Holders of publicly issued debt securities are afforded a variety of protections under the Trust Indenture Act of 1939 (the “TIA”). Among these are the provisions of Section 314(d)(1), which require issuers of secured bonds to comply with certain procedural requirements when collateral securing the bonds is released. In an appropriate (but admittedly rare) case, Section 314(d)(1) could provide protection to bondholders against an abusive collateral release.
The Basics of Section 314(d)(1)
Section 314(d)(1) provides for the delivery of a certificate or opinion to the trustee prior to the release of collateral secured by a lien under an indenture qualified under the TIA. The certificate or opinion must come from an engineer, appraiser or other expert. In addition to certifying or opining as to the fair value of the released collateral, it must include a statement that, in the opinion of the expert, the proposed release will not impair the security under the indenture in violation of the indenture’s terms. If the fair value of the collateral and all other property released since the beginning of the calendar year is less than 10% of the aggregate principal amount of the outstanding bonds issued under the indenture, the expert may be an officer or employee of the issuer. If it is 10% or more, the expert must be independent, and must be selected or approved using reasonable care. (If the collateral being released exceeds the 10% threshold, Section 313(b) of the TIA also requires the trustee to deliver a brief report to the holders of the bonds with respect to the release of collateral.)
Section 314(d) casts a wide net. It applies to any release of collateral having a fair value more than the greater of $25,000 or 1% of the principal amount of the outstanding bonds. Also, because the provisions of Section 314(d)(1) are automatically incorporated through the operation of Section 318(c) into every secured indenture qualified under the TIA, failure to comply with Section 314(d) could give rise to a default under the indenture, whether or not the indenture contains an express provision for reports to the trustee prior to the release of collateral.
SEC Qualifications to Section 314(d)(1)
In 2001, the SEC issued an order (Allied Waste N Am., Inc. (August 8, 2001)) in which it exempted the issuer from compliance with Section 314(d)(1) for its secured bonds, under the following circumstances: The collateral also secured other debt, to wit, credit agreement indebtedness. The bonds were to be secured under separate agreements where decisions regarding the collateral and the release of collateral were to be made by a party other than the trustee for the bonds, to wit, the lenders under a credit facility. Neither the trustee nor the bondholders had any control over the decisions affecting the collateral.
The conditions of Allied Waste are typically applicable in the case of second lien secured debt, and the SEC staff specifically granted no-action relief under Section 314(d)(1) for second lien debt in Pregis Corp. (December 7, 2007). The rationale of the exemption for second-priority liens rests on the inability of the second lien bondholders, directly or acting through their trustee, to control the release of the collateral. If they cannot control the release, the expert report contemplated by Section 314(d)(1) would not inform the exercise of any of their rights.
In 2002, the SEC issued an order (Algoma Steel Inc., (December 23, 2002)) exempting from Section 314(d)(1) dispositions of collateral in the ordinary course. The SEC staff had previously issued no-action letters (Mary Kay Cosmetics, Inc. (June 17, 1986); Jack Eckerd Corporation (February 5, 1991)) relieving issuers from complying with Section 314(d)(1) in similar circumstances. Ordinary course of business appears to include the disposition of inventory, accounts receivable, equipment leases, and obsolete equipment and the making of cash payments in accordance with the terms of the indenture. In providing the requested exemptive relief in Algoma Steel, the SEC noted the following: The indenture permitted the issuer to dispose of collateral in the ordinary course and to release the collateral from the lien of the indenture. The issuer would be delivering annual financial statements to the trustee. And the issuer would be delivering to the trustee a semiannual certificate stating that all dispositions of collateral during the relevant six-month period occurred in Algoma Steel’s ordinary course of business and that all the proceeds were used as permitted by the indenture.
While Section 314(d)(1) is incorporated into TIA-secured indentures by operation of law, indentures typically contain express language mirroring the requirements of the section. The formulation is usually along the following lines:
The Issuer will comply with the provisions of TIA Sections 314(b), 314(c) and 314(d), in each case following qualification of this Indenture pursuant to the TIA except to the extent not required as set forth in any SEC regulation or interpretation (including any no-action letter issued by the Staff of the SEC, whether issued to the Issuer or any other Person). . . .
Any release of Collateral permitted [hereby] will be deemed not to impair the Liens under this Indenture and the Security Documents in contravention thereof and any person that is required to deliver an Officer’s Certificate or Opinion of Counsel pursuant to Section 314(d) of the TIA, shall be entitled to rely upon the foregoing as a basis for delivery of [a required] certificate or opinion. . . .
Any certificate or opinion required by Section 314(d) of the Trust Indenture Act may be made by an Officer of the Issuer, except in cases where Section 314(d) requires that such certificate or opinion be made by an independent engineer, appraiser or other expert. . . .
Notwithstanding anything to the contrary herein, the Issuer and its Subsidiaries will not be required to comply with all or any portion of Section 314(d) of the Trust Indenture Act if they determine, in good faith based on advice of counsel, that under the terms of that section and/or any interpretation or guidance as to the meaning thereof of the SEC and its staff, including no-action letters or exemptive orders, all or any portion of Section 314(d) of the Trust Indenture Act is inapplicable to the released Collateral.
Of course, the fact that an indenture permits the release of collateral, and the recitation in the indenture that the permitted release of collateral will not be deemed to impair its liens, are insufficient to excuse compliance with Section 314(d)(1).
The Annotated Trust Indenture Act (67 Bus. Law. 919 (August 2012)), and an updating case law search, do not identify any cases decided under Section 314(d)(1) of the TIA, and it is likely that its provisions are rarely outcome determinative. Nonetheless, it should be a go-to provision of the TIA whenever an issuer disposes of collateral, and it would not be inappropriate to inquire of the trustee concerning the expert report on which a release of collateral is conditioned in the absence of the SEC-crafted exceptions. Compliance with an asset sale covenant is, of course, no excuse for failing to observe the requirements of Section 314(d)(1). Where something seems amiss with a non-ordinary course collateral disposition — e.g., what purports to be a fair value disposition does not seem to be so — Section 314(d)(1) could provide an avenue for remedy or redress. Aside from giving rise to a possible (additional) violation of the indenture, like all provisions of the TIA (and the other federal securities laws), the intentional violation of Section 314(d)(1) is potentially criminal under Section 325 of the TIA. Finally, the absence of a reference to Section 314(d) in a secured indenture, including in the TIA cross-reference table, could be indicative of third-party control over the collateral, which would invite close review of applicable intercreditor arrangements.