Recent Court Decisions on New York Law-Governed Indentures and Their Impact

INDENTED: RECENT COURT DECISIONS ON NEW YORK LAW GOVERNED INDENTURES AND THEIR IMPACT THEIR AND INDENTURES GOVERNED YORK LAW ON NEW COURT DECISIONS RECENT INDENTED: KEY POINTS Recent court decisions have created unpredictability in indenture interpretation while also Feature contributing to a growing body of judicial guidance. Practitioners may want to make sure their intentions are set forth as clearly as possible in the text of indentures they negotiate.

Authors Adrian J S Deitz, James A McDonald, Riley Graebner and Shannon Togawa Mercer Indented: recent court decisions on New York law-governed indentures and their impact

Several recent US court decisions interpreting New York law-governed bond the agreement as a whole, prioritise specifc indentures have broken new ground, interpreting indentures in a manner that language over general language, give words differed from the way many practitioners had done so in the past. Some of these and phrases their ordinary meaning, examine new cases have introduced instability into the market while others have created whether a particular interpretation creates greater certainty, but overall these cases have expanded the body of case law internal inconsistencies, look to commercial - guiding bond practitioners. This article surveys recent key decisions turning on efect and disfavour an interpretation that interpretations of terms within New York law-governed indentures that have changed renders language superfuous. When evaluating the way practitioners draft and interpret these instruments. extrinsic evidence (which a court may do if it fnds ambiguity in the language), courts can look to a variety of sources, including the Issuers of bonds governed by New Chesapeake Energy Corporation v Bank of New summary of terms in the ofering document, nYork law indentures – the instrument York Mellon Trust Company, N.A., 57 F. Supp. an issuers’ public reports, internal reports to containing the rights and obligations of the 2d 316 (S.D.N.Y. 2013) ofers a roadmap to management, statements to rating agencies and issuer, the trustee for the bondholders and the indenture interpretation under New York law. regulators by the issuer, public declarations noteholders under the bonds – had been able Following the basic framework for contract on investor calls, the underwriters’ sale force to rely upon a relatively stable body of court interpretation,3 the court in Chesapeake stated communications to potential investors and decisions in interpreting covenants and other that the primary objective in interpreting the expert testimony as well as communications provisions in indentures. However, there have terms of an indenture is that the intent of among counsel and other transaction parties been a number of notable judicial decisions, the parties is revealed in the language of the in the negotiation of the indenture. particularly from appellate courts, that have agreement. Where the text is defnite and impacted the interpretation of bond indentures precise in meaning, it is unambiguous and RIGHT TO RECEIVE PAYMENT and surprised many practitioners. Tese therefore “the intent of the parties must be In late 2014, the Southern District of New decisions may impact how issuers interpret bond found within the four corners of the contract”. York issued a decision in Marblegate Asset indentures and may result in changes in the If a reasonably intelligent person viewing Management LLC v Education Management drafting of certain indenture provisions in the the contract objectively could interpret the Corp (Marblegate), 75 F. Supp. 3d 592 future. Te following is a survey of recent key language in more than one way, then the court (S.D.N.Y. 2014), that drew the attention of decisions turning on interpretations of terms deems the text ambiguous and may consider high yield industry participants as well as the within New York law-governed indentures extrinsic evidence as to the parties’ intent.4 international fnancial press and demonstrated that have changed the way practitioners draft What constitutes an unambiguous text the power of litigation by noteholders. Tis and interpret these instruments. can be a matter for debate and is a question of decision also illustrated the disruptive efects law for the court to determine. In Chesapeake, on the marketplace of a court introducing PRINCIPLES OF INTERPRETATION the lower court determined that the text was uncertainty on indenture interpretation issues Fundamentally, New York law-governed unambiguously in favour of the issuer, only thought to be long settled. indentures are contracts that are interpreted to be overruled by the appellate court holding Education Management Corporation in accordance with general principles of New that the text was unambiguously in favour of (EMC) issued secured and unsecured notes York contract law. Recent judicial decisions the noteholder plaintifs. One member of the governed by a New York law indenture. Te have reinforced this construct, building on appellate panel dissented, claiming the text notes were guaranteed by EMC’ s parent a principle set forth in a case from the early was ambiguous on the basis that the district company, EDMC. EDMC ofered to exchange 1980s, Sharon Steel v Chase Manhattan Bank court judge was surely a reasonably intelligent the secured notes for a combination of new N.A., that indenture interpretation “is a person and therefore evidence that the language secured term loans and EDMC common matter of basic contract law”.1 In particular, the was ambiguous. In evaluating whether a stock. Te noteholders who accepted the Southern District of New York’ s2 decision in text is ambiguous, courts typically look at ofer were required to consent to the release of

