Market participants invest billions of dollars each year in debt, secured and unsecured. The credit support for the debt would be illusory without carefully crafted covenants that prevent the company from selling or transferring its assets outside the reach of creditors. Reliance on these covenants is critical for investors.

Like many issuers, Global Marine Inc. included such a covenant in its indenture when in 1998 it issued $300 million of 7% First Lien Notes. Nearly 20 years later, the trustee for the Notes, Wilmington Trust Company (WTC), filed a lawsuit asserting that a series of transactions from 2003 to 2016 stripped Global Marine of all or substantially all of its assets, leaving Global Marine an “empty box” with no ability to pay future debt service.

Global Marine moved to dismiss the case on the basis that the assets were sold validly by its subsidiaries, which were not bound by the same covenant, and that WTC’s lawsuit was barred by the statute of limitations, since the asset transfers occurred more than six years prior to WTC’s complaint. In May 2018, a New York state court denied the motion to dismiss, ruling that it would be premature to rule that the statute of limitations had run.

Global Marine

Global Marine is a holding company whose subsidiaries are (or were once) engaged in the “offshore turnkey drilling” business. When it issued the Notes in 1998, the company drilled oil and gas wells for its clients using a fleet of mobile offshore drilling rigs. The prospectus for the Notes stated that the company and its subsidiaries owned 31 mobile drilling rigs at that time.

The indenture for the Notes contained the following covenant regarding the sale of assets: “The Company shall not, in any transaction or series of transactions, consolidate with or merge into any Person, or sell, lease, convey, transfer or otherwise dispose of all or substantially all of its assets to any Person. ...” As is typical for these covenants, there is an exception to allow a sale of all assets if the purchaser executes a supplemental indenture in which it expressly assumes the obligation to pay the Notes and all other obligations of the company under the indenture.

At the time of issuance, Global Marine was a public company with its common stock listed on the New York Stock Exchange. Global Marine merged with another offshore drilling contractor in 2001 to become GlobalSantaFe Corp. As a result of the merger, Global Marine was a wholly owned subsidiary of GlobalSantaFe. Global Marine then chose to deregister as a public company and ceased to file financial statements with the SEC in 2002.

The Litigation

WTC filed a complaint on Nov. 28, 2017, in New York Supreme Court alleging that Global Marine breached the covenant by engaging in a series of transactions that sold all or substantially all of the company’s income-producing assets.1 It further argued that the breach constitutes a past and ongoing event of default giving rise to acceleration of the Notes and a make-whole payment due to noteholders.

According to WTC, the improper sale of Global Marine’s assets began in 2003. In 2003 and 2004, Global Marine transferred 20 of its 31 drilling rigs into a new subsidiary in which Global Marine held a 42% equity stake. WTC alleges that the company’s equity interest in the subsidiary — and as a result, in the 20 rigs — “appears to have ceased” in 2004.

In 2007, Global Marine’s parent, GlobalSantaFe, merged with Transocean Ltd. Transocean’s core business strategy is focused on deepwater drilling and does not involve the core assets of Global Marine. WTC contends that this systematic strategy led Transocean to transfer 11 of Global Marine’s 12 remaining drilling platforms in a series of transactions occurring in 2008, 2012, 2015 and 2016.

As of late 2017, Global Marine’s sole drillship, the C.R. Luigs, has been “cold-stacked” or essentially mothballed. WTC contends that Global Marine “at once held itself out to investors in its debt as ‘one of the largest offshore drilling contractors in the world,’ [and] now appears to have no business at all, and seemingly exists only as an empty box on Transocean’s corporate organizational chart.”

According to WTC, purchasers of the Notes relied upon the indenture’s covenant against sales for two reasons: “[T]he covenant protects Global Marine’s noteholders by ensuring that Global Marine has sufficient continuity of income-producing assets to meet its repayment obligations under the Notes, and the covenant ensures that Global Marine does not fundamentally transform the nature and character of the business that initially supported issuance of the Notes.” In other words, the covenant ensures that Global Marine would have the same fundamental characteristics and financial ability to the pay debt service on the Notes as the company did at issuance in 1998.

Starting in late 2016, noteholder CS Credit, a beneficial holder of more than 25% of the Notes, attempted to obtain information from Global Marine about the asset sales, since the company has not reported information publicly since 2002. Global Marine’s counsel asserted that the company had provided WTC with all necessary compliance certificates required under the indenture and would not provide further information requested by CS Credit. CS Credit served a notice of default to Global Marine on March 24, 2017.

The Notes continue to be paid timely and there is no allegation of any payment default.

The Company’s Motion to Dismiss

Global Marine filed a motion to dismiss the complaint on Jan. 26, 2018.2

In the motion, Global Marine asserted that when its subsidiaries sold their respective drilling rig assets, it did not constitute a sale of Global Marine’s assets. As a holding company, Global Marine’s assets consist of its equity in subsidiaries, cash and cash equivalents, and receivables. The sales alleged by WTC were not sales by Global Marine, but instead sales made by its subsidiaries.

