On October 22, 2020, the New York Court of Appeals (the “Court”) granted partial summary judgment to a group of minority holders (the “Minority Noteholders”) of senior secured notes (the “Notes”), reversing a lower court decision that had permitted a strict foreclosure on the collateral securing the Notes and cancellation of the Notes leaving the Minority Noteholders without the ability to receive or sue for payment under the Notes. The 4-3 decision in CNH Diversified Opportunities Master Account, L.P. v. Cleveland Unlimited, Inc., 42 2020 NY Slip Op 05976 (N.Y. 2020), addresses issues similar to those that the Second Circuit confronted in Marblegate Asset Management LLC v. Education Management Finance Corp., 846 F.3d 1 (2d Cir. 2017), but further clarifies and arguably expands the rights of minority noteholders. Despite the fact that the indenture and related security documents explicitly permitted strict foreclosure with the consent of holders of a majority of the Notes (the “Majority Noteholders”), the Court concluded that the Minority Noteholders’ rights to receive and sue for payment pursuant to Section 316(b) of the Trust Indenture Act of 1939 (the “TIA”) and the indenture were violated because the exercise of such remedies terminated all such legal rights. The Court’s decision in CNH highlights the complexities of interpreting collective action provisions in indentures and any related agreements in connection with out of court restructurings, especially with respect to the exercise of even clearly enumerated remedies.
CNH Facts and Decision
The Minority Noteholders held approximately 3.33% of the outstanding principal amount of the Notes, which were issued by Cleveland Unlimited, Inc. (the “Issuer”) pursuant to an indenture (the “Indenture”) that incorporated certain provisions of the TIA. After the Issuer defaulted on its obligation to pay the principal and interest owed on the Notes, the Issuer, certain affiliates and the Majority Noteholders entered into a series of restructuring transactions whereby, among other things, the Issuer’s parent guaranteed the Notes and pledged 100% of the Issuer’s stock to the noteholders as collateral in exchange for a forbearance from the noteholders and the trustee. Shortly after the end of the forbearance period, the trustee, at the direction of the Majority Noteholders and without the explicit consent of the Minority Noteholders, executed a “strict foreclosure” pursuant to the New York Uniform Commercial Code on all of the outstanding stock of the Issuer that was pledged as collateral, distributing the stock on a pro rata basis to all Majority Noteholders and Minority Noteholders. The Minority Noteholders were notified that the result of the strict foreclosure was that the Notes were to be deemed paid and cancelled and that all obligations set forth in the Indenture were terminated.1 Notably, following the debt-for-equity exchange, the Minority Noteholders’ legal rights to recover principal and interest were purportedly extinguished, while the Issuer and the Note guarantors remained intact with all of their respective operating assets.
The Minority Noteholders commenced suit against the Issuer and the guarantors (collectively, the “Defendants”), arguing that the Defendants had impermissibly terminated the Minority Noteholders’ right to receive principal and interest as well as their right to sue to enforce such payment rights without their consent. The New York Supreme Court granted summary judgment in favor of the Defendants, and the Appellate Division affirmed, relying, in part, on Marblegate. In Marblegate, the issuer engaged in a series of out of court restructuring transactions related to notes issued pursuant to an indenture qualified under the TIA,2 which transactions ultimately left the issuer as “an empty shell.” The Second Circuit ultimately held that Section 316(b) of the TIA prohibits only “non-consensual amendments of core payments terms (i.e., the amount of principal and interest owed, and the date of maturity).”3 Since the issuer in Marblegate was an empty shell, the plaintiffs alleged that they no longer had any practical ability to collect payment of principal and interest. However, in Marblegate, the plaintiffs’ legal rights to receive principal and interest and to pursue available remedies were left intact. Accordingly, the Second Circuit held no violation of Section 316(b) of the TIA had occurred.
