Trust Indenture Act and Involuntary Restructurings: Impact Of

Presenting a live 90-minute webinar with interactive Q&A

Trust Indenture Act and Involuntary Restructurings: Impact of Marblegate and Caesars Bankruptcy Litigation Navigating Obligor and Bondholder Rights, Implications for the 144A-for-Life Market TUESDAY, APRIL 12, 2016 1pm Eastern | 12pm Central | 11am Mountain | 10am Pacific

Today’s faculty features:

Michael J. Riela, Shareholder, Vedder Price, New York

Steven B. Smith, Of Counsel, Blank Rome, New York

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Trust Indenture Act and Involuntary Restructurings: Impact of Marblegate and Caesars Bankruptcy Litigation

VEDDER PRICE®

. Marblegate Asset Management v. Education Management Corp. . MeehanCombs Global Credit Opportunities Funds v. Caesars Entertainment. . Impact of these decisions on out-of-court restructurings. . Implications of these decisions on “144A for life” transactions.

6 VEDDER PRICE® The Trust Indenture Act

. The Trust Indenture Act of 1939 (“TIA”) established statutory standards for trust indentures that govern debt securities that are offered to the public. . The TIA also set requirements for indenture trustees, and required financial reports by issuers.

7 VEDDER PRICE® Section 316 of the TIA

. Section 316(b) of the TIA provides, in part: – “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, on or after the respective due dates expressed in such indenture security, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such holder, …”

8 VEDDER PRICE® Marblegate Asset Management v. Education Management Corp.

. Two Decisions: – Marblegate Asset Management v. Education Management Corp., 75 F.Supp.3d 592 (S.D.N.Y. 2014) (Marblegate I).

– Marblegate Asset Management v. Education Management Corp., 111 F.Supp.3d 542 (S.D.N.Y. 2015) (Marblegate II).

9 VEDDER PRICE® Marblegate I

. In Marblegate I, the District Court denied a request for a preliminary injunction blocking a proposed out-of-court restructuring of Education Management Corporation’s debt. . The Court held that: – Plaintiffs failed to establish likelihood of irreparable harm; – Balance of equities did not favor injunctive relief; – Public policy did not favor injunctive relief; but – Plaintiffs would likely succeed on the merits of their claim that the restructuring proposal violated Section 316(b) of the TIA.

10 VEDDER PRICE® Marblegate Facts

. Most of Education Management Corporation’s (“EDMC”) revenues are derived from federal student aid programs under Title IV of the Higher Education Act of 1965. . EDMC had not met the financial responsibility standards established by the Secretary of Education. . An institution can no longer receive Title IV funds if it files for bankruptcy or has an order for relief entered against it.

11 VEDDER PRICE® Marblegate Facts (cont’d.)

. EDMC had outstanding debt of approximately $1.5 billion, – $1.3 billion of secured debt. – $217 million of unsecured notes that were issued by Education Management LLC (a subsidiary of EDMC) and later guaranteed by EDMC. – The indenture underlying the unsecured notes was qualified under the TIA, so Section 316(b) of the TIA applied. . Funds affiliated with Marblegate Asset Management, LLC and Magnolia Road Capital LP held approximately $20 million of the outstanding unsecured notes that were issued by Education Management LLC.

12 VEDDER PRICE® Marblegate Facts (cont’d.)

. In May 2014, EDMC informed its investors that it was experiencing significant financial distress and that it anticipated significant negative cash flow during the following fiscal year. . Department of Education had recently announced proposed “gainful employment” regulations that evaluate programs’ eligibility for Title IV funding based on graduates’ earnings relative to their debt. . EDMC estimated that over half of its programs may fail to meet those standards.

13 VEDDER PRICE® Marblegate Facts (cont’d.)

. EDMC negotiated a restructuring agreement with an ad hoc group of creditors, which contained two alternatives. • Alternative 1 (Restructuring): Unanimous creditor support was required for this alternative. – $150 million of the outstanding secured debt would be repaid. The rest of the outstanding secured debt would be exchanged for new secured loans and approximately 77% of EDMC’s common stock. (54.6% recovery). – Unsecured noteholders would receive equity convertible to approximately 20% of EDMC’s common stock. (32.7% recovery). – Current shareholders would receive 4% of EDMC’s common stock, plus warrants.

