Relevant Document:Opinion
In an opinion issued Friday evening, U.S. District Judge Jesse Furman found that Windstream Services violated the indenture for its 6.375% senior unsecured notes due 2023 by “engaging in an impermissible Sale and Leaseback Transaction and that its subsequent maneuvers did not waive or cure the default arising from that breach.”
Among other things, Judge Furman’s opinion awards Aurelius money judgment in the amount of $310.5 million on account of the notes plus interest after July 23, 2018, which the court estimates to be $61,347 per day. In addition the court finds that the breach ripened into an event of default under the indenture in December 2017 and Aurelius’s notice of acceleration sent to Services at that time “was valid and effective” and the court determines that “all principal together with all accrued and unpaid interest on the Notes became immediately due and payable as of that date.” Judge Furman says in the opinion that Aurelius “shall confer with the other parties” and draft a proposed judgment consistent with the opinion, and shall file it on ECF for the court’s approval no later than Feb. 25.
Although in their respective pleadings, U.S. Bank as indenture trustee of the company's 6.375% senior notes due 2023 and Aurelius also seek fees and costs, Judge Furman notes in a footnote that the parties have not briefed those issues and that he accordingly is not ruling on them.
He adds that, “given the high likelihood of an appeal from this Court’s judgment, it would make sense to defer any such decision until the litigation fully runs its course” (emphasis added). Accordingly, Judge Furman requests that Aurelius and the trustee file an application for attorney’s fees and costs within thirty days of the judgment in the becoming final and not appealable.
Returning to the opinion, Judge Furman rules that the “Court’s task is not to opine on the financial wisdom” of Services’s decisions but instead “to enforce the Indenture’s plain terms.” With that in mind, the court concludes that Services’ “financial maneuvers -- and many of its arguments here -- are too cute by half.” The opinion comes roughly six months after a bench trial
concluded in July 2018 on the 2015 Uniti spinoff and 2017 note exchange
dispute between Services, Aurelius and U.S. Bank.
The litigation dealt with two separate sets of transactions: the 2015 spinoff transaction and the November 2017 exchange transactions that issued new senior 6.375% notes due 2023. The 2017 exchange sought to solicit consents to waive any default stemming from the 2015 transaction. Aurelius
did not seek to invalidate the 2017 debt exchange, but a declaration that the new exchange notes were not permissible “additional notes” under the indenture and that the additional notes did not have a right to vote on the waiver. Judge Furman’s ruling also enjoins Services from taking any further action to issue new 6.375% notes due 2023 in violation of the indenture.
In the 2015 transaction, certain subsidiaries of Services transferred assets to a REIT, which then leased the assets to Services’ parent holding company, Windstream Holdings, Inc., which in turn allowed the transferor subsidiaries to use and occupy the assets. Aurelius has
stated that the spinoff was an impermissible sale and leaseback transaction within the meaning of the indenture.
In
September 2017, Aurelius sent Windstream a notice of default claiming that “the transfer of certain assets and the subsequent lease of those assets in connection with the spinoff of Communications Sales & Leasing, Inc. (now known as Uniti Group, Inc.) in April 2015 constituted a Sale and Leaseback Transaction (as defined in the Indenture) which did not comply with the Sale and Leaseback covenant under the Indenture.” In October 2017, Aurelius, exercising authority by virtue of its controlling position in the notes, directed trustee U.S. Bank to file suit, alleging that the transaction breached the covenant in the notes indenture prohibiting a “Sale and Leaseback Transaction.” Aurelius argued that the default, if uncured, would then trigger an acceleration provision in the indenture that would make the notes’ entire aggregate principal amount, plus any unpaid interest, due immediately, notes the opinion.
Judge Furman observes that Services responded to the Aurelius argument outside the courtroom through “an elaborate series of exchange offers and consent solicitations that, together, were designed, first, to dilute Aurelius’s voting interests and, second, to obtain a waiver of any default arising from the alleged Sale and Leaseback Transaction from a new majority of Noteholders created through the exchange offers.” In the process, Services increased its total indebtedness by $40 million. The first of these exchange offers occured on
Oct. 19, 2017.
