In a highly-anticipated decision on a long-running bondholder dispute, the US Court of Appeals for the Second Circuit issued its judgment last week in Marblegate Asset Management LLC v Education Management Corp. It concluded that “Section 316(b) [of the US Trust Indenture Act 1939] prohibits only non-consensual amendments to an indenture’s core payment terms”, i.e. the amount of principal and interest owed and the maturity date. In doing so, it overturned a controversial first instance decision that expansively interpreted §316(b) to protect bondholders’ “practical ability” to receive full payment. The traditional view has been restored.

Section 316(b) Trust Indenture Act 1939

This section provides that the right of any bondholder “to receive payment of the principal of and interest on such indenture security, on or after the respective due dates” or “to institute suit for the enforcement of any such payment” shall not be “impaired or affected” without the consent of that holder. Whilst §316(b) applies to SEC-registered bonds, so-called “144A for life” bonds customarily contain indenture language similar to that of §316(b) (even though they are not technically required to contain the mandatory TIA provisions, and often expressly dis-apply the application of TIA provisions).

The appeals court in Marblegate confirmed the traditional, narrow interpretation of this section – namely, that it effectively prohibits majority bondholders from using collective action clauses collusively to modify an indenture’s payment terms. The appeal court rejected the broader interpretation adopted by the court of first instance (that §316(b) prohibited amendments that impair noteholders’ practical ability to receive payment).

The reversal of the controversial first-instance decision in Marblegate provides much-needed clarity regarding situations where a restructuring transaction may impact a distressed issuer’s practical ability to repay its bonds.

Relevance for European restructurings

In a global restructuring market, the implications of Marblegate stretch well beyond US borders. Indeed, of European HY bond issuances in the last three years, c.86% are governed by NY law.[1] Even if only a small proportion of that debt is SEC-registered, the indentures for the debt typically contain language similar to that of §316(b), as noted above. A court applying NY law would therefore most likely rely on §316(b)-related case law in interpreting the language. The Marblegate decision, therefore, is relevant to potential restructurings of all issuers of such debt, wherever they are incorporated.

In particular, the decision leaves open the potential use of an English scheme of arrangement to restructure NY law governed debt. TIA-governed indentures require unanimity to amend payment terms, while in Europe, typically, payment terms in indentures can be amended with 90% consent. The use of an English scheme therefore presents an alternative mechanism to implement a substantive restructuring with a much lower consent threshold: 75% in value and over 50% in number of those creditors voting on the scheme.

This has often been done by either (i) ensuring that jurisdiction is in the UK for scheme purposes (often CoMI) and obtaining recognition of the scheme (and underlying restructuring of the bonds) under Chapter 15 of the US Bankruptcy Code or, occasionally, (ii) changing the governing law from NY law to English law.

Given the issues raised in the appeal, careful consideration will need to be given to a potential change of governing law for the purposes of using a scheme, although we consider that the appeal suggests this avenue would not necessarily contravene §316(b). We also consider that using a scheme (without any change in governing law) to reduce the requisite approval level for any amendment to payment terms etc., from unanimity or 90% consent to 75% in value, does not contravene §316(b). This view is supported even further by the appeal court’s judgment.

Further information

For a detailed consideration of the judgment and key take-aways, see our US colleagues’ post on Weil’s Bankruptcy Blog here.