14 VEDDER PRICE® Marblegate Facts (cont’d.)

. Alternative 2 (“Intercompany Sale”): This alternative would be pursued in the absence of unanimous creditor support. – The EDMC parent guarantee of the secured debt and of the Education Management LLC unsecured notes would be removed. – The secured lenders would foreclose on the company’s assets, and the lenders would sell the foreclosed assets to a newly-formed subsidiary of EDMC. – The new subsidiary would then issue new debt and equity to the creditors who had consented to the restructuring. – Unsecured noteholders who refused to participate would still retain their claims, but because the assets would have been transferred from the issuer and guarantor, no assets would be available to satisfy their claims.

15 VEDDER PRICE® Marblegate Facts (cont’d.)

. Marblegate and Magnolia dissented from the proposal, and they requested that the District Court issue a preliminary injunction that would halt the restructuring. . The basis for the preliminary injunction request was that two elements of the Intercompany Sale (the removal of the parent guarantee and the foreclosure sale) allegedly violated Section 316(b) of the TIA.

16 VEDDER PRICE® Marblegate I Ruling

. The District Court denied the request for a preliminary injunction, holding that the plaintiffs had failed to demonstrate that they would suffer irreparable harm, that the balance of the hardships tipped in their favor, or that an injunction would be in the public interest. . However, the District Court concluded that the plaintiffs had demonstrated a likelihood of success on the merits of their claim that the Intercompany Sale violated TIA Section 316(b). . Court held that the Intercompany Sale is the type of debt reorganization that the TIA was designed to preclude.

17 VEDDER PRICE® Marblegate I Ruling (cont’d.)

. Analyzing the text and the legislative history of TIA Section 316(b), the Court held that it is a broad protection against non-consensual debt restructurings outside of bankruptcy; not a narrow protection that only prohibited majority holders from amending certain “core terms” of the indenture. . Even under the broad interpretation of Section 316(b), many indenture terms may still be amended without a unanimous vote, including amendments that can pressure other noteholders into accepting exchange offers. – e.g., modification of covenants that prohibit the payment of dividends, net worth covenants, and covenants that prohibit the issuer from incurring senior debt.

18 VEDDER PRICE® Subsequent Developments

. After Marblegate I, EDMC proceeded with the Intercompany Sale, but refrained from removing the parent guarantee from Marblegate’s notes. . EDMC sought declaratory relief to enable it to release the parent guarantee from those notes.

19 VEDDER PRICE® Marblegate II Ruling

. The Court framed the question as follows: – Does a debt restructuring violate Section 316(b) of the TIA 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 in the terms of their bonds? . The Court answered the question in the affirmative, and held that the Intercompany Sale violated Section 316(b) of the TIA. . The Court directed Education Management Corporation (the parent) to guarantee any past and future payments of principal and interest to Marblegate under the notes. . Appeal to the Second Circuit is pending. Oral argument to be held soon.

20 VEDDER PRICE® Other TIA 316(b) Decisions

. UPIC & Co. v. Kinder-Care Learning Centers, Inc., 793 F.Supp. 448 (S.D.N.Y. 1992). . Magten Asset Management Corp. v. Northwestern Corp. (In re North Western Corp.), 313 B.R. 595 (Bankr. D. Del. 2004) (Section 316(b) protects only a holder’s legal rights, not its practical rights to receive the principal and interest itself). . YRC Worldwide Inc. v. Deutsche Bank Trust Company Americas, No. 10- 2106, 2010 WL 2680336 (D. Kan. July 1, 2010) (Section 316(b) protects only the noteholders’ legal right to institute suit to enforce the payment obligations). . Federated Strategic Income Fund v. Mechala Group Jamaica Ltd., No. 99- Civ-10517, 1999 WL 993648 (S.D.N.Y. Nov. 2, 1999) (Section 316(b) protects noteholders’ ability to receive payment in some circumstances, not just the noteholders’ right to bring an action for payment).

