In a decision last month, DCF Capital, LLC v. US Shale Solutions, LLC (Sup. Ct. NY Co. Jan. 24, 2017), a New York State Supreme Court justice held that a noteholder that had properly accelerated indenture debt may sue to collect that debt notwithstanding the operation of a standard no-action clause. This holding, while appealing from a noteholder perspective, may not be compelled by Section 316(b) of the Trust Indenture Act on which it rests and is contrary to some prior case law.
Defendant US Shale Solutions was the issuer of notes under an indenture dated August 2014 and qualified under the Trust Indenture Act. Plaintiff DCF Capital was the holder of $1 million of the notes, which allegedly constituted a majority of the notes outstanding. The defendant failed to make interest payments on the notes on Sept. 1, 2015, and March 1, 2016. By letter dated March 4, 2016, the plaintiff’s manager wrote to the trustee under the indenture. In the letter, the plaintiff stated that it held a majority of the outstanding notes, that under the indenture the trustee or 25% of the holders of the outstanding notes could accelerate the notes, and that “we would like to instruct [the Trustee] to exercise its power to accelerate repayment of our notes (including principal and interest) immediately.”
The trustee did not accelerate the notes, nor did it commence any suit against the defendant issuer to collect on the notes.
In August 2016, the plaintiff filed its action for breach of the indenture. The defendant issuer moved to dismiss, arguing that the plaintiff had failed to comply with the conditions precedent in the no-action clause of the indenture. As is customary, those provisions included requirements that the holder has given notice to the trustee of a continuing event of default; that holders of at least 25% of the aggregate principal amount of the notes have made written request to the trustee to pursue a remedy; that the holders offer and, if requested, provide to the trustee indemnity; that the trustee has not complied with the request within 60 days; and that holders of the majority of the outstanding notes have not countermanded the request within the 60-day period. The plaintiff conceded that it was not in compliance with the requirements of the no-action clause, as it had not offered indemnity to the trustee.
The plaintiff’s response, and indeed its conduct in the case, appears curious. The plaintiff argued that it was not required to provide indemnity as it was only demanding that the trustee serve a notice of acceleration rather than commence suit against the issuer. The plaintiff also argued that its failure to comply with the no-action clause was irrelevant because it had the right under the indenture to bring suit for enforcement of payment. Of course, the real answer should have been that the no-action clause is wholly inapplicable to acceleration, where the noteholders are free to act on their own and aren’t required to first make demands on the trustee. Indeed, as the court noted, it was unclear why the plaintiff even made a demand upon the trustee to accelerate, as it was the alleged holder of in excess of 25% of the outstanding notes.
The Court’s Decision
Sorting through this strange record on a motion to dismiss, the court proceeded as follows. First, it observed that Section 316(b) of the TIA gives a noteholder the absolute right to sue for payment without compliance with the no-action clause. Second, as a holder of at least 25% of the aggregate principal amount of the notes, the plaintiff had the right to accelerate the notes by reason of the missed interest payments. Third, the court held that the complaint itself could serve as a demand for acceleration, because the indenture does not prescribe any specific form of acceleration notice. And finally, having so accelerated the notes, the plaintiff was assured by Section 316(b) of the right to sue for nonpayment, any alleged precondition in the indenture to the contrary notwithstanding. Accordingly, the court denied the motion to dismiss.
The decision was rendered in the context of the motion to dismiss, and the court did not have the benefit of a factual record which might have clarified the various curiosities of this case, some noted by the court and others that may be inferred by a reader.
The court’s conclusion that the pre-emptory provisions of TIA 316(b) apply to the full principal amount of notes under an indenture once they have been properly accelerated is perhaps plausible — and certainly appealing from a noteholder perspective — but by no means compelled. Section 316(b) speaks of the right to receive “payment of principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security.” In the absence of a detailed review of the history and purpose of Section 316(b), which the court did not undertake, it is not self-evident that the term “due date” was intended to include obligations due by acceleration. While no court appears to have addressed the issue in depth, some cases have assumed that Section 316(b) does not in fact apply to accelerated debt. See Brady v. UBS Financial Services, 538 F.3d 1319 (10th Cir. 2008) (in the context of addressing a statute of limitation issue, courts takes for granted that a no-action clause applies to a suit on accelerated debt); McMahan & Co. v. Wherehouse Entertainment, Inc., 859 F. Supp. 743, 747-48 (S.D.N.Y. 1994) (Section 316(b) does not preempt applicability of a no-action clause to enforcement of a change of control put, reasoning by analogy to an “acceleration of payment of principal and interest, the time of which is not certain and, indeed, may never come”), aff’d in part, rev’d in part on other grounds, 65 F.3d 1044 (2d Cir. 1995). Indeed, careful drafters, when they want to assure that maturity includes accelerated maturity, take pains to make that point explicitly in the documentation.
The court’s holding that a complaint purporting to sue on unpaid principal and interest of a defaulted note is the equivalent of a notice of acceleration is also interesting. Possibly, the court was simply reasoning that it would be a wasted exercise in form over substance to require the plaintiff — if it truly was the holder of a majority of the notes — to send a formal notice of acceleration. Or maybe the court was acting on legal principle. In this regard, it drew an analogy to a case in which a New York appellate court construed a complaint as fulfilling the notice requirements of the UCC. This is obviously not a scenario that is likely to arise with any regularity and, in and of itself, has no great import. Still, even seemingly innocuous departures from the strict construction of indenture documentation are out of keeping with the rigorousness that is commonly applied to indenture interpretation. In that sense, the court’s decision may be a departure from the norm.