In Through the Looking Glass, Lewis Carroll’s sequel to Alice’s Adventures in Wonderland, there is a famous exchange between Humpty Dumpty and Alice regarding the meaning of words. Toward the end of that dialogue, Alice asked Humpty Dumpty what he meant by the word “impenetrability.” Humpty Dumpty’s response was to not only give the word a meaning that would not be found in any dictionary, but to also expand the meaning he gave the word so that it required affirmative action on Alice’s part. In response, Alice proclaimed: “That’s a great deal to make one word mean.” In a recent decision by the U.S. District Court for the Southern District of New York, Wilmington Savings Fund Society, FSB v. Cash America International, Inc., Case No.15-CV-5027 (JMF), 2016 WL 5092594 (S.D.N.Y. Sept. 19, 2016), the word “may” was also seemingly made to mean a great deal.

The Wilmington decision is important because it appears to creates a heretofore unappreciated meaning to an optional redemption provision in the event there is any “voluntary” default by the issuer. According to this District Court, as a matter of New York law, an optional redemption provision effectively becomes a mandatory redemption obligation of the issuer anytime the issuer commits a voluntary default under an indenture and the noteholders determine not to accelerate the notes (and this notwithstanding that the indenture nowhere so provides).

Cash America, a Texas-based public company, issued $300 million of notes pursuant to an indenture. The indenture contained a covenant that stated that Cash America would not sell or dispose of any of its “properties.” One of the exceptions to that covenant, however, was that Cash America was permitted to make a disposition of its properties as long as “the aggregate book value of the properties disposed of … does not exceed” 10% of Cash America’s “Consolidated Total Assets.” The indenture also provided (by use of the word “may”) that Cash America had the option, but not the obligation, to redeem the notes prior to maturity as long as Cash America paid a “make-whole” premium in connection with any such redemption. The obligation to pay the make-whole premium was not, however, triggered by an event of default or an acceleration of the notes (both of which could have been so provided in the indenture).

In 2014, well before the 2018 maturity date of the notes, Cash America publically announced, and then subsequently completed, a spin-off of one of its significant subsidiaries, Enova, by distributing 80% of the common stock of Enova to Cash America’s shareholders. At the time of the spin-off, the book value of 10% of Cash America’s Consolidated Total Assets amounted to $208,174,100. The book value of 80% of Enova’s assets was apparently $608,350,040, well in excess of the disposition limit. And the indenture stated that “[f]or the purposes of determining book value of property constituting capital stock or similar equity interests of a Subsidiary of the Company disposed of … such book value shall be deemed to be the aggregate book value of all assets of the Subsidiary that shall have issued such capital stock or similar equity interest.” But Cash America took the position that, because the property being disposed of was Enova’s stock and the normal means of determining the “book value” of stock is to determine the net book value of the assets of the company that issued the stock by taking the book value of its assets minus its liabilities, the book value of 80% of Enova’s common stock was only $79,640,000, an amount that was well below 10% of Cash America’s Consolidated Total Assets and thus a permitted disposition.

The fact that the District Court granted summary judgment in favor of the noteholders regarding the question of whether Cash America had in fact violated the dispositions covenant in completing the spin-off should not come as a surprise to anyone. The District Court read the indenture and interpreted it according the actual words used in the indenture, much like the Second Circuit did recently in Chesapeake Energy Corp. v. Bank of N.Y. Mellon Tr. Co., No. 15-2366-cv (2d Cir. Sept. 15, 2016), which was discussed in a recent posting to Weil’s Global Private Equity Insights blog, available here. What was surprising, however, was the remedy the District Court fashioned for that covenant breach.

According to the District Court, because the indenture specifically stated that the traditional remedy of acceleration was permissive (i.e., Section 6.02 of the indenture provided that upon the occurrence of an Event of Default, the noteholders “may … declare the principal of and accrued interest on the Notes immediately due and payable”), and because the indenture specifically preserved the right of the Trustee to pursue “any available remedy … to collect the payment of principal of and interest on the Notes or to enforce the performance of any provision of the Notes or the Indenture,” a voluntary default under the dispositions covenant was enough to effectively convert an optional redemption right (which was a “may” in favor of Cash America) into a mandatory redemption feature that could be specifically enforced by the noteholders. So, the “may” in the right to accelerate the maturity of the notes in favor of the noteholders allowed the noteholders to forego acceleration, but then use their “any available remedy… to enforce performance” right to in fact accelerate (without actually accelerating) by treating the dispositions covenant default as if the issuer had in fact elected to redeem the notes by virtue of the default (thus triggering the payment of the make-whole premium that was not otherwise triggered by a default or acceleration by the noteholder). Accordingly, the issuer’s “may” became the noteholders “may” in terms of triggering the redemption feature with the corresponding make-whole premium.