21 VEDDER PRICE® The Caesars Decisions

. Two Decisions: . Meehan Global Credit Opportunities Funds, LP v. Caesars Entertainment Corp., F. Supp. 3d 507 (S.D.N.Y. 2015)(Caesars I) -- Judge Shira A. Scheindlin, U.S.D.J. (January 15, 2015)

. BOKF, N.A. v. Caesars Entertainment Corp. (In re Caesars Entertainment Corp.), Case Nos. 15-1561 and 15-4634, 2015 WL 5076785 (S.D.N.Y. Aug. 27, 2015)(Caesars II)

22 VEDDER PRICE® Caesars I: Background

. Caesars Entertainment Operating Company, Inc. (CEOC) is a direct operating subsidiary of Caesars Entertainment Corp. (CEC), the asset-rich parent company.

. CEOC issued (i) $750 million 0f 2016 notes, and (ii) $750 million of 2017 notes.

. The notes were investment grade when issued.

. Governing Indentures each included unconditional guarantees by CEC, and provisions prohibiting CEOC from divesting its assets.

23 VEDDER PRICE® Caesars I: Background (Cont’d.)

. August 2014 Transaction: CEOC and CEC purchased a substantial portion of the notes at par plus accrued interest in a private transaction (a purchase price which was a 100% premium over market). . In exchange for the purchase price, the “Favored Noteholders” made three promises: – To support any future restructuring of CEOC. – To consent to “the removal and acknowledgment of the termination of the CEC guarantee.” – To consent to the “modification of the covenant restricting disposition of ‘substantially all’ of CEOC’s assets.” . The August 2014 Transaction left CEC free to transfer CEOC’s assets without any obligation to back CEOC’s debts.

VEDDER PRICE® 24 Caesars I: Background (Cont’d.)

. Plaintiffs were holders of notes issued by CEOC who were not invited to participate in the transaction. . With the release of the CEC guarantee, plaintiffs faced losing the only source for repayment. . Plaintiffs sued CEC and CEOC alleging that the August 2014 Transaction removed the guarantees -- leaving noteholders with a worthless right to collect principal and interest from CEOC. . In other words, the release of the guarantees effected a nonconsensual change to plaintiffs’ payment right and affected plaintiffs’ practical ability to recover payment. . Thus, the August 2014 Transaction violated the TIA, and the governing Indentures & the implied covenant of good faith.

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Caesars I: Background (Cont’d.)

. Both defendants moved to dismiss the complaint for failure to state a claim upon which relief can be granted pursuant to Rule 12(b)(6) of the Federal Rules of Civil Procedure.

. On January 13, 2015, second lien noteholders issued by CEOC filed an involuntary chapter 11 against CEOC in Delaware.

. Two days later, CEOC and 172 subsidiaries – but not CEC – filed a voluntary chapter 11 in Chicago.

. The District Court sustained the complaint, relying heavily on the logic in Marblegate I.

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Caesars I: Applicable Law

. The TIA – Section 316 – 316(a)’s terms are permissive (i.e., an indenture can expressly exclude majority action) – 316(b) is mandatory and protects a bondholder’s right to receive payment of both principal and interest. . No-Action Clauses – Individual bondholders required to satisfy conditions precedent before initiating suit. – Protects issuers from the expense involved in defending individual lawsuits that are frivolous or not in the economic interest of the corp. and its creditors. – Preclude state law claims; cannot bar claims under the TIA. . Breach of Contract and the Implied Covenant of Good Faith and Fair Dealing

27 VEDDER PRICE® Caesars I: Analysis – Plaintiffs State A Claim Under Section 316(b) . CEC argued: –Complaint failed to allege impairment of the legal right to payment because CEOC was not in default of its obligation to make payments.

–TIA does not guarantee that issuer will be able to meet its obligations; it only protects the legal right to receive payment when due.

. The Court’s Ruling: –CEC’s narrow reading was not mandated by the statutory text; right to receive payment can be impaired prior to due date.

–Narrow reading doesn’t follow from the legislative history and purposes of the TIA.

28 VEDDER PRICE® Caesars I: Analysis – Plaintiffs State A Claim Under Section 316(b) (Cont’d.) – Agreed with reasoning of Marblegate I: 316(b) doesn’t just protect against formal, explicit modification of the legal right to receive payment. – Allegation that August 2014 Transaction stripped plaintiffs of valuable CEC guarantees leaving then with an empty right to assert a payment default from an insolvent obligor was sufficient to state a claim under 316(b). – Had the CEC guarantees not been removed, CEOC’s filing would have had no impact on CEC’s liability. – Therefore, the removal of the guarantees was an impermissible out-of-court restructuring achieved through collective action.