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EDMC from its guarantee obligations (which under a covenant which governed a sale of Two years later, the Second Circuit would automatically trigger a release of the substantially all of the assets of the issuer) reversed the district court in Marblegate and guarantee of the unsecured notes) as well as and make the necessary modifcations to the returned the industry to the status quo prior to the transfer of EMC’ s assets to a new EDMC indenture – and therefore the transaction Marblegate and Caesars. Te court concluded subsidiary, leaving EMC a shell company. Te was conditioned upon such consent. Tose that s 316(b) applied only to amendments indenture permitted amendments to allow for noteholders who had consented to such of core payment terms. Tus, the release the foregoing with the consent of holders of a modifcations were able to exchange their notes of EDMC’ s guarantee would not violate majority of notes, thereby leaving unsecured for cash equal to the principal amount of the s 316(b). Noting that the scope of the “right noteholders and non-participating secured notes plus accrued interest and transactional … to receive payment” was the cases’ “core noteholders with notes in a company with costs.8 Not all noteholders were given the right disagreement”, the Second Circuit frst looked virtually no assets, such that the issuer would to participate in this consent/exchange ofer: to the text of s 316(b) and proceeded to analyse be unable to meet its payment obligations the issuer sought consents from, and ofered its legislative purpose under the remaining notes. Marblegate, a cash in exchange for notes to, holders of a and history. Te court found the text of noteholder, argued that EMC’ s exchange ofer majority of the bonds but not all noteholders. s 316(b) ambiguous with the “right … to receive was a restructuring conducted outside the US Plaintif noteholders (who were not able to payment” suggesting this could extend to a Chapter 11 process which had functionally participate in this consent) alleged that this number of rights, narrow or broad. Te court eliminated Marblegates’ right as noteholder transaction impaired their right to receive explained that it was unlikely that the right was to receive payment on its notes in violation payment under the notes under s 316(b) of the intended to be broad because the TIA does of s 316(b) of the Trust Indenture Act of TIA by removing the guarantee of the asset- not aford absolute and unconditional rights 1939 (TIA).5 Section 316(b) provides that, rich company, even though the indenture, by to payment.10 Te court also emphasised that for an indenture qualifed under the TIA, its terms, permitted these amendments with broadly construing the word “right” in this a noteholders’ right to receive payment of the consent of holders of a majority of the context would lead to “improbable results and principal and interest from the due dates notes, which was obtained. Te court agreed interpretive problems”. Te court proceeded to thereof or to institute suit for enforcement of and found that s 316(b) protects against more look at the provisions’ legislative purpose and such payment, may not be impaired without than just explicit modifcation of the legal intent and found that the relevant portions each noteholders’ consent. Tis provision had right to receive payment, but also covers of the TIA were meant to exclusively address generally been interpreted by practitioners as actions that have the efect of impairing the amendments of indenture provisions that precluding changes to “money terms” of the issuers’ ability to make payments on the notes. directly impact the right to payment of the indenture without each noteholders’ consent. Te long-standing understanding of many notes as required by the indenture. Te court agreed with Marblegate: s 316(b) practitioners was that the application of Because the TIA only applies to the foreclosed more than just amendments to s 316(b) was limited to explicit amendments terms of notes that are qualifed under payment terms; it also prohibited actions, to only the most fundamental of economic the TIA (essentially only notes registered