There is caselaw aplenty declaring that the failure to specify that a make-whole is triggered by default or acceleration means that it is not in fact triggered by default or acceleration, but only by the issuer’s voluntary election to prepay. Indeed, there is even a New York Court of Appeals decision, Jade Realty LLC v. Citicorp Commercial Mortgage Trust 2005-EMG, 980 N.E.2d 945 (N.Y. 2012), declaring that a make-whole premium that was calculable only upon a default (based on the exact words used in the make-whole formula) was not payable on a voluntary prepayment—an admittedly odd result to have been so intended, but a result nevertheless dictated by the actual words used in the note. And yet the District Court, applying New York law, declared that a default in this context did in fact trigger the payment of the make-whole despite the failure of the indenture to so provide.

In reaching this result, the District Court did not suggest that the words of the indenture dictated this outcome; rather the District Court relied on a 1982 Second Circuit decision, Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039 (2d Cir. 1982), involving a situation in which an issuer adopted a plan of liquidation and then proceeded to carry it out through a series of transactions in an effort to specifically avoid a successor obligor provision in an indenture. By adopting the plan of liquidation, the issuer had effectively made the notes become due as a matter of law and, therefore, treating the resulting transactions as triggering the make-whole provision makes some sense. In the words of the Second Circuit:

The default here stemmed from the plan of voluntary liquidation approved on March 26, 1979, followed by the unsuccessful attempt to invoke the successor obligor clauses. The purpose of a redemption premium is to put a price upon the voluntary satisfaction of a debt before the date of maturity. While such premiums may seem largely irrelevant for commercial purposes in times of high interest rates, they nevertheless are part of the contract and would apply in a voluntary liquidation which included plans for payment and satisfaction of the public debt. We believe it undermines the plain purpose of the redemption provisions to allow a liquidating debtor to avoid their terms simply by failing to take the steps necessary to redeem the debentures, thereby creating a default. We hold, therefore, that the redemption premium must be paid.

It does not appear that any such plan or actual attempt to liquidate Cash America was involved in the Wilmington case. Cash America was not a “liquidating debtor” that had thereby caused the notes to become due. Rather Cash America was a non-liquidating issuer that had clearly defaulted under the indenture by completing the spin-off, but Cash America did not cause the notes to become due, or elect to redeem them; and the noteholders themselves determined not to accelerate precisely because the indenture did not provide for the payment of a make-whole in the case of an acceleration or default. The noteholders were aware of Cash America’s intent to complete the announced spin-off and could have exercised their right to “enforce the performance of any provision of the Notes or the Indenture” by seeking to enjoin the spin-off prior to its completion or to seeking to rescind the resulting spin-off after its completion. But the noteholders chose not to do so, as was their right.

Cash America defaulted on the notes by completing the Enova spin-off. And the noteholders had the right, but not the obligation, to accelerate the notes as a remedy for that default. The noteholders chose not to require the notes to be paid in full by accelerating. But having foregone their pre-breach remedies to prevent breach, the noteholders were also entitled to pursue any other available remedy for breach of contact. The traditional remedy for breach of contract, of course, is damages. Specific performance is normally only available as an equitable remedy where damages are in fact inadequate to compensate the non-defaulting party for the defaulting parties breach. And, as the District Court noted, “damages for breach of contract seek to place the non-breaching party ‘in as good a position as it would have been in had the contract been performed.’” Moreover, “contract remedies are generally designed to compensate the non-breaching party, not punish the breaching party for bad intent.” Indeed, as noted by the Delaware Supreme Court, in DuPont v. Pressman, 679 A.2d 436, 445 n.18 (Del. 1996), subject to the available remedy of damages, “the celebrated freedom to make contracts [includes] a considerable freedom to breach them as well.”

So, was the make-whole premium deemed damages for the default somehow, the theory being that the default had effectively deprived the noteholders of the benefit of their bargain and the only way to compensate for that breach was to require the notes to be repaid in full, with a make-whole premium? Or, was make-whole premium that was otherwise only payable in the event of an optional redemption by the issuer an implied liquidated damages provision that provided that an “available remedy” for any voluntary default under the indenture was to allow the noteholders to force the issuer to redeem the notes, with a corresponding make-whole premium?

The District Court did not suggest either such rationale. And, it is not clear that the noteholders suffered any actual damages as a result of this particular default. After all, Cash America still had approximately $1.47 billion in assets available even after the spin-off. Instead, relying upon Sharon Steel, the District Court suggested that it was specifically enforcing an obligation to pay the notes in full, with a make-whole premium, as a result of a “voluntary” default under the indenture.

Indenture interpretation for transaction planning by deal professionals and their counsel is a combination of carefully parsing the exact words used in the indenture and the application of applicable legal precedent as to the meanings of those words. To the extent that this decision constitutes or becomes precedent, there are some changes to drafting convention that may be required in the future to ensure that an optional redemption in favor of the issuer remains an option in favor of the issuer, and that an optional acceleration clause that does not provide for the payment of a make-whole doesn’t have the effect of doing so nonetheless.