A New York trial court recently held that a breach of contract claim brought by a third-party beneficiary noteholder of an indenture could proceed to trial against the indenture trustee, JPMorgan Chase Bank (“JPMC”), based on JPMC’s withholding disbursements from the noteholder to indemnify itself for fees and expenses for anticipated litigation. Harch International Limited v. Harch Capital Management, Inc., 601312/2005 (N.Y. Co.). JPMC moved for summary judgment arguing that its decision to create a reserve account to indemnify itself for future liabilities was contemplated by the terms of the indenture. In denying JPMC’s motion, the court found that material issues of fact existed regarding the reasonableness of JPMC’s decision to withhold the funds, and that JPMC had not established that it was entitled to indemnify itself with the specific funds at issue as a matter of law.  


In 1997, Harsh Capital Management, Inc. (“HCM”) sponsored the formation of Harch International Limited (“HIL”), an off-shore hedge fund, and subsequently became HIL’s investment advisor. In 2000, HCM additionally sponsored the formation of Harch CLO I Limited (“Harch CLO”), a special-purpose entity created to issue notes secured primarily by collateralized debt obligations. HCM was further retained as Harch CLO’s collateral manager pursuant to a collateral management agreement. Harch CLO issued four classes of notes pursuant to an indenture (the “Indenture”) between itself, as issuer; Harch CLO I Corporation, as co-issuer; and JPMC, as trustee. The noteholders further were the intended third-party beneficiaries of the Indenture, but not parties to it. JPMC’s rights and obligations as trustee were defined by the Indenture, including its obligation to administer the proceeds from the note issuance. The Indenture included an indemnification clause pursuant to which Harch CLO was to indemnify JPMC against losses or expenses arising out of its obligations as trustee, and reimburse JPMC for certain funds expended in accordance with its terms (the “Indemnification Clause”).  

As HIL’s investment advisor, HCM invested $30 million of HIL’s capital in 100% of the Class D Subordinated Notes issued under the Indenture. In early 2005, after determining that HCM had failed to inform HIL of certain reinvestments in additional Class D Subordinated Notes, HIL demanded that Harch CLO redeem all the outstanding notes. Harch CLO complied with this request in March 2005, but retained an incentive fee. As part of Harch CLO’s requested liquidation, JPMC received approximately $1.45 million in accrued interest payments from the note issuance (“Accrued Interest Funds”), which it held in trust in a specifically designated account (the “Collection Account”).  

In April 2005, HIL commenced an action against HCM and Harch CLO to recover the retained incentive fee. Upon the threat and eventual commencement of the lawsuit, HCM and Harch CLO sent demands for indemnification to JPMC to pay their legal fees in connection with the litigation. In anticipation of the accruing costs associated with the pending action, its probable involvement in the litigation, and its belief that it would be entitled to the Accrued Interest Funds pursuant to the Indemnification Clause, JPMC sent notice to HIL and other noteholders that it had transferred the Accrued Interest Funds to a separate interest-bearing account (the “Reserve Account”) and refused any request to disburse those funds pending resolution of the action.

In September 2005, HIL filed an amended complaint adding JPMC as a defendant, and asserting two additional causes of action against JPMC for breach of contract. The amended complaint alleged, in part, that JPMC breached the Indenture when it transferred the Accrued Interest Funds to the Reserve Account and refused to disburse the funds to the noteholders. In November 2005, JPMC served its answer and asserted two counterclaims. JPMC’s first counterclaim interpleaded the Accrued Interest Funds due to the conflicting claims arising over them, and asserted JPMC’s right to indemnification for fees and expenses. The second counterclaim sought a declaration that JPMC was entitled to payment priority from the Accrued Interest Funds under the terms of the Indenture. After more than five years of motion practice, including several previous motions and cross-motions for summary judgment, JPMC filed a motion for summary judgment to dismiss HIL’s remaining breach of contract claim and to grant JPMC’s counterclaims for indemnification and payment priority. The court denied the motion in its entirety.

The Breach of Contract Claim

JPMC first argued that HIL’s claim for breach of contract should be dismissed because the terms of the Indenture permitted JPMC’s decisions to preserve the Accrued Interest Funds and to withhold disbursements to address any potential future liabilities. Although the Indenture did not explicitly authorize the establishment of the Reserve Account, JPMC believed that it was authorized, in part, by a broadly drafted section of the Indenture stating that “the Trustee shall not be liable for any action it takes or omits to take in good faith that it reasonably and prudently believes to be authorized or within its rights or powers hereunder.” JPMC argued that it did not breach the Indenture because its decision to create the Reserve Account to preserve the Accrued Interest Funds was made in good faith and prudent under the circumstances. JPMC reasoned that if it had disbursed the Accrued Interest Funds, it potentially would have put its own funds at risk and incurred liabilities to HCM and Harch CLO, each of whom demanded indemnification from JPMC.  

The court rejected this argument, ruling that whether JPMC’s decision to withhold the Accrued Interest Funds was prudent or made in good faith was not an issue for the court to decide on summary judgment. Instead, the terms of the Indenture required an additional inquiry into whether JPMC’s belief that its actions were authorized under the Indenture was reasonable. Because the Indenture did not explicitly authorize Defendant to establish a Reserve Account or to refuse disbursement of the Accrued Interest Funds, the court ruled that whether JPMC’s actions in doing so were reasonably necessary depended on all of the relevant circumstances, and is generally a question of fact that precludes summary adjudication. The court further clarified that despite rejecting JPMC’s summary judgment motion, it was not finding that JPMC had breached the Indenture. Instead, the holding only determined that JPMC failed to conclusively establish as a matter of law that its actions were not a breach of the Indenture and, therefore, the case should proceed to trial on that issue.

Counterclaims for Indemnification

JPMC further argued for summary judgment in favor of its counterclaims seeking a declaration that JPMC was (i) entitled to indemnification from the Reserve Account, and (ii) entitled to payment priority of the Accrued Interest Funds. JPMC argued that the indemnification’s broad language applies to third-party claims and that the Indenture’s “waterfall” provision required Harch CLO to pay any indemnification claims by JPMC before HIL or HCM received any payments.  

The court, however, found that JPMC had not conclusively shown that it was entitled to indemnification from the Accrued Interest Funds pursuant to the terms of the Indenture. Although the express terms of the Indenture required indemnification for attorney’s fees expended for third-party claims such as the instant lawsuit, the Indenture did not similarly explicitly entitle JPMC to indemnification specifically from the interpleaded Accrued Interest Funds. The court noted that, while the Indenture allowed JPMC to deduct money deposited in a “Payment Account,” it did not address whether JPMC could further indemnify itself from the funds deposited in the separate Collection Account, the original source of the Accrued Interest Funds before JPMC transferred them to the Reserve Account. Similarly, while the Indenture granted JPMC payment priority for its accrued fees and expenses over any the noteholders’ rights to interest payments, the explicit right to payment priority referred only to deposits in the Payment Account. Finding that the Indenture did not resolve all questions of fact regarding whether JPMC could indemnify itself from the Accrued Interest Funds or its right to payment priority from the Collection Account, the court denied JPMC’s motion.


The Harch International Limited decision demonstrates the importance of a well-drafted indemnification provision to mitigate the potential upfront litigation costs faced by indenture trustees whom are often thrust into disputes between issuers and noteholders. Even a broadly worded provision providing comprehensive indemnification for a trustee’s “reasonable” actions may force the trustee to later litigate through trial its right to recoup its costs and expenses.