In two recent cases, the United States District Court for the Southern District of New York has indicated that Section 316(b) of Trust Indenture Act of 19391 (the “TIA”) requires unanimous consent for out-of- court restructurings that impair bondholders’ practical ability to receive payments, even if the bondholders’ technical, legal ability to receive payments remains intact.2
In Marblegate Asset Management et al. v. Education Management Corp., Marblegate Asset Management, LLC, Marblegate Special Opportunities Master Fund, L.P. (collectively, “Marblegate”), Magnolia Road Capital LP, and Magnolia Road Global Credit MasterFund L.P. (collectively, “Magnolia,” and with Marblegate, “Plaintiffs”) sought a preliminary injunction to block a proposed out-of-court restructuring of the debt of Education Management LLC, Education Management Finance Corporation and Education Management Corporation (“EDMC,” and collectively, “Defendants”) that would require Plaintiffs to convert their debt to equity or potentially lose their practical ability to receive principal and interest payments.3
EDMC had approximately $217 million in unsecured notes, some of which were held by the Plaintiffs. The notes are governed by a March 5, 2013, Indenture (the “Indenture”) and are covered by the TIA.4
In May 2014, EDMC informed creditors and investors that it was experiencing financial difficulties.5 As EDMC was negotiating with its creditors to resolve its financial distress, it entered into a Proposed Restructuring Agreement (the “Proposed RA”) with certain of its creditors; the Proposed RA was governed by the Restructuring Support Agreement.6
The Proposed RA provided two options for EDMC to restructure its debt. Under the first option, if EDMC was able to secure consent of 100% of its creditors,
$150 million of the revolving loans would be repaid and made available for re-borrowing; certain letters of credit drawn from the revolver would be extended until March 2019; and the remainder of EDMC’s secured debt (constituting $1.155 billion), including the term loans, would be exchanged for $400 million in new secured term loans and preferred stock convertible into roughly 77% of EDMC’s common stock.7
The Defendants issued an exchange offer for the notes on October 1, 2014 (the “Exchange Offer”) in order to attempt to consummate the first option for this voluntary restructuring. The Defendants, however, received less than 100% creditor acceptance. The Defendants’ failure to receive 100% consent to the Exchange Offer triggered the second option for restructuring the debt – an Intercompany Sale, which was accomplished through a number of contemporaneous steps:
- the secured lenders would release EDMC’s parent guarantee of their loans (which the secured lenders recently obtained in the Third Amended and Restated Credit and Guaranty Agreement (the “2014 Credit Agreement”)), thus triggering the release of EDMC’s parent guarantee of the Notes under Indenture §10.06;
- the secured lenders would exercise their rights under the 2014 Credit Agreement and Article 9 of the Uniform Commercial Code to foreclose on ‘substantially all of the assets’ of Defendants; and
- the secured lenders would immediately sell these assets back to a new subsidiary of EDMC. This new subsidiary would then distribute debt and equity to the creditors who had consented to the Restructuring Support Agreement…8
The Plaintiffs filed a motion for a temporary restraining order and preliminary injunction. The Plaintiffs asserted the Intercompany Sale and the removal of the parent guarantee impaired their right to receive payment in violation of the TIA. The Plaintiffs contended they would be left with no practical ability to receive anything for their claims because the original issuer would have no assets to satisfy the claims due to the Intercompany Sale, and the release of the parent guarantees would preclude the Plaintiffs from any recovery against the parent.
