Among the litany of events of defaults often found in indentures and other credit documents is an issuer’s admission in writing of its inability to pay its debts as they come due. Like other insolvency events of default, this one is automatic. No notice is required, and there is no cure period. Somewhat surprisingly, there is little case law interpreting the meaning of an issuer’s admission of inability to pay debts. What is considered an “admission” for these purposes, and in what context does such an admission need to be made? Two New York cases have addressed this question, although neither addressed circumstances in which creditors were seeking to put an issuer into default under an indenture or similar document.
Magten Asset Management Corporation v. The Bank of New York
In Magten Asset Management Corporation v. The Bank of New York,1 a bondholder sued an indenture trustee for failure to protect bondholder interests following an alleged event of default arising from an alleged admission by an issuer of its inability to pay its debts generally.
Magten was the holder of securities originally issued by Montana Power Co. in 1996 and subsequently assumed by NorthWestern Corp. The indenture for these securities listed the “admission [by the issuer] in writing of its inability to pay its debts generally as they become due” as an event of default.2 The Bank of New York was the indenture trustee.
Magten alleged that NorthWestern’s Form 10-K, filed with the SEC on April 16, 2003, constituted an admission by NorthWestern of its inability to pay its debt generally. The alleged admissions included the following:
- [B]ased on current plans and business conditions, the Company expects that its cash flows from operations, cash and cash equivalents will be sufficient to meet its cash requirements for the next 12 months.
- The Company believes that it may need additional funding sources or proceeds from the sale of noncore assets by the end of 2004 or early 2005. In 2005, the Company faces substantial debt maturities.
- Absent the receipt of significant proceeds from the sale of noncore assets, the raising of additional capital or a restructuring of existing debt, the Company will not be able to meet its substantial debt maturities.
- The Company is currently working with outside advisors to identify alternatives to restructure its long-term debt.
- Even if we are successful in selling some or all of our non-core assets, we will have to restructure our debt or seek new capital.
In September 2003, NorthWestern filed for bankruptcy. Shortly thereafter, BNY resigned as indenture trustee and a successor trustee was appointed. The securities issued under the indenture were treated as subordinated debt in the bankruptcy and were offered a small recovery.
Magten alleged that NorthWestern’s Form 10-K disclosure constituted an “event of default” under the indenture, which triggered an obligation on the part of BNY to take certain actions to protect bondholder interests. Because BNY failed to take these actions, Magten alleged that BNY was liable for breach of contract and fiduciary duties.3
The court rejected Magten’s argument. The indenture, the court said, requires an admission on the part of the issuer, not that the trustee itself examine whether the obligor was actually paying its debts or able to do so. While the financial reports indicated that NorthWestern was undergoing serious financial difficulties, in the view of the court this was not an admission by the issuer that it could not pay its debts as they came due.
D.B. Zwirn Special Opportunities Fund, L.P. v. SCC Acquisitions, Inc.
A more recent New York decision addresses similar language, albeit outside the indenture context. D.B. Zwirn Special Opportunities Fund, L.P. v. SCC Acquisitions, Inc.4 dealt with a carve-out guaranty pursuant to which the guarantor’s obligations were triggered only upon the happening of certain specified events, including if the borrower “admits, in writing, its insolvency or inability to pay its debts as they become due.” The borrowers subsequently delivered financial reports to the lender indicating that the borrowers’ liabilities significantly exceeded their assets.
The lenders sued the guarantor for payment on the guaranty, claiming that the only conclusion that could be drawn from the financial statements was that the borrower was insolvent and unable to pay its debts. The trial court agreed and ruled that the borrowers’ financial statements constituted an admission both of its insolvency and of its inability to pay its debts as they became due.
The Appellate Division reversed. Citing Magten, the appellate court held that “[a]lthough the affiliates’ financial reports show they were experiencing financial difficulty, the statements contained in the reports were not written admissions as contemplated by [the guaranty] because they did not contain the express statement required by the contract.”
Neither Magten nor D.B. Zwirn addresses a situation in which bondholders have sought to accelerate the debt of an issuer based upon an admission of inability to pay debts. Magten was concerned with the imposition of liability on a trustee, while D.B. Zwirn dealt with a carve-out guaranty, where the concerns and motivations of the document drafters could be different.5 Also, if as suggested by D.B. Zwirn, only a precise recitation of the inability to satisfy debts as they came due would satisfy the admission requirement for purposes of indentures and similar credit documents, this common provision would be virtually a dead letter.6 The contours for satisfying the admission requirement, therefore, arguably remain open. Nonetheless, Magten and D.B. Zwirn are important data points for interpreting the “admission” event of default and should be considered by bondholders seeking to invoke the provision against a distressed issuer.