The financial engineering of iHeartCommunications, Inc. in its ongoing attempts to deleverage seems to spawn a continuous stream of interesting issues. In iHeartCommunications, Inc. v. Benefit Street Partners LLC (W.D. Tex. March 16, 2017), the defendant holders of Priority Guaranty Notes (PGNs) of iHeartCommunications1 attempted to remove their case to federal court on the grounds that the trustees for the notes were federally chartered banking corporations. The attempt was rebuffed by the court, finding that the limited role of the trustees was insufficient to justify removal. The tactic may nonetheless be something to keep in mind in future, more appropriate situations.
The decision arose out of a running dispute between iHeartCommunications, a subsidiary of iHeart Media Inc., and its PGN noteholders regarding the transfer by iHeartCommunications of certain assets to an unrestricted subsidiary. In December 2015, with the objective of increasing its liquidity in order to repurchase its debt, iHeartCommunications caused its wholly owned subsidiary Clear Channel Holdings, Inc. to transfer 100 million shares of Class A stock in Clear Channel Outdoor Holdings Inc. to its wholly owned subsidiary Broader Media LLC. Clear Channel Outdoor Holdings is a publicly traded company, 90% of whose stock is owned by Clear Channel Holdings. Broader Media is an unrestricted subsidiary of iHeartCommunications under the terms of the relevant indentures. iHeartCommunications maintained that the transfer of the Clear Channel Outdoor Holdings shares to Broader Media was a permitted investment under the terms of the indentures, a position disputed by the holders of the notes issued under those indentures.
On application to a Texas state court, iHeartCommunications sought and obtained in July 2016 a declaratory judgment that the transfer of the Clear Channel Outdoor Holdings shares was indeed a permitted investment in compliance with the indentures. (For a more detailed discussion of this decision and its implications, see Debt Dialogue, November 2016.) iHeartCommunications then proceeded to utilize the liquidity afforded by the contribution of the Clear Channel Outdoor Holdings shares to Broader Media to repurchase the iHeartCommunications debt in the market at discounted prices. As an unrestricted subsidiary, Broader Media was not constrained by the restricted payment covenants of the indentures in its ability to repurchase the debt.
Not content with its victory over the noteholders in the declaratory judgment action, iHeartCommunications brought suit against them to recover damages for lost opportunity costs. Between the time that iHeartCommunications first sought to repurchase its notes in the market in February 2016 and the time it was able to do so after disposing of the challenges of the noteholders, the price of the notes had run up, with the result that the cost to iHeartCommunications to repurchase the notes had increased by some $100 million. The petition for damages, originally filed in state court, was brought on the grounds of tortious interference with prospective business relations, economic duress, civil conspiracy, and breach of the covenant of good faith and fair dealing.
In addition to the claim for damages, which was brought solely against the noteholders, iHeartCommunications also sought a declaratory judgment against all defendants, including both the noteholders and the indenture trustees for the notes. iHeartCommunications requested a declaration from the state court that Broader Media’s prior repurchase of the iHeart debt did not violate the indentures, that notices of default based upon the repurchases are not permitted under the indentures and that future repurchases of iHeart debt by Broader Media would not violate the indentures.
Removal and the Edge Act
iHeart brought its damages and declaratory judgment action in Texas state court. The defendant noteholders then removed the case to federal court. Lacking diversity or any federal question, the defendant noteholders based the removal on the Edge Act, a statute originally passed by Congress in 1919, and amended to its current form in 1933 as part of the Glass-Steagall Act.
The Edge Act was adopted with the objective of making the United States more competitive in international banking. It authorized the creation of federally chartered Edge Act banks (or Edge Act corporations) that could engage in international banking transactions. In their quest for removal, the defendants in the Benefit Street Partners action sought to rely on 12 U.S.C. § 632, included in the 1933 amendment. Section 632 provides that
[a]ll suits of a civil nature ... to which any corporation organized under the laws of the United States shall be a party, arising ... out of other international or foreign financial operations, ... shall be deemed to arise under the laws of the United States, and the district courts of the United States shall have original jurisdiction of all such suits; and any defendant in any such suit may, at any time before the trial thereof, remove such suits from a State court into the district court of the United States.
The defendants in the case reasoned as follows: Their notes were distributed to noteholders outside the United States in the initial private placements. The trustees under the indentures for the PGNs — US Bank, National Association, Wilmington Trust, National Association and UMB Bank, and National Association — are all corporations organized under the laws of the United States. The trustees were defendants in the declaratory judgment aspect of the case, and the court could exercise supplemental jurisdiction over the damages claims. Ergo, the United States district court had jurisdiction, and iHeartCommunications’ action against the noteholders could be removed to federal court, which the noteholders presumably viewed as a more hospitable forum.
The Court’s Decision
In a carefully reasoned decision, the federal district court rejected the defendant noteholders’ analysis and sent them packing back to state court. At the outset, the court rejected iHeartCommunications’ position that the case lacked all international nexus because the transfer of the Clear Channel Outdoor Holdings shares to Broader Media was a wholly domestic affair. The declaratory judgment action, the court said, arose out of something larger and could not be viewed in isolation. But this was hardly enough to justify removal.
The court placed substantial reliance on an earlier Second Circuit case, American International Group, Inc. v. Bank of America, 712 F.3d 775 (2d Cir. 2013) (AIG). As interpreted in subsequent lower court decisions, the AIG case stands for the proposition that “section 632 only confers federal jurisdiction if the suit arises out of an offshore banking or financial transaction of [the particular] federally chartered corporation.”
The court was skeptical of whether the offshore sale of the PGNs in the initial distribution could even be attributed to iHeartCommunications. As is typical in a private placement of this sort, the issuer sells to “initial purchasers,” domestic investment banks who then proceed to resell the securities to their customers, some of whom may be located abroad. The court concluded that it need not decide whether the offshore sales constituted the necessary foreign activity because the AIG nexus test failed for a more fundamental reason.
The activity of the trustees, whose involvement as Edge Act corporations is a predicate element to the applicability of the statute, was wholly onshore. The trustees were parties to the indentures, which were domestic contracts. They had nothing to do with the marketing of the PGNs and had no control over whether the notes were sold internationally.
Moreover, the case itself had no connection with the conduct of the trustees. They were made defendants in the case only so they would be on notice of a declaratory judgment construing a contract to which they are a party. In the majority of cases predicated on Section 632, the court observed, there was alleged wrongdoing on the part of the Edge Act corporation, or damages were sought from the corporation. Unlike in those cases, here the purpose of the statute would not be served by the availability of federal jurisdiction. That purpose, as stated in the AIG case, “was to give Edge Act banks predictable uniformity of adjudication supervised by the federal courts, and thus better protection against potentially divergent and conflicting strictures imposed by banking authorities in 48 [sic] states.” The trustees here, not being economic parties in interest, were not in need of such protection.
The federal court therefore refused jurisdiction and returned the case to state court.
Relying on the Edge Act to move their case to federal court was a clever but ultimately unsuccessful gambit on the part of the iHeartCommunications PGN noteholders. Yet one can envision situations in which the Edge Act might be utilized to confer federal jurisdiction, where an indenture trustee is a federally chartered banking institution. One possible scenario that comes to mind is a situation in which such an institution serves as trustee for a debt issuance by an offshore subsidiary of a domestic issuer, and the trustee is actively involved in restructuring activity following a default. If litigation were to arise in such a circumstance, the Edge Act might be something to keep in mind, either offensively where the trustee seeks to go into court or defensively where the trustee finds itself subject to suit.