Restructuring lawyers and distressed companies alike were granted welcome relief by the US Second Circuit Court of Appeals when it overturned the decision of the District Court in the case of Marblegate Asset Management, LLC v Education Management Finance Corp.[1]

In 2014, Education Management Finance Corp. (“EDMC”) sought to restructure its debts outside of a formal bankruptcy process, through creditor consultation and cooperation, reducing the company’s debt burden by approximately $1.1 billion. EDMC put two options to its creditors, settling on the second, as a result of failure to obtain unanimous creditor consent to option one, which would constitute an “Intercompany Sale” of foreclosed assets to a newly incorporated subsidiary of EDMC, releasing EDMC from a guarantee it had provided in favour of the company’s unsecured noteholders. After the Intercompany Sale had taken place, the new EDMC subsidiary would distribute debt and equity only to those consenting creditors. While no term of the noteholders indenture had changed, non-consenting noteholders would not receive anything from the new company.

As a non-consenting noteholder, Marblegate brought proceedings against EDMC to block the Intercompany Sale on the grounds that it violated Section 316(b) of the US Trust Indenture Act 1939 (“TIA”). Marblegate argued that, while the contractual terms of the note had not changed, the foreclosure on substantially all of EDMC’s assets and subsequent sale back to its newly formed subsidiary stripped non-consenting noteholders of their practicable ability to receive payment on the notes.

The core disagreement in the case was whether the phrase “right…to receive payment” forecloses more than formal amendments to payment terms that eliminate the right to sue for payment. Marblegate argued that the right to receive payment is impaired “when the source of assets for that payment is deliberately place beyond the reach of non-consenting noteholders”, an argument the Court of Appeals rejected. After analysis into the legislative text and its history, the Court of Appeals found in favour of EDMC, ruling that the TIA only prohibits amendments to core payment terms without the consent of all noteholders. As the restructure did not formally amend the payment terms of the indenture that governed the notes, no such violation of the TIA had occurred – absent changes to the Indenture’s core payment terms…Marblegate cannot invoke Section 316(b) to retain an “absolute and unconditional” right to payment of its notes.

The 2014 decision of the District Court chilled out-of-court restructurings. However, the Court of Appeals affirmation of the ability of entities to carry out an out-of-court restructuring without unanimous consent of its creditors will allow the market to regain some stability and give distressed companies an alternative option to instigating formal, expensive and time consuming court–ordered bankruptcy proceedings. The decision may still be subject to an appeal.