Global Marine’s subsidiaries’ assets sales did not violate the indenture, according to Global Marine, because the asset sale covenant only restricts the company from selling all or substantially all of its assets. “Company” is defined to only include Global Marine. Other provisions in the indenture reference the company and its subsidiaries, so the reference to only the company in the asset sale provision means that the subsidiaries’ sales should not be subject to the covenant. WTC asserts that limiting the covenant to the parent company in this case would “render that promise effectively meaningless.”3

Global Marine then sought to dismiss the complaint on two grounds. First, even if the covenant applied to the company itself, Global Marine asserted that the action was time barred. The statute of limitations for a breach of contract, including the covenant at issue in Global Marine, is six years under applicable New York law. The issue is when the breach had occurred — if it was clear from the law that the company sold all, or substantially all, of its assets before 2011, then WTC’s complaint was time barred.

Global Marine argued that any sale of substantially all assets would have occurred in 2003 and 2004 when 20 of 31 rigs were transferred to non-subsidiaries. Furthermore, WTC alleged that the company began its “systematic strategy” of selling assets in 2008. Per that allegation, Global Marine contended that any covenant breach occurred in 2008. In either case, WTC’s complaint in 2017 meant that the breach fell outside the six-year statute of limitations period.

Second, the company asserted that CS Credit’s notice of default was deficient because the indenture requires a notice of default to be delivered by the indenture trustee or a registered holder (i.e., the registered holder Cede & Co. and not a beneficial holder such as CS Credit). Because WTC subsequently filed its own notice of default on Feb. 1, 2018, which Global Marine admitted was sufficient, the issue was dropped by Global Marine prior to oral argument.

Trial Court Denies the Motion to Dismiss

The court held oral argument on the motion to dismiss on May 14, 2018. The parties and the court appeared to agree — or at least did not dispute at oral argument — that whether the transactions amounted to a sale of “all or substantially all” of the company’s assets was something that could not be determined on a motion to dismiss. Assuming that the plaintiff would prevail on that issue, the legal issues of the covenant’s applicability to Global Marine’s subsidiaries and the statute of limitations remained.

During oral argument, Justice Barry R. Ostrager barely addressed Global Marine’s argument regarding the covenant’s applicability to Global Marine’s subsidiaries. The court asked Global Marine’s counsel: “This is a breach of contract action and you’re seeking to dismiss it on Statute of Limitations grounds. ... [If] the only party to the notes that is subject to [the covenant] is Global Marine Inc., then that’s not a Statute of Limitations motion; that’s a motion for failure to state a claim upon which relief can be granted.”

Following oral argument on the motion to dismiss, Justice Ostrager issued a brief decision on the record addressing the statute of limitations. Justice Ostrager determined that because at least some of the transactions at issue occurred after 2011, then it was inappropriate to dismiss the case. Further discovery is required, according to the court, even though Justice Ostrager remarked that “[Global Marine] may have a terrific motion for summary judgment that everything happened, for purposes of this indenture in 2003 and 2004 and the case should be dismissed on summary judgment.”

In colloquy, Justice Ostrager noted that future summary judgment briefing could focus on the issue of whether the 2003 and 2004 transactions constituted a sale of all or substantially all assets. WTC’s counsel disagreed as a factual matter and previewed one additional argument: Even if the company sold all its assets in 2003 and 2004, its covenant remained in place during the 2016 transaction. The company therefore could have violated the covenant in 2016 — within the statute of limitations window — by again selling all its assets (i.e., by selling the consideration it had received for the sale of its assets in 2003 and 2004).

Remarks

Holders of notes issued by a non-reporting issuer face a not insignificant challenge in following the business and affairs of the issuer and their impact on the creditworthiness of its debt instruments. Asset dispositions that can affect the credit support for its notes may not come to light until some time after the fact. Prior to the occurrence of an event of default, noteholders may not be able to rely on the trustee to be proactive in this regard, since before the occurrence of an event of default, the trustee’s duties are limited by the express terms of the indenture. It therefore behooves noteholders to remain on their toes and attempt to promote an information flow through appropriate direction to the trustee or otherwise.

Without active monitoring, when news of asset dispositions do come to light, the statute of limitations may pose an insurmountable bar to recovery irrespective of the merits. The recent ruling of the trial court in the Global Marine litigation is therefore positive news for noteholders. The decision appears to indicate that the New York courts will lend a sympathetic ear to noteholder plaintiffs seeking to avoid the draconian consequences of the statute of limitations at the pleading stage, and allow them the opportunity to access information through discovery on the basis of which they may be able to end-run the statute.

The summary judgment stage of the Global Marine litigation may produce further guidance on the treatment of serial asset sales and the applicability of the statute of limitations to disposition of assets in violation of an indenture.