On April 8, 2015, we distributed a Corporate Alert outlining two important decisions of the US District Court for the Southern District of New York and their potential effects on future debt exchange offers.1 Since then, the Education Management court has issued a final ruling on the following question, as stated by the court in its most recent decision: “does a debt restructuring violate Section 316(b) of the Trust Indenture Act (the Act) when it does not modify any indenture term explicitly governing the right to receive interest or principal on a certain date, yet leaves bondholders no choice but to accept a modification of the terms of their bonds?”2 On June 23, 2015, the court in Education Management concluded that, after examining the text, history and purpose of the Act, the answer to that question is yes.3
As it did in its original ruling, the Education Management court relied on an expansive reading of Section 316(b) of the Act, which states that “Notwithstanding any other provision of the indenture to be qualified, the right of any holder of any 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. . . .”4 Although some courts had previously found that Section 316(b) protected only the noteholder’s legal right to demand payment, the court in its most recent decision found that such a reading “would be unfaithful to the text and the drafting history.”5 In line with the dicta in its earlier decision and the decision of the court in Caesars,6 the most recent decision of the court again looked to the statutory history and purpose of the Act to find “that they supported a broad reading meant to inhibit debt restructurings outside the formal mechanisms of bankruptcy.”7
The court concluded that “the restructuring gave dissenting bondholders a Hobson’s choice: take the common stock, or take nothing.”8 In doing so, the restructuring contravened the purpose of the Act, i.e., to prevent minority bondholders from being forced to relinquish their claims outside of the formal mechanisms of debt restructuring. Accordingly, the court ruled that the proposed restructuring would violate the Act and mandated that the parent guarantee of the existing notes that would have been stripped as a result of the consent solicitation and tender offer remain in place.9 In so ruling, the court construed the Act as broadly protecting bondholders’ substantive rights to receive payment, not just the right to demand payment.
Both Education Management and Caesars addressed proposed restructurings in which non-consenting noteholders would lose the benefit of existing guarantees or in which the borrower would be stripped of assets, leaving non-consenting noteholders without any practical avenue to recover on their notes. The impact of these decisions may ultimately be limited to the facts of the cases. However, the broad language used by the courts in both cases could potentially be used by non-consenting noteholders to oppose indenture modifications that are less onerous than those at issue in Education Management and Caesars and thereby interfere with the execution of more typical market transactions.10 We will continue to monitor future developments with respect to these cases and advise of any material developments.11