29 VEDDER PRICE® Caesars I: Analysis – MeehanCombs Failed to Adequately Allege Ownership or Control Under 316(a) . Section 316(a) permits holders of a majority of the principal amount to direct trustee to exercise any power conferred by the Indenture. . Statute provides that securities held by the issuer or by any person directly or indirectly controlling or controlled by or under direct or indirect common control of the issuer shall be disregarded. . MeehanCombs alleged that because Caesars either controlled the notes of the Favored Noteholders, those notes should not have been counted toward the required majority needed for approval of the August 2014 Transaction. – MeehanCombs did not allege ownership because the Favored Noteholders’ consents were given before the notes were sold to Caesars. . The Court found that the “control” allegations were not sufficiently pled and dismissed this claim without prejudice.

30 VEDDER PRICE® Caesars I: Analysis – The No-Action Clauses

. CEC argued: –Plaintiffs’ state law claims were barred. –The exception to the no-action clause is only triggered after a payment default. –“for the same reasons that apply to the section 316(b) claim, this narrow exception applies only to suits by noteholders after a payment default, which has not occurred.”

. Plaintiffs’ argued: –Excused from compliance because they were seeking to enforce their right to payment of principal and interest.

31 VEDDER PRICE® Caesars I: Analysis – The No-Action Clauses (Cont’d.)

. The 2016 & 2017 Indentures both granted an absolute and unconditional right to bring an action to enforce the payment obligations. – Provisions were required by 316(b) of the TIA. – Plain language of the Indentures, however, did not limit the applicability of those provisions to suits for past due amounts (i.e., intentionally excluded the modifying clause, “on or after [the] respective [due] dates . . .” . Therefore, CEC’s reliance on cases interpreting provisions that simply repeat 316(b) were unavailing. . The Court found that the complaint plausibly alleged that the actions taken by CEC impaired plaintiffs’ right to payment under the notes. Thus, plaintiffs’ consent to the supplemental indentures was required. VEDDER PRICE® 32

Caesars II: Background

. BOKF is the successor indenture trustee under 4/16/2010 Indenture for 12.75% second priority senior secured notes. . UMB Bank (UMB) is the indenture trustee under four first lien indentures that comprise approx. $6.345 billion of CEOC’s recourse first lien bond debt. . CEC, a signatory to the Indentures, irrevocably and unconditionally guaranteed the obligations. . The Indentures contain a release provision: the guarantee will terminate upon the occurrence of certain events. . Indentures are qualified under and governed by the TIA.

33 VEDDER PRICE® Caesars II: Background (Cont’d.)

. In January 2008, Apollo Global Management and TPG Global acquired CEC in a LBO for $30.7 billion. – Funded through issuance of $24 billion in debt – $19.7 billion of total was secured by liens on substantially all of CEOC’s assets. . 2013 Annual Report (3/17/2014): CEC warned that a restructuring, amendment or re-fi would be necessary. . May 2014 Transaction: – CEOC planned to issue $1.75 billion in new term loans to refinance debt due in 2015. – CEC sold 5% of CEOC’s common stock to institutional investors.

34 VEDDER PRICE® Caesars II: Background (Cont’d.)

. Because CEOC was no longer a wholly owned subsidiary, the guarantee was automatically terminated under the Indentures. . Several weeks later, CEC authorized CEOC board to adopt a stock performance incentive plan, which enabled CEOC to grant shares of CEOC stock to its directors and officers. . After the August 2014 Transaction, CEOC reaffirmed its contention that CEC’s guarantee had been released at CEOC’s election in June 2014. . None of the noteholders represented by plaintiffs consented or were given the opportunity to consent to any of the transactions.

35 VEDDER PRICE® Caesars II: Background (Cont’d.)

. After CEOC filed bankruptcy in January 2015, BOKF served CEC with a demand for payment; CEC responded that it was not subject to the guarantee.