In analyzing the merits of the Plaintiffs’ claims, the Court concluded that the Plaintiffs could not obtain a preliminary injunction9 due to their inability to demonstrate irreparable harm, failure to show that the balance of equities weighed in their favor, and failure to demonstrate that an injunction would be in the public interest.10 The Court noted, however, in dicta, that the Plaintiffs had demonstrated a likelihood of success on the merits of their claim that the Intercompany Sale violated the TIA.11
The Court considered whether the protections of the TIA against nonconsensual debt restructurings were to be read broadly or narrowly - in other words, “whether the ‘right… to receive payment’ is to be read narrowly, as a legal entitlement to demand payment, or broadly, as a substantive right to actually obtain such payment.”12 The Court noted that in an earlier Southern District of New York ruling, in Federated Strategic Income Fund v. Mechala Grp. Jam. Ltd., 1999 WL 993648 (S.D.N.Y. Nov. 2, 1999) (“Federated”),13 that Court had concluded that the TIA “protects the ability, and not merely the formal right, to receive payment in some circumstances.”14 The Court also observed that other courts and commentators who have considered the legislative history and purpose of the TIA have concluded that Section 316(b) of the TIA was enacted to encourage bankruptcy filings in the absence of unanimous consent to out-of-court bond restructurings.15
Although the Plaintiffs were unable to secure an injunction or temporary restraining order, the Court stated that “where a debt reorganization that seeks to involuntarily disinherit the dissenting minority is brought about by a majority vote, that violates the fundamental purpose of the Trust Indenture Act,” and that “the Intercompany Sale is precisely the type of debt reorganization that the Trust Indenture Act is designed to preclude.”16
A few weeks after the decision in Education Management, the United States District Court for the Southern District of New York again analyzed the TIA in connection with an out-of-court bond restructuring in Caesars and held that the TIA protects non-consenting bondholders’ practical ability to receive payment and not merely a technical right to payment.
The Caesars Plaintiffs17 hold certain of the notes issued by Caesars Entertainment Operating Co. Inc. (“CEOC”) and guaranteed by Caesars Entertainment Corp. (“CEC”). Supplemental indentures issued in August 2014 (the “August 2014 Transaction” or the “Amendments”) removed the guarantee from the parent company, CEC, and left the Caesars Plaintiffs with an opportunity to collect only against the initial issuer, CEOC, which was divesting its assets and was laden with debt well in excess of its assets.18
The Caesars Plaintiffs alleged that the August 2014 Transaction was a nonconsensual change to their payment rights, which violated the terms of Section 316 of the TIA. The Caesars Defendants19 moved to dismiss the complaints.
The Court concluded that certain Caesars Plaintiffs sufficiently stated a claim under Section 316 of the TIA to survive the Caesars Defendants’ motion to dismiss.20 In making such a finding, the Court rejected CEC’s argument that the TIA “protects only a noteholder’s legal right to receive payment when due.”21 The Court noted that such a narrow reading of the TIA is not mandated by the statutory text and cited Education Management and Federated Courts with approval for the proposition that the TIA should be interpreted more broadly.22
CEC also attempted to distinguish Caesars from Education Management by informing the Court that CEOC would soon be filing for bankruptcy and therefore the August 2014 Transaction was not a true out- of-court debt restructuring. The Court, however, found this argument unavailing.23
Education Management and Caesars clarify that in the Southern District of New York, unanimous consent is required if bondholders’ practical right to receive payment is compromised in an out-of-court restructuring. As defendants in both Education Management and Caesars noted, however, courts in other jurisdictions have concluded that the TIA requires only that the technical legal right to receive payment remain undisturbed in a nonconsensual, out-of-court restructuring. See In re Nw. Corp., 313 B.R. 595, 600 (Bankr. D. Del. 2004) (Section 316(b) of the TIA “applies to the holder’s legal rights and not the holder’s practical rights to the principal and interest itself … there is no guarantee against defaults.”); YRC Worldwide Inc. v. Deutsche Bank Trust Co. Am., 2010 WL 2680336, at *7 (D. Kan. July 1, 2010) (“TIA § 316(b) does not provide a guarantee against the issuing company’s default or its ability to meet its obligations. Accordingly, the fact that the deletion of section 5.01 might make it more difficult for holders to receive payments directly from plaintiff does not mean that the deletion without unanimous consent violates TIA § 316(b)”). Further, as the Caesars Court noted, “there is scant case law on point.”24