In the courtroom, Services also responded by bringing counterclaims against U.S. Bank and Aurelius, seeking a judicial declaration that it did not breach the bond indenture through the impermissible sale and leaseback transaction as defined in the indenture. In turn, Aurelius brought counterclaims of its own, seeking “in essence, both a declaration that Services was in default — despite its efforts to secure a waiver — and a money judgment for the aggregate principal amount of its Notes plus interest,” says the opinion.
Agreeing with Aurelius, the court determines that the 2015 transaction was a sale-leaseback transaction and that, in effecting the transaction, Services failed to comply with the senior notes indenture.
Judge Furman finds that, along with other breaches described in more detail below, the breach ripened into an event of default under the indenture in December 2017 and Aurelius’s notice of acceleration sent to Services at that time “was valid and effective” (emphasis added). As a result, as noted above, the court determined that “all principal together with all accrued and unpaid interest on the Notes became immediately due and payable as of that date.” The ruling also dismisses Services’ counterclaims with prejudice.
Windstream, Aurelius, Friedman Kaplan, Robbins Russell, and Kirkland & Ellis did not respond to requests for comment.
The 2015 Transaction Was a Sale and Leaseback Transaction
Judge Furman notes that the first question before the court was whether the 2015 transaction constituted a breach of section 4.19 of the indenture, which prohibited Windstream Services and certain of its restricted subsidiaries from entering into a sale and leaseback transaction unless certain conditions, outlined in sections 4.19 (i), (ii) and (iii) of the indenture, were met.
The opinion highlights that there was no dispute amongst the parties that the implicated subsidiaries were restricted subsidiaries under section 4.19 or that one or more of the conditions set in sections 4.19 (i), (ii) and (iii) were not met. In addition, the judge comments that there is no dispute that the transaction involved the sale or transfer by the transferor subsidiaries of transferred assets to CS&L.
According to Judge Furman, “the propriety of the 2015 Transaction depends in the first instance on whether it was a ‘Sale and Leaseback Transaction’ within the meaning of the Indenture,” which in turn depends on whether the transferor subsidiaries leased the transferred assets “either directly from CS&L under the Master Lease or indirectly from Holdings under a lease or sublease” after transferring the assets to CS&L.
In examining whether the transaction was a sale leaseback, Judge Furman in a footnote comments that “the parties spill considerable ink addressing whether the 2015 Transaction qualifies as a sale and leaseback transaction” under GAAP, a question that is “irrelevant because ‘Sale and Leaseback Transaction’ is a defined term in the Indenture.” The judge also notes that the court does not address Services’ efforts to describe a valid business reason for the transactions structure, stating that “Services’ motivations for structuring the transaction in the way it did are not relevant to that question.”
For two independent reasons, Judge Furman concludes that the transferor subsidiaries leased back the transferred assets, qualifying the 2015 transaction as a sale and leaseback transaction within the meaning of the indenture.
First, the court finds that the transferor subsidiaries lease the transferred assets as a matter of law. Second, the court determines that Services is judicially estopped from denying the existence of a lease. The court found that Services’ other arguments were without merit.
Noting that the word “lease” is not defined in the indenture, the court turns to the plain and ordinary meaning of the word when used as a noun. Judge Furman writes that there are two critical components to a lease: “first, transfer of the right to use or occupy property for a specified term; and second, consideration, usually rent.” The court finds that both components were present in the 2015 transaction.
According to Judge Furman, the transferor subsidiaries “plainly
hold” the transferred assets in a manner consistent with a leasehold interest. In support of this conclusion, the court points to Services’ exclusive right to use the leased property in accordance with the master lease, stating “as a matter of practical reality, the Transferor Subsidiaries have exclusive control over the Transferred Assets during the term of the Master Lease.” In addition, the opinion highlights that the transferor subsidiaries are paying “healthy consideration” in exchange for the right to use and occupy the transferred assets.
The opinion states that Holdings recognizes the payments made by the transferor subsidiaries as consideration for the right to use the transferred assets provided to them by Holdings. Judge Furman notes that there are documents in the record, “Officer Certificates” delivered by Services to the trustee and certain board resolutions, that identify the monthly payments as “distributions” or “dividend payments.” The decision says, “those self-serving labels, however, are not controlling.”
