. February 26, 2016), Judge Katherine Forrest carefully analyzed the issue and concluded that such clauses are wholly inapplicable to such suits.

The Facts

BlackRock Core Bond Portfolio is yet another one of the cases arising out of the RMBS meltdown in the latter half of the preceding decade that are wending their way through the trial courts. The plaintiffs in the case are a group of investors in 27 Delaware statutory trusts created between 2004 and 2007 that issued residential mortgage-backed securities backed by billions of dollars’ worth of loans, many of which did not live up to the represented criteria for inclusion in the securitization. The investors sued U.S. Bank in its capacity as indenture trustee, alleging a variety of claims, including breach of contract, violations of the Trust Indenture Act, breach of fiduciary duty and conflict of interest.

The Court's Analysis

The no-action clause at issue is typical. Holders of notes are prohibited from instituting any proceeding with respect to the indenture unless (1) the holder has given written notice to the trustee of a continuing event of default; (2) the holders of not less than 25% of the outstanding notes have made a written request to the trustee to institute the proceeding; (3) the holders have offered the trustee reasonable indemnity; (4) the indentured trustee has failed to institute the proceeding within 60 days after its receipt of notice and offer of indemnity; and (5) no inconsistent direction  is given to the indenture trustee during such 60-day period by holders of the majority of the outstanding notes.

In their bid to avoid application of the no-action clause, the plaintiffs relied on a Second Circuit decision from the early 1990s, Cruden v. Bank of New York, 957, F. 2d 961 (2nd Circuit 1992). In that case, the Second Circuit famously stated that no-action clauses are to be strictly construed. It went on to hold that such clauses should not be interpreted to require a demand on a trustee to sue itself, an exercise that would obviously be futile. In her carefully reasoned opinion, however, Judge Forrest observed that Cruden did not end the inquiry. While Cruden stands for the proposition that demand on the trustee to commence such a suit is not required, the court in Cruden was not required to, and did not, address the question of whether other provisions of a no-action clause may nonetheless be applicable to suits brought by bondholders against their trustee.

Relying on general principles of contract interpretation, the court engaged in a granular analysis of the various provisions that constitute the no-action clause. While conceding that certain parts of the no-action clause could have independent application, the court nonetheless concluded that the no-action provisions must be read as a whole. Each subpart, the court said, provides a foundational step to implement the full process. The court therefore held that when the demand requirement falls, the entire clause likewise falls away, including any requirement of written notice to the trustee.

The Takeaway

Despite the implications of Cruden and BlackRock Core Bond Portfolio appearing to impart a presumption of narrowness to the no-action clause, practitioners should not assume that courts will read these clauses tightly. Thus, as implied by Quadrant, where a no-action clause addresses remedies “with respect to this indenture or the securities,” courts will bar noteholders from independently pursuing breach of fiduciary duty, fraudulent conveyance claims or similar claims, even though they fall outside the four corners of the indenture. Lang v. Citibank, N.A. (Del. Ch. 2002);Feldbaum v. McCrory Corp. (Del. Ch. 1992) (both applying New York Law). Also, courts will apply the no-action clause not only to suits against the issuer, but also to claims against non-issuer defendants. Feldbaum v. McCrory Corp.Careful attention must be paid to the wording of the no-action clause in each specific case, and aside from suits against indenture trustees, these clauses remain a serious impediment to unilateral action relating to indenture debt by individual bondholders.