. BOKF and UMB commenced an action to enforce CEC’s guarantees of $7 billion in notes.

. Moved for partial summary judgment seeking a declaration that the purported release of the guarantee violated TIA 316(b).

36 VEDDER PRICE® Caesars II: Applicable Law

. Section 316(b) of the TIA: an issuer cannot, outside of bankruptcy, alter its obligation to pay bonds without the consent of each bondholder. . Contract interpretation under NY law: – A contract that is complete, clear and unambiguous on its face must be enforced according to the plain meaning of its terms. – Contract language is unambiguous when it has a definite and precise meaning, with no reasonable basis for a difference of opinion. – Evidence outside the four corners of the document is generally inadmissible.

37 VEDDER PRICE® Caesars II: Impairment Under the TIA

. Continues to adhere to view that 316(b) protects a noteholder’s practical ability, as well as the legal right, to receive payment when due. . Open question: What must plaintiffs prove to demonstrate an impairment? . Plaintiffs argued there are two elements: – An impairment of the right to receive payment; and – Without the holder’s consent. . Thus, because guarantees were stripped without consent, 316(b) has been violated.

38 VEDDER PRICE® Caesars II: Impairment Under the TIA – CEC’s Response . Impairment must be either (i) an amendment of a core term, or (ii) a restructuring of the debt. . Impairment should be evaluated as of the time of each transaction. – Plaintiffs must prove CEOC was insolvent at the time the guarantees were terminated, leaving the noteholders with no ability to recover as of the time of the transaction. . Guarantees were never intended to provide credit support; release of guarantee that provided no real value cannot be an impairment. . There were genuine disputes of material fact as to whether challenged transactions were a restructuring.

39 VEDDER PRICE® Caesars II: Ruling

. To prove impairment, plaintiffs needed to prove either an amendment to a core term or an out-of- court reorganization. . But, the alleged impairment must be evaluated as of the date that payment becomes due because it is only then that the right to payment has been affected.

40 VEDDER PRICE® Caesars II: Nature of the Guarantee

. The Court found that the language of the guarantee was “clear, unequivocal and unambiguous” and must be enforced according to its terms. . No indication that the guarantee was put in place just to facilitate regulatory filings. . Nothing in the release provisions created an ambiguity. . No dispute that whatever the release provision allowed, it could not provide CEC with a path to impair noteholders’ rights under 316(b). – That plaintiffs consented to the provision by agreeing to the Indenture is of no moment since signatories to a contract cannot consent to violate the law.

41 VEDDER PRICE® Caesars II: Amendment of Core Terms or Out-of- Court Reorganization . Mere release of the guarantee does not prove impairment. . Judge Failla in Marblegate II reviewed legislative history of 316(b) to conclude that it was designed to prevent a “nonconsensual majoritarian debt restructuring.” – Did not go beyond that conclusion because the transaction at issue was precisely what the TIA was designed to preclude. . In Caesars II, Court was forced to determine what actions, beyond the detrimental amendment of core terms, constitute an impairment.

42 VEDDER PRICE® Caesars II: Disjunctive “or” Suggests Broad Protection

. The use of the disjunctive “or” supports the conclusion that 316(b) protects the right to sue for payment and the right to receive such payment. – “The right of any holder of any indenture security to receive payment of the principal of and interest . . . or to institute suit for the enforcement of any such payment.” . Legislative history: the final version of 316(b) was significantly revised from previous version in at least two key respects: – Instead of providing discretion to the SEC, the TIA set out mandatory indenture provisions; and – The addition of the language providing for a right to receive payment in addition to the right to institute suit. . In other words, the purpose of 316(b) was to protect minority bondholders against debt reorganizations resulting from a majority vote, outside of judicial supervision.

43 VEDDER PRICE® Caesars II: Court Rejects CEC’s Contention

. Court rejected CEC’s contention that plaintiffs must establish a restructuring of their particular debt. . An impairment occurs where a company restructures debt arising under other notes, in the context of an out-of-court reorganization, leaving some noteholders, with an unaltered formal right to payment, but no practical ability to receive repayment.

