A recent case out of the Southern District of New York, Citibank, NA, London Branch v. Norske Skogindustrier ASA(S.D.N.Y. March 8, 2016), once again illustrates the difficulty of obtaining injunctive relief against prospective indenture violations of a financially troubled issuer.

The Facts

Norske was a Norwegian-headquartered paper company with global operations and paper mills in several countries. The company had two issues of near-term maturing debt, €121,421,000 principal amount of 11.75% notes due 2016 and €218,106,000 principal amount of 7% of senior notes due 2017. Norske was experiencing liquidity issues, and in February 2015, to shore up its finances, the company issued €290,000,000 principal amount of 11.75% senior secured notes due 2019. The 2016 and 2017 notes were unsecured. The 2019 notes were guaranteed by various subsidiaries of the company and secured by the stock of the subsidiary guarantors and assets located in Australia and Tasmania, but not Norske’s assets located in Europe or certain European bank accounts.

Despite the added liquidity from the 2019 notes, Norske’s financial situation continued to deteriorate, and by the end of 2015, it faced default on upcoming principal and interest payments due on the 2016 and 2017 notes. After fits and starts, in December 2015, Norske entered into an agreement with principal holders of the 2016 and 2017 notes whereby the company would offer to exchange those notes for a package of securities consisting of exchange notes, unsecured notes, perpetual notes and equity subscription rights. Importantly, the exchange notes were to be secured by the unencumbered assets of the subsidiary guarantors, including European paper mills and bank accounts.

With the exchange offer initially set to close in February 2016, Citibank, acting through its London branch in its capacity as indenture trustee for the 2019 notes, brought an action in New York State Supreme Court to enjoin the exchange offer as being in violation of the indenture for the 2019 notes. The New York state court issued a temporary restraining order, after which the case was removed to federal court in the Southern District of New York. Following briefing and a hearing, the district court denied the request for an injunction. As is conventional, the court considered whether the plaintiff was likely to succeed on the merits and whether the plaintiff would suffer irreparable injury absent an injunction. While the court indeed found that the exchange offer, upon consummation, would violate the 2019 notes indenture, it declined to issue an injunction because of the failure to satisfy irreparable harm.

The Arguments and the Court's Analysis

Citibank’s claim that the exchange offer violated the 2019 notes indenture rested on the interpretation of competing provisions of the indenture’s indebtedness covenant. On the one hand, the covenant included a refinancing basket, but expressly excluded from that basket a refinancing of the 2016 and 2017 notes. On the other hand, the covenant contained a basket for qualified securitization financing (QSF), defined as “any financing” pursuant to which the issuer or any guarantor transfers or grants a security interest in specified assets. Norske had maintained that it was permissible to issue the exchange notes under the QSF basket even though the issuance of the exchange notes as a refinancing would be prohibited under the refinancing basket. The indenture for the 2019 notes, it was noted, expressly allowed the issuer to select among available baskets for the purpose of permitted issuances. Citibank challenged this analysis. It argued that the QSF basket was available only for financings, i.e., new money debt raises, and not a “refinancing” such as the exchange offer. The court sided with the plaintiff and adopted the textual distinction between a “financing” and a “refinancing.” Likelihood of success on the merits was therefore established.

Next, Citibank argued that if the exchange offer were not enjoined, it would suffer irreparable harm. According to Citibank, the exchange offer was unlikely to permanently repair Norske’s perilous finances and a bankruptcy filing was likely to occur. Absent the exchange offer, the assets that would secure the exchange notes would be unencumbered and therefore available to other creditors, including the holders of the 2019 notes, for recovery in bankruptcy.

The court rejected Citibank’s contentions on a number of grounds. First, the court said, Citibank had not demonstrated that a default on its own debt was imminent, and indeed there was testimony that should the exchange offer go forward, the company would continue to make payment on the 2019 notes. The court observed, moreover, that if the exchange offer were not allowed to proceed, the company would be in a worse financial position. Furthermore, the court accepted apparently uncontested testimony that the collateral currently securing the 2019 notes would be adequate to repay the notes in full in bankruptcy. Finally, the court rejected plaintiff’s claim that the “insolvency exception” to the irreparable harm test should be applied. Under that exception, courts have held that in the face of an issuer’s impending insolvency, irreparable harm will be deemed to exist. The court declined to apply the exception, because insolvency of the issuer was more likely to occur were the court to issue the requested injunction.

Finding no irreparable harm, the court rejected Citibank’s request to scuttle the exchange offer. In denying the requested injunction, the court made a point of citing to Judge Faila’s decision in Marblegate Asset Management v. Education Management Corp., 75 F. Supp. 3d 592 (S.D.N.Y. 2014). In that case, famous for finding a violation of Section 316(b) of the Trust Indenture Act, the court denied injunctive relief notwithstanding its determination that a pending restructuring would violate the TIA and the severely compromised financial condition of the issuer.

The Takeaway

The case offers a number of lessons. First, courts may be receptive to arguments based on fine textual nuances in interpreting complex indenture provisions and holding issuers to a literal reading of their debt documents. Second, as inMarblegate, courts may refuse to interfere with restructuring efforts that seek to avoid an imminent descent into insolvency, notwithstanding legal or contractual niceties that would be violated in the course of the restructuring. Each case, of course, turns on its facts, and other outcomes could be expected where harm to nonparticipating debt holders is more palpable. Nonetheless, the case provides a useful data point for judicial approaches to financially charged situations where competing interests of debtholders pull indenture interpretation in different directions.