INDENTED: RECENT DECISIONS COURT ON INDENTURES NEW LAW-GOVERNED YORK AND THEIR IMPACT including indenture amendments which terms, such as payment of principal and with the SEC) and generally does not have the substantive efect of impairing a interest, coupon, redemption prices and other apply to notes issued privately (typically to noteholders’ right to payment without such “money terms”. Practitioners widely believed qualifed institutional buyers), the decisions noteholders’ consent. that most other terms could be modifed contributed to a demonstrable shift in the Two weeks later, the Southern District of or waived by holders of a simple majority market away from public sale and SEC New York issued an opinion in Meehancombs of bonds, where the indentures expressly registration of notes to avoid any impact Global Credit Opportunity Funds L.P. v provide that provisions can be amended by – unintended or otherwise – from the Caesars Entertainment Corp. (Caesars), 6 which majority bondholder consent, even where such TIA with approximately 30% of US bond concurred with Marblegate’s protection of amendments could impact the issuers’ practical issuances being privately sold in 2014 as noteholders through the relatively broad ability to make payments under the notes. compared to over 60% in 2018. Other factors application of s 316(b) of the TIA. When Te Marblegate and Caesars decisions created contributed to the shift, including acceptance Caesars was acquired by two private equity signifcant uncertainty for issuers seeking of the private ofering route by investors, funds in 2008, Caesars attempted to move bondholder consent to amend indentures, and speed to market and reduction of regulatory assets to afliates and leave the debt at the for law frms who are customarily required burdens of the private process. operating company level, while removing a to render legal opinions in connection with parent guarantee of the notes.7 Te indenture indenture amendments. Alarmed by the TO MAKE WHOLE OR NOT TO MAKE required consent of holders of a majority of decisions, twenty-eight law frms issued a WHOLE? the principal amount of the notes to release white paper with guidance on the issuance of Te following cases turn on the interplay the parent guarantee and permit the asset legal opinions in connection with indenture between two customary indenture provisions. transfer (which was otherwise prohibited amendments in light of these two decisions.9 Te frst allows an issuer to optionally redeem

246 April 2019 Butterworths Journal of International Banking and Financial Law INDENTED: RECENT COURT DECISIONS ON NEW YORK LAW GOVERNED INDENTURES AND THEIR IMPACT THEIR AND INDENTURES GOVERNED YORK LAW NEW ON COURT DECISIONS RECENT INDENTED: Biog box Adrian J S Deitz and James A McDonald are partners at Skadden, Arps, Slate, Meagher Feature and Flom. Adrian is the head of Skadden’s Asia-Pacifc Capital Markets Group, focusing on international securities oferings and the fnancings and US securities law aspects of mergers and acquisitions. James concentrates on corporate fnance transactions with a focus on international oferings of securities, including high-yield debt oferings. Email: [email protected] and [email protected] notes prior to maturity by paying the principal under the indenture, the issuer would have “formed the map to guide the parties through amount of the notes plus accrued interest plus needed to redeem the notes by paying the a post-acceleration redemption”. Finally, the a redemption premium equal to the present make-whole plus principal and interest. court found that the refnancing of the notes value of future interest payments up to the frst Te court declined to consider the issuer’s constituted a redemption, triggering the optional redemption date plus the redemption motivations in undertaking the spin-of without requirement to pay the make-whole. premium payable at the frst redemption date redeeming the notes but limited its focus on (a “make-whole” premium). Te second allows voluntary versus involuntary actions. Te court Momentive holders to accelerate the maturity of notes also noted that the parties could have included In In re MPM Silicones, LLC. (Momentive), upon an event of default, requiring immediate explicit language in the indenture to make clear Case No. 15-1682 (2d Cir. Oct. 20, 2017), payment of the principal amount of the notes that the make-whole was not payable upon the Second Circuit considered a similar fact (in the case of certain bankruptcy events, acceleration following event of default. pattern and came to a diferent conclusion, acceleration is automatic under the indenture). reversing both the Southern District of New Traditionally, industry practitioners took In re Energy Future Holdings York and the bankruptcy court’s decisions. In the view that under customary indentures In In re Energy Future Holdings Corp. Momentive, the debtors’ reorganisation plan upon an event of default, the noteholders’ (In re Energy), 842 F.3d 247 (3d Cir. 2016), ofered the holders of two classes of notes a - remedy is the right to “accelerate” the the Tird Circuit considered whether as a choice: accept the plan and receive cash equal maturity of the notes such that the full result of an issuer’s bankruptcy proceedings to the outstanding principal and interest due principal amount of the notes plus accrued noteholders were entitled to an amount (without the make-whole) or reject the plan interest become immediately repayable – but equal to principal and interest only or a and receive replacement notes, the principal not any make-whole premium (unless the make-whole premium as well. Energy Future amount of which would refect the make- indenture explicitly provided for payment Holdings (EFH) commenced Chapter 11 whole premium to the extent so determined of a make-whole upon acceleration, which is proceedings and sought to repay certain notes by the court. Te noteholders rejected the not customary). In some recent cases, courts at principal plus interest and to refnance a plan and objected. Te bankruptcy court have ruled that in addition to an entitlement portion of the notes. Te indenture trustees confrmed the plan despite the objections on to repayment of the principal amount and opposed this plan and sought a declaration the basis that the indenture, in its view, did not accrued interest upon acceleration of notes that the refnancing of the notes triggered the require payment of the make-whole premium. following an event of default, noteholders may obligation to pay the make-whole amount.11 In considering the application of the make- be entitled to payment of the make-whole Te district court for the District of whole provision, the Second Circuit found redemption premium. Delaware ruled that noteholders were not that the issuance of replacement notes after entitled to the make-whole premium, on the automatic acceleration did not qualify as Cash America the basis that the acceleration of the notes a redemption for the purposes of an optional In Wilmington Sav. Fund Soc’y v Cash Am. Int’l upon the Chapter 11 fling precluded the redemption that would trigger payment of a