44 VEDDER PRICE® Caesars II: Were the Guarantee Transactions an Out- of-Court Restructuring?

. CEC: plaintiffs must establish CEOC’s insolvency at the time of each challenged transaction. . Argument unsupported by plain language of 16(b): “the right of any holder . . . To receive payment . . . On or after the respective due dates . . . Shall not be impaired . . .” . Plaintiffs failed to meet their burden of demonstrating that there was no genuine dispute of material fact as to whether the guarantee transactions effected a nonconsensual debt restructuring. – Were the transactions routine corporate transactions undertaken in an effort to improve CEOC’s financial condition? – Or, were the transactions part of plan to accomplish an out-of- court restructuring of all CEOC debt?

45 VEDDER PRICE® Caesars II: Threshold Questions to be Addressed by the Second Circuit

. Court sua sponte certified order for an interlocutory appeal. . What rights does 316(b) protect? – Does it protect practical rights to principal and interest or only their legal rights? . What is the appropriate standard to assess impairment? – Must plaintiffs show that a nonconsensual out-of-court restructuring occurred? – Must there be an amendment to the indenture itself? . As of when (and how) should the impairment be evaluated? – Must a court evaluate each transaction separately at the time it was undertaken? – Is the impairment to be evaluated as of the date for demand of payment?

46 VEDDER PRICE® Impact of Marblegate and Caesars on Out-of- Court Restructuring of Debt

. Marblegate and Caesars could have broad implications on future efforts to achieve out-of-court-restructurings. – Notwithstanding that the decisions were limited to situations involving involuntary releases or parent guarantees and the intent to transfer assets of an issuer. . Distressed investors could have greater bargaining power when negotiating with financially distressed companies and with the majority bondholders. – The Court: “Where individual bondholders can free-ride off an exchange offer, as they retain claims for the full value of their debt against a newly solvent issue, they are better off refusing the offer.” – Marblegate recovered more than other noteholders because of its holdout tactics. . Continued litigation regarding the interpretation of 316(b). – Cliffs Natural Resources and Vanguard National Resources Class Actions. VEDDER PRICE® 47 Impact of Marblegate and Caesars on Out-of- Court Restructuring of Debt

. There could be an increase in the number of bankruptcy filings (prepackaged or otherwise), and decrease in out-of-court restructurings, as minority bondholders refuse to consent to amendments negatively affecting their payment rights. . Companies will take added care in the terms of their debt offerings to avoid a later impasse in a restructuring. . The decisions (i) emphasize the importance of transparency in the courts of restructuring transactions, and (ii) highlight the delicate balance courts are seeking to strike between protecting minority bondholders’ rights and deferring to the business judgment of companies and majority bondholders. . Distressed debt investors would be wise to observe the development of practices from these decisions closely and monitor how the Act is interpreted by courts in the future.

48 VEDDER PRICE® Impact on 144A for Life Transactions

. Rule 144A is a safe harbor exemption from the registration requirements of Section 5 of the Securities Act of 1933 for certain offers and sales of qualifying securities. . A Rule 144A financing is a transaction where an investment bank buys securities from an issuer pursuant to a private placement and immediately resells the securities to Qualified Institutional Buyers (QIBs). . A 144A for life offering is a Rule 144A financing that does not provide registration rights for the buyers of the securities. The issuer in a 144A for life offering does not need to become a reporting company under the Securities Exchange Act of 1934.

49 VEDDER PRICE® Impact on 144A for Life Transactions (cont’d.)

. Indentures governing bonds issued in 144A for life transactions do not have to contain the mandatory TIA provisions. . However, many 144A for life transactions have indentures that contain language similar to that of Section 316(b) of the TIA. . How can you fix that in a Rule 144A indenture? – Parties can have future indentures contain clearer language than the language in TIA Section 316(b) regarding how a holder’s right to receive payments can be affected in a restructuring. – Issuers and requisite number of bondholders could agree to revise any provisions that are similar to TIA Section 316(b) in existing indentures. – Can provide for consent thresholds for amendments to “payment terms” that are less than 100%.

50 VEDDER PRICE® Faculty

Steven B. Smith (212) 885-5162 [email protected]

Special thanks to Evan Zucker, Esq. of Blank Rome for assisting in the preparation of the materials.

Michael J. Riela

(212) 407-7766 [email protected]

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