Judge Furman reasons that even if the transferor subsidiaries’ monthly payments were properly characterized as “dividend” payments rather than rent, the court concludes that the transferor subsidiaries “pay, and have paid, consideration for their use and occupation of the Transferred Assets in the form of maintenance, taxes, utilities, insurance, and capital improvements.” Judge Furman adds that between the closing and mid-2017, the transferor subsidiaries spent more than $339 million on capital improvements to the transferred assets which “are recognized as expenses on the Transferor Subsidiaries’ financial statements.” The court says that though these payments, the transferor subsidiaries have paid, and are paying, consideration for the use and occupation of the transferred assets. Judge Furman concludes,
“the labels used by the parties to the 2015 Transaction aside, the Transferor Subsidiaries ‘lease[d]’ the Transferred Assets within the ordinary meaning of the term ‘lease.’”
Continuing, the opinion states that Services is “judicially estopped from denying that the Transferor Subsidiaries ‘lease’ the Transferred Assets.” Judge Furman says that in seeking and obtaining approval for the 2015 transaction, Windstream entities “made explicit representations” to nine state regulatory bodies that the transferor subsidiaries would transfer ownership of the assets in question and then “lease them back on an exclusive, long-term basis.” For instance, in sworn testimony, John Fletcher, general counsel to both Services and Holdings, reassured the Kentucky Public Service Commission that the transferor subsidiaries would have necessary assets to continue to provide adequate telecommunication service to Kentucky consumers because they “will have an exclusive long-term lease and right … to use and occupy all the assets that are within their system today.”
Judge Furman says that these representations in addition to others mentioned in the opinion, which were accepted by multiple state regulatory bodies, are “flatly inconsistent with the position Services takes here - namely, that the Transferor Subsidiaries did not lease the Transferred Assets” (emphasis added). The decision says that at trial, Fletcher made attempts to retroactively minimize the significance of the representations by calling them “imprecise,” “shorthand abbreviated statements,” and “poorly constructed.” However, the opinion says that these comments are unavailing, particularly in light of Fletcher’s “admission that the previous statements were not inaccurate or misleading.”
In addition, the opinion says that for the purposes of the sale leaseback analysis,
it does not matter that “Windstream (accurately) disclosed to the state regulators that Holdings would be the sole signatory on the Master Lease” (emphasis added). The relevant question for purposes of determining whether the 2015 transaction constituted a sale and leaseback transaction within the meaning of the indenture is whether the transferor subsidiaries “leased” the transferred assets after transferring them to CS&L, says the decision. Judge Furman remarks, “The fact that Holdings is the sole Windstream party to the Master Lease does not answer that question, as the Master Lease explicitly authorizes Holdings to sublease the Transferred Assets to the Transferor Subsidiaries without prior approval from CS&L.”
The opinion states that Service’s remaining arguments that there was no lease, and no sale and leaseback transaction are “without merit.” Services maintains that no sale and leaseback transaction occurred because it “occurs only when the transferor and lessee are the same ‘Person,’” but the “Trustee contends - and the Court holds - that the Transferor Subsidiaries themselves ‘lease’ the Transferred Assets,” says the ruling.
Services contends that the Court should not view the arrangement as a lease “because the Transferor Subsidiaries have ‘no obligations’ to fund the rent payments,” but that is “inconsistent with Windstream’s own statements - to regulators and in the financial statements of both Holdings and the Transferor Subsidiaries,” “inconsistent with economic reality,” and “inconsistent with the law,” the opinion states.
Judge Furman concludes that the
“Transferor Subsidiaries’ use and enjoyment of the Transferred Assets walks like a lease and talks like a lease...because it is a lease” (emphasis added). The court therefore holds that the 2015 transaction constitutes a sale and leaseback transaction within the meaning of the indenture, and “unless excused or cured by the 2017 Transaction, the 2015 Transaction constitutes a breach of Section 4.19 of the Indenture.”
The 2017 Notes Were Issued In Violation of Section 4.09 of the Indenture
Judge Furman states that the 2017 notes do not qualify as additional notes within the meaning of the indenture “because they were issued in violation of Section 4.09 of the Indenture, which provides protections to Noteholders by limiting the amount of additional indebtedness that Services may incur.” Given Services’ concession that if the 2015 transaction constituted a sale and leaseback within the meaning of the indenture, as the court holds that it does, “then its Consolidated Leverage Ratio before the 2017 Transaction exceeded the 4.5 to 1 threshold.” It therefore follows that Services did not have capacity under section 4.09 of its indenture for the 2017 notes to qualify as “Permitted Debt,” says the opinion.