Relying on Section 6.07 of the Indenture, which contained language preserving each noteholder’s right to receive payment and bring suit for the enforcement of payment, as well as guidance from the TIA as to the intended application of the applicable Indenture provisions,4 the Court held that purported cancellation of the Notes violated the Minority Noteholders’ legal rights. The Court found that Section 6.07 of the Indenture protected such legal rights and was drafted with the intent to override any potentially conflicting language in the Indenture. The Court further found that the structure and design of Section 316(b) of the TIA demonstrated “an intent to protect bondholders’ legal rights to payment and to bring suit from the effects of collective action.”5 Accordingly, notwithstanding that the Majority Noteholders were able to direct the trustee to effectuate the strict foreclosure, it was a violation of Section 6.07 of the Indenture and Section 316(b) of the TIA to cancel the Notes without the Minority Noteholders’ consent. Although the dissenting opinion disagreed, the Court also interpreted all other collective action provisions of the related Collateral Trust Agreement and Security Agreement as being subject to the rights contained in Section 6.07 of the Indenture.6
The Court distinguished Marblegate on the basis that the plaintiffs in Marblegate relied on a theory of interference with their practical ability to receive payment but, unlike the plaintiffs in CNH, their legal rights to payment and suit were preserved. The CNH Court clarified language from the Marblegate opinion that was commonly understood to limit Section 316(b)’s protections to cases involving “formal amendments” of “core payment terms” by finding that Section 316(b)’s protection against nonconsensual formal amendments also extends to noteholders’ “legal rights to obtain payment by suing.”7
The CNH decision extends the logic of the Marblegate decision to affirm that noteholders holding debt securities governed by indentures qualified under the TIA (or that incorporate TIA provisions by reference) are required to consent to any impairments to their legal rights to payment of principal and interest on such debt securities or to bring suit to recover such payments. Importantly, both decisions are clear that the TIA does not provide any guarantee of the practical ability to receive such payments.8 It remains to be seen whether future courts or restructuring parties will regard CNH as a useful companion case to Marblegate or whether, as the dissent concluded, the case “needlessly injects uncertainty” into the corporate debt market. Minority noteholders may seek to rely on the holding in CNH to attempt to extract value from issuers and majority noteholders during restructuring negotiations. Issuers and other creditor groups may find themselves providing greater incentives to minority noteholders to consummate out of court restructurings in order to avoid expensive and potentially time-consuming chapter 11 filings or other litigation. However, issuers and majority noteholders are not left without recourse: out of court transactions can still be structured in a manner that relies on collective action so long as the underpinnings of the transaction harmonize the Marblegate and CNH decisions.
1CNH, at 7.
2Marblegate, 846 F.3d at 3. The TIA applies to all “qualified” indentures (i.e., indentures that cover debt securities issued in offerings which have been registered with the Securities and Exchange Commission).
3Id. at 7. Section 316(b) of the TIA provides that the right of any holder of a security governed by an indenture to receive payment of principal and interest or to bring suit to enforce such payment shall not be impaired or affected without the holder’s consent. 15 U.S.C. § 77ppp(b).
4The Indenture in the CNH case was not qualified, but the Court accepted that Section 316(b) of the TIA applied because (i) Section 6.07 of the Indenture tracked the language of Section 316(b) and (ii) the Indenture also incorporated by reference any provision of the TIA required to be included in qualified indenture.
5CNH at 13.
6Id. at 20. Reading all of the agreements together, the dissent determined that the Minority Noteholders had in fact consented through the operation of the terms of the Collateral Trust Agreement to the actions to be taken by the trustee following a default, such as the strict foreclosure. Id. (dissenting) at 8. The majority opinion found the Indenture governed.
7Id. at 17 (majority opinion). The dissent followed the lower courts in their narrower interpretation of the Marblegate opinion. The dissent noted that the terms of the Notes were governed by “unmodified indenture documents.” Id. at 14 (dissenting).
8Id. at 3 (majority opinion).
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