Inc. (Cash America), Case No 15-CV-5027 noteholders’ ability to seek the make-whole. make-whole premium. Te court emphasised (JMF), 2016 WL 5092594 (S.D.N.Y. Sep. 19, On appeal, the Tird Circuit reversed that “redemption” is usually reserved for the 2016), Cash America spun of a subsidiary by the district court decision, fnding that pre-maturity repayments of debt, and in this distributing 80% of the subsidiary’s stock. Te the refnancing of notes in the bankruptcy case, acceleration moves the maturity date of Southern District of New York found that the proceeding triggered the make-whole provision. debt to the acceleration date. Furthermore, spin-of violated the terms of an indenture, First, the court found that the Chapter 11 the issuance of replacement notes was not triggering an event of default. In considering the resulted in acceleration of the notes, such optional on the part of the issuer, but rather remedy available to the aggrieved noteholders, that the notes became immediately payable. was the result of an automatic acceleration. the court noted that it is well-established under However, the court went on to fnd that such Te Second Circuit’s decision in Momentive New York law that when notes are already acceleration did not preclude redemption of left an interpretative split between the Second due and payable following an acceleration of the notes, fnding that “redemption” does not Circuit and the Tird Circuit’s decision in In re notes, and the issuer subsequently defaults, mean “pre-payment” and therefore even if the Energy. Te US Supreme Court has declined the noteholders cannot seek a prepayment notes had become immediately payable due to to review Momentive, leaving the circuit split premium. However, the court found that the Chapter 11 fling, the noteholders could on the application of make-whole provisions where acceleration resulted from the voluntary still seek the make-whole upon a subsequent in the context of bond defaults in place for actions of the issuer (here, the spin-of) versus redemption of the bonds. Te court dispatched now. Tis uncertainty has encouraged more involuntary actions (eg bankruptcy events), the issuer’s argument that the optional explicit language in indentures governing noteholders were permitted to seek specifc redemption provision and the payment upon whether make-whole premiums are due after performance of the optional redemption an event of default were “diferent pathways” bankruptcy fling. Te split may also encourage provisions since to efect the spin-of validly and instead found that the two provisions forum shopping on this issue.

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Biog box Feature Riley Graebner and Shannon Togawa Mercer are associates at Skadden, Arps, Slate, Meagher and Flom focusing on cross-border capital markets transactions. Email: [email protected] and [email protected]

