The law on debt restructurings and liability management is back to where it was. Yesterday, the Second Circuit Court of Appeals reversed the controversial District Court decisions in the Marblegate-Education Management bondholder litigation. The case attracted wide-spread attention in financial markets, and we discussed it in an earlier client alert. The District Court interpreted the non-impairment provision in section 316(b) of the Trust Indenture Act, a Depression-era statute governing bond indentures. The provision prohibits a bondholder’s right “to receive payment” of principal and interest on the respective due dates expressed in the bond from being “impaired or affected” without the bondholder’s consent. According to the District Court, the provision prohibited not just amendments to payment terms, but also other transactions that affected a bondholder’s practical ability to recover—at least when they occurred in connection with a “debt restructuring.”
In a 2-1 decision, the Second Circuit found the meaning of section 316(b) ambiguous. Due to that ambiguity, the court resorted to the legislative history to determine its meaning. The court quoted from SEC reports, the Congressional record and various sources on restructuring law and practice in the 1930s. Using arguments developed in a law review article by Shearman & Sterling Capital Markets partner Harald Halbhuber that is cited in the opinion, the court concluded that foreclosure-based reorganizations not unlike the one in Marblegate were a well-known restructuring technique at the time. Based on the historical evidence, the court was convinced that Congress did not intend to ban such restructuring techniques.
Going beyond foreclosures, the Second Circuit’s opinion affirmatively states that section 316(b) “prohibits only non-consensual amendments to an indenture’s core payment terms.” According to the opinion, core payment terms are “the amount of principal and interest owed, and the date of maturity.” Although not the subject of this appeal, the broad holding of the Second Circuit probably also effectively overrules the District Court decisions in the Caesars bondholder litigation that had followed and expanded Marblegate.
For the new issuance market, the decision means that there may now be less pressure for high yield issuers to avoid the Trust Indenture Act by issuing under Rule 144A for life. However, Rule 144A for life also has other benefits, including the absence of an SEC requirement for Rule 3-10 consolidating guarantor/non-guarantor financial information.
For debt restructurings and liability management, the decision brings the law back to where most practitioners thought it was before Marblegate. Among other things, the decision provides issuers some comfort that they can again seek to implement exchange offers through the use of exit consents without uncertainty that such exchange offers will be found to violate section 316(b). Such exchange offers may involve, among other things, the stripping of covenants, removal of anti-layering protections, release of collateral and the release of guarantees. Additionally, so-called uptiering exchange offers (i.e., the exchange of secured debt for existing unsecured debt) should no longer have to be capped at what is available under the existing lien baskets to avoid uncertainty regarding section 316(b).
The inapplicability of the Trust Indenture Act does not mean that there are no restrictions on the ability of companies to incentivize bondholders to participate in non-bankruptcy restructurings. The opinion of the Second Circuit contains a useful reminder that bondholders, just like other creditors, can always attack restructurings under fraudulent conveyance, successor liability or similar equitable theories.
One of the three judges on the panel dissented and sided with the plaintiff Marblegate. He did not see any ambiguity in the statutory language of section 316(b) and therefore did not consider the legislative history. In light of the dissent, it seems possible that the plaintiff will ask for a rehearing of the decision by the full court. If the rehearing request is unsuccessful, as it typically is, the plaintiff may seek review by the U.S. Supreme Court. Stay tuned.