The opinion also says that Services’ invocation of section 4.09(b)(v) of the indenture, which references “permitted refinancing indebtedness,” relates to “certain circumstances not relevant here.” Judge Furman states that whether the 2017 notes were issued in accordance with section 4.09 of the indenture depends first on whether the notes increased the “amount” of Services’ indebtedness, which “[i]t plainly did.”
Judge Furman references the testimony of Services’ expert witness
Michiel McCarty, who opined that Services did not increase the “amount” of indebtedness because the amount “involves a determination of economic or mathematical ‘equivalence,’” stating that “defining ‘amount of Indebtedness’ in such a subjective and vague manner [...] would create uncertainty to the detriment of both Services and its creditors.”
He adds that “[e]ven more perversely, as Aurelius explains, if McCarty’s view were adopted, Services’ leverage ratio would actually decrease as the company became more distressed [...] giving it a greater capacity to issue more debt under Section 4.09” (bold emphasis added). Judge Furman states that this “absurd result would turn Section 4.09, which exists to protect creditors, on its head.”
Continuing, the opinion says that since the 2017 transaction caused the “amount of Indebtedness” to increase, the court’s determination of whether the 2017 transaction was consistent with section 4.09 “comes down to whether the incremental increase of approximately $40 million was used to pay (1) ‘accrued and unpaid interest thereon,’ (2) ‘the amount of any reasonably determined premium necessary to accomplish [the] refinancing,’ or (3) ‘such reasonable expenses incurred in connection therewith.”
However, Judge Furman says that the court does not need to “dive into that thicket” because Services admitted that “no premium was paid to Noteholders in connection with the [2017] Exchange Offers” (emphases added).
These admissions are binding and preclude Services from arguing that a premium was paid, the opinion states.
Judge Furman writes that since the new notes issued in connection with the 2017 transaction were not valid additional notes, it follows
“the Third Supplemental Indenture, which purported to waive any Default or Event of Default arising from the 2015 Transaction, was and is invalid” (emphasis added).
The opinion clarifies that although the court holds that the 2017 transaction did not succeed in waiving or “curing” the default caused by the 2015 transaction, “the Court does not hold that the New Notes issued in connection with the 2017 Transaction are invalid.” Instead, the ruling says that
the court merely holds that the new notes do not constitute “Additional Notes” within the meaning of the indenture and that as a result there were insufficient consents for the third supplemental indenture and “it is therefore invalid” (emphases added).
As a result, Services did not obtain a waiver of its breach relating to the 2015 transaction and Aurelius’s notice of default ripened into an event of default on Dec. 7, 2017, Judge Furman concludes. Aurelius is therefore entitled to a money judgment in the amount of the notes it holds plus interest: “That figure, about which there is no dispute, is $310,459,959.10, with an additional $61,347.50 per day in interest after July 23, 2018.”
Services’ Breach of Contract Counterclaim Against the Trustee Fails
The decision also addresses Services’ breach of contract counterclaim against the trustee for maintaining this lawsuit after it executed the third supplemental indenture. The opinion says, “[g]iven the Court’s holdings above, it follows that Services’ breach-of-contract claim fails.”
However, Judge Furman also clarifies that Services’ breach of contract counterclaim “would have failed even if the Trustee had not prevailed on its claims with respect to the 2015 Transaction.” The opinion says that it would be “absurd” to conclude that the trustee breached its obligations to Services by submitting the parties’ “complicated and intertwined” disputes to the court for resolution. This is especially true, writes Judge Furman, since the third supplemental indenture “itself explicitly acknowledges, and accounts for, the possibility of a legal challenge to its validity.”
Similarly, the ruling says it would be “absurd” to suggest that the trustee did not proceed in good faith. He adds that even had the trustee had breached its contractual obligations, it would not be responsible for attorney’s fees since the indemnification provided to the trustee through section 7.07(b) of the indenture “plainly extends to the actions taken by the Trustee that are the subject of