Expansive Trust Indenture Act Interpretation May Negatively Affect Bond Restructurings
Marblegate Asset Mgmt. v. Educ. Mgmt. Corp., Case No. 14 Civ. 8584 (KPF), 2014 WL 7399041 (S.D.N.Y. Dec. 30, 2014)
MeehanCombs Global Credit Opportunities Fund, LP v. Caesars Entm’t Corp., No. 14-CV-7091 SAS, 2015 WL 221055 (S.D.N.Y. Jan. 15, 2015).
In two recent decisions, Marblegate Asset Management v. Education Management Corp. and MeehanCombs Global Credit Opportunities Funds, LP v. Caesars Entertainment Corp., the United States District Court for the Southern District of New York adopted an interpretation of Section 316(b) of the Trust Indenture Act of 1939 (the “TIA”) that may complicate future exchange offers and, in some cases, force in-court restructurings that might otherwise have been completed out-of-court. While the court’s reading of the TIA was mere dicta in Education Management, it was core to the holding in Caesars Entertainment.
Education Management Corporation (“EDMC”), a large for-profit provider of college and graduate education, sought to restructure $1.522 billion in secured loans and unsecured notes, both issued by its subsidiary Education Management LLC and guaranteed by EDMC. EDMC negotiated a restructuring support agreement (“RSA”) with its creditors that contemplated two possible out-of-court transactions, the first requiring the consent of 100% of its creditors, and the second taking place if that consent could not be obtained. Under the second transaction: (i) the secured lenders would release EDMC’s guarantee of their loans, which would also automatically release EDMC’s guarantee of the unsecured notes pursuant to their terms; (ii) the secured lenders would exercise their right under the credit facilities to foreclose on substantially all of EDMC’s assets; and (iii) the secured lenders would sell the assets to a new subsidiary of EDMC in exchange for new debt and equity to be distributed only to consenting creditors. Non-consenting holders of unsecured notes would be left with claims against an entity that no longer held any assets; without the benefit of the EDMC guarantee.
Falling just short of the required 100%, EDMC was forced to pursue the second nonconsensual alternative. The Education Management plaintiffs were among the holdouts and sought a preliminary injunction to enjoin the restructuring, alleging that it violated the TIA and the terms of the TIA-qualified indenture governing the unsecured notes. While the Education Management court denied relief to the plaintiffs, it went on to explore in dicta (ultimately adopted by the Caesars Entertainment court) the merits of their case, concluding that the plaintiffs had demonstrated a likelihood of success on their claim that the proposed restructuring violated the TIA.
Section 316(b) of the TIA provides that “the right of any holder of any indenture security to receive payment of the principal of an interest on such indenture security … shall not be impaired or affected without the consent of such holder….” Read narrowly, and as generally understood, the TIA only protects a legal right to seek payment by requiring the consent of each holder to amend certain “core terms,” such as the indenture’s payment terms. After a review of an unpublished district court decision and the TIA’s legislative history, the Education Management court reasoned that the TIA should be read as “a broad protection against non-consensual debt restructurings” protecting each noteholder’s “substantive right to actually obtain” payment, and not merely the “legal entitlement to demand payment.”
Applying this expansive interpretation of the TIA, the court found that the nonconsensual restructuring contemplated by the RSA would “effect a complete impairment of dissenters’ right to receive payment” and therefore was illegal under the TIA. The court further stated that Section 316(b) of the TIA “was intended to force bond restructurings into bankruptcy where unanimous consent could not be obtained.”
Caesars Entertainment Corporation (“CEC”), along with its subsidiaries, including Caesars Entertainment Operating Company, Inc. (“CEOC”), own and manage dozens of casinos in the United States. CEOC issued $750 million in senior unsecured notes due in 2016 and $750 million in senior unsecured notes due in 2017, all guaranteed by CEC. In August 2014, with a restructuring on the horizon, CEOC and CEC purchased a substantial portion of the notes at par plus accrued interest in a private transaction. In exchange, the holders of these notes agreed to: (i) support a future restructuring of CEOC; (ii) release CEC’s guarantees; and (iii) modify the covenant restricting the disposition of “substantially all” of CEOC’s assets to measure future asset sales based on CEOC’s assets as of the date of the amendment of the indentures. Due to the amount of CEOC’s secured debt, with the release of the guarantee by CEC, the plaintiffs, which were noteholders that were not invited to participate in the deal, faced losing the only source for repayment on the unsecured notes. The plaintiffs sued CEC and CEOC on the theory that the release of the parent guarantee violated the TIA and the TIA-qualified indentures.
Relying on the reasoning in the Education Management decision and quoting from it extensively, the Caesars Entertainment court concluded that the plaintiffs’ allegations were sufficient to state a claim under Section 316(b) of the TIA. The court held that, as alleged, the removal of the parent guarantee was “an impermissible out-of-court debt restructuring achieved through collective action. This is exactly what TIA section 316(b) is designed to prevent.”
The implications of these decisions are potentially significant. While their facts are extreme, involving involuntary releases of guarantees and attempts to strip a borrower of assets without requiring the new owner to assume liability for the notes, the stated rationale of these decisions is extraordinarily broad and could impact far less dramatic transactions. Both decisions stated that Section 316(b) prohibits out-of-court debt restructurings achieved through collective action. Although the decisions do not clearly define what constitutes a debt restructuring for these purposes, they could suggest that any modifications of an indenture – and even automatic guarantee releases and other actions provided for or permitted under an indenture – that actually impair a dissenter’s ability to obtain payment might be prohibited. Exchange offers, however, commonly involve exit consents whereby exchanging noteholders consent to indenture amendments stripping certain covenants and events of default under typical majority-rule amendment provisions. These alterations of the debt terms are designed to discourage noteholders from holding out in order to free ride on concessions made by majority holders. While the Education Management court states that exit consents will be permissible in some cases, the Education Management and Caesars Entertainment decisions call into question the continued viability of this restructuring tool, at least if coupled with other steps such as guarantee releases and transfers of assets out of the reach of dissenting bondholders. In so doing, these decisions may force more companies into bankruptcy or, at minimum, increase the execution risk and related costs of out-of-court bond restructurings. In addition, companies may have another disincentive to register their bonds with the Securities and Exchange Commission and thereby subject their bond indentures to the TIA.