While many amendments to bond indentures can be made without consent from all bondholders, “non-impairment” clauses provide that the indenture may not be amended or restructured in any way that will affect or impair a bondholder’s right to receive principal and interest when due without unanimous consent. Such clauses, which the Trust Indenture Act mandates in indentures governing publicly issued bonds, have long been viewed as a critical protection for minority bondholders, assuring payment of principal and interest when due under the indenture even if the majority of bondholders are willing to accept less than payment in full.

In Chapter 11, the restrictions imposed by nonimpairment clauses have typically deterred indenture trustees from negotiating settlements outside of a plan of reorganization. As such, the clauses have prevented debtors from cutting deals around minority bondholders without complying with Section 1129 of the Bankruptcy Code. To restructure bond debt, the debtor must therefore propose a plan that treats bondholders the same as other structurally similar creditors, or separately classify bondholders and either obtain their vote in favor of the plan (which requires over 2/3 in amount and in number of bondholders to accept their treatment) or meet the cramdown standards of Section 1129(b).

A recent decision by Bankruptcy Judge Adlai S. Hardin in the Delta Airlines case threatens to change this.1 In that case, the bankruptcy court approved a settlement agreement between an indenture trustee and the debtor over the objection of non-consenting bondholders. In so ruling, the judge held that once a debtor files for bankruptcy, non-impairment clauses are unenforceable. Relying on no direct authority, the court held that such clauses are “meaningless in bankruptcy because, unless the debtor is solvent and able to pay all creditors 100 cents, all creditors are impaired whether they consent or not.”2 “In default situations where contractual rights are already impaired by exogenous events,” it continued, “nonimpairment clauses are moot and the Trustee’s power to sue and settle subject to direction by a majority in amount or a specified minimum percentage will be sustained over the objection of a minority or individual.”3

The dissenting bondholders took an expedited appeal that was resolved in late August 2007 with District Judge John Koeltl affirming both the holding and the rationale of the bankruptcy court, while at the same time concluding that the appeal had been rendered equitably moot by the appellants’ failure to obtain a stay of the bankruptcy court’s order.4 The appellants have already appealed Judge Koeltl’s decision to the Second Circuit.

If upheld by the Second Circuit, these decisions threaten to change bondholder dynamics in Chapter 11 cases and the role of indenture trustees in settling bondholder claims. At the least, they will encourage more risk-averse bondholders to seek to direct indenture trustees to enter settlements that may not be acceptable to many bondholders. Moreover, the decisions will, in some cases, increase the leverage of minority bondholder groups. In some indentures, less than a majority can direct the indenture trustee to litigate—and, under the Delta decisions’ reasoning, settle—the claims of all bondholders. Indeed, in the Northwest Airlines case, Kramer Levin represented a bondholder resisting a settlement entered into by the indenture trustee at the direction of two bondholders holding only 48% of the issue that provided bondholders with an unsecured claim for only 58% of the face amount of their bonds. While the matter was successfully resolved without litigation, the indenture trustee made clear that it believed it had a right to settle claims upon receiving a direction from holders of as little as 20% of the bonds.

As long as the Delta decisions remain good law, bondholders should keep a close eye on discussions between the indenture trustee or other bondholder groups and the debtor, and should demand to be involved in any settlement discussions from the outset. If the indenture trustee demands that holders become restricted before speaking with them further, holders should contact counsel, who can sometimes work out arrangements with indenture trustees to obtain more information on their behalf.