In re Ultra Petroleum constitute additional indebtedness that did Te views expressed herein are not necessarily Recently, the Fifth Circuit also weighed-in on not ft into any of the permitted debt baskets those of Skadden, Arps, Slate, Meagher and the applicability of the make-whole premium or general “ratio debt” exception in the Flom (UK) LLP or its afliates or any one or to bonds that had been accelerated in debt covenant of the indenture. One of the more of its clients. In re Ultra Petroleum, No. 17-20793 (5th Cir. exceptions in the indenture’s debt covenant Jan. 17, 2019). Te case involved a relatively allowed indebtedness incurred through any 1 691 F.2d 1039, 1049 (2d Cir. 1982). idiosyncratic fact pattern where the issuer qualifed securitisation fnancing. Te issuer 2 Te US judicial system is separated into state entered bankruptcy insolvent and later argued that the new notes to be issued in the and federal courts. Federal district courts became solvent during bankruptcy due to a exchange ofer were permitted under this are predominately trial-level courts whose rise in commodity prices. Te court found exception on the basis that the indenture’s decisions are appealable to the circuit (or that noteholders of an issuer in bankruptcy, defnition of qualifed securitisation fnancing appellate) courts. Tere are 13 circuit courts even if the issuer is potentially solvent, are not included “any fnancing” as well as any with regional or subject matter jurisdiction. entitled to the make-whole where the make- refnancing thereof. Te court dismissed Circuit court decisions are appealable to the whole represents future interest payments. this interpretation on the basis that the US Supreme Court. Federal bankruptcy court Litigation on this point has caused the indenture used the terms “fnancing” and decisions are appealable in the frst instance to industry to reconsider the way the event of “refnancing” diferently, with “permitted the relevant federal district court. default provision is drafted. Some issuers refnancing indebtedness” used to refer to 3 57 F. Supp. 2d 316, 331 (S.D.N.Y. 2013). have added language stating that no premium scenarios in which debt is renewed, refunded, 4 57 F. Supp. 2d 316, 331 (S.D.N.Y. 2013). is payable as a result of an event of default refnanced, replaced, exchanged, defeased 5 Te TIA applies to indentures qualifed under and that the make-whole amount shall only or discharged. Te court then referred to the TIA, which typically is limited to indentures apply following an issuer’s voluntary election Black’s Law Dictionary for the defnition of for notes that have been registered under the to redeem the notes pursuant to the optional fnancing: the “act or process of raising or Securities Act of 1933. Te TIA would typically redemption provision. Other issuers, facing providing funds” without any suggestion of not apply to indentures for notes issued on an resistance from investors, have refrained from refnancing. If the issuer’s arguments were “unregistered” or “Rule 144A” basis that did not adding clarifying language. Te impact of the right, the court reasoned, then all fnancing also involve a subsequent registered exchange Fifth Circuit’s decision remains to be seen, would be permitted refnancing indebtedness, ofer (also called an A/B exchange). However, but because the court took the approach that, rendering the defned term meaningless. the language at issue in Marblegate and Caesars upon a default, bond holders are not entitled In this case, the court said that the plain appears in both TIA qualifed and non-TIA to the premium if it looks like un-matured meanings of “fnancing” and “refnancing” qualifed indentures and therefore the decisions interest, issuers and practitioners may be were sufcient to be read alongside each other were relevant to nearly all indentures. unable to draft around the ruling. and without confict. 6 80 F.Supp. 3d 507 (S.D.N.Y. 2015); 2015 WL 5076785 (S.D.N.Y. 2015).

INDENTED: RECENT DECISIONS COURT ON INDENTURES NEW LAW-GOVERNED YORK AND THEIR IMPACT CAN THEY DO THAT? CONCLUSION 7 80 F.Supp. 3d 507, 510-11 (S.D.N.Y. 2015). One barrier to litigation is that an issuer’s Recent case law interpreting New York law- 8 80 F.Supp. 3d 507, 511 (S.D.N.Y. 2015). actions under the indenture are often not governed indentures and the laws that apply 9 Te law frm to which the authors of this public. Issuers are typically required to produce have concrete implications for practitioners article belong is among the list of frms annual and quarterly reports as well as certify and issuers. Te volatility created by the who issued this white paper. http://www. compliance as to the covenants on an annual simple act of interpretation of indenture nortonrosefulbright.com/fles/chadbourne/ basis but are not required to give details on provisions is on display in cases such as tia316b-opinionwhitepaper.pdf. corporate actions and how such actions comply Marblegate, In re Energy, Momentive, and 10 846 F.3d 1, 8 (2d Cir. 2017). with indenture covenants. However, when an In re Ultra Petroleum. Tis trend in recent 11 842 F.3d 247, 253 (3d Cir. 2016). issuer’s incurrences of debt are made public it cases suggests increased potential for creates an avenue for noteholders to challenge unpredictability as more disputes over Further Reading: the issuer’s interpretation of the indenture. indentures are litigated. While the Supreme “Make-whole” provisions under New Court has thus far stayed out of the fray, the York and English law (2015) 2 JIBFL Norske Skogindustrier pool of circuit court opinions in this area, 93. In Citibank, N.A. v. Norske Skogindustrier and a lingering circuit split, may increase the High-yield bonds: an introduction to ASA, Case No. 16-cv-850, 2016 WL likelihood of Supreme Court review. To that material covenants and terms (2014) 4 1052888 (S.D.N.Y. Mar. 8, 2016), Norske end, those drafting and negotiating indentures JIBFL 242. launched an exchange ofer to refnance will want to make sure their intentions are LexisPSL: Restructuring & certain notes. Te trustee claimed that written as clearly as possible in the text of the Insolvency: Getting into bed with issuing the proposed exchange notes would indenture itself. n bondholders (2012) 4 CRI 120.

248 April 2019 Butterworths Journal of International Banking and Financial Law