In a 2-1 opinion, the Second Circuit overruled the district court in Marblegate Asset Management LLC v. Education Management Corp., finding no violation of the Trust Indenture Act (“TIA”) in connection with an out-of-court debt restructuring.

Background

Section 316(b) of the TIA provides that “the right of any holder of an indenture security to receive payment of the principal of and interest on such indenture security . . . shall not be impaired or affected without the consent of such holder.” Most courts to consider the issue have interpreted Section 316(b) as prohibiting the impairment of only the core payment terms of principal amount owed, interest rate and maturity date. However, three district court decisions, including the decision on appeal in the Marblegate case, held that Section 316(b) also precludes impairment of the practical ability to recover on notes.[1]

In Marblegate, the issuer, EDMC, conducted an out-of-court restructuring of approximately US$1.5 billion of debt to avoid a bankruptcy filing which would have rendered it ineligible for federal student-aid funding on which it depends for its existence as a for-profit education company.

Dissenting noteholders included plaintiffs (collectively, “Marblegate”), who held approximately US$14 million of EDMC’s unsecured notes and refused to participate in EDMC’s debt-for-equity exchange. Marblegate sued and bought a motion to enjoin the restructuring, arguing that it violated the TIA. The U.S. District Court for the Southern District of New York denied Marblegate’s motion, finding that the plaintiffs would not be irreparably harmed by the restructuring. However, the court found that Marblegate was likely to succeed on the merits of the case, holding that the TIA should be interpreted broadly and that Section 316(b) was intended to prevent majority noteholders from forcing out-of-court debt restructurings absent unanimous bondholder consent. Following this decision, EDMC proceeded with the restructuring and sought a final determination from the district court in the case. The district court ruled that EDMC’s restructuring impermissibly impaired the rights of the holdout bondholders to collect on EDMC’s notes and ordered EDMC to pay the notes in full to the bondholders.

Proposed Amendments to the TIA

In December 2015, proposed legislation amending the TIA was introduced in Congress which would have narrowed the scope of 316(b) by making explicit that bondholders’ “right . . . to receive payment” is “impaired or affected” only if the indenture is amended to reduce the principal or interest rate, or to extend the maturity date of the indenture. These proposed amendments were ultimately withdrawn.

Second Circuit Decision

The Second Circuit vacated the SDNY’s judgment in Marblegate, holding that Section 316(b) of the TIA prohibits only non-consensual amendments to an indenture’s “core payment terms;” it does not provide an “absolute and unconditional right to payment.” Because the Marblegate indenture was not modified with respect to principal, interest, and maturity terms, bondholders “retain[ed their] legal right to obtain payment” and the TIA was not violated. This decision upholds the narrow interpretation of the TIA advocated by issuers and could negate any perceived need for the proposed amendments to the TIA, at least in the Second Circuit.

Judge Straub dissented, finding that the decision on appeal was supported by the plain language of Section 316(b), and that EDMC’s restructuring violated the TIA by giving the bondholders “a Hobson’s choice” between altered payment rights or no payment at all. The dissent encouraged a legislative amendment of the TIA if Congress is unsatisfied with the majority opinion’s interpretation.

The Marblegate bondholders have asked for an extension to file a petition on February 7, 2017 for a rehearing en banc before all active judges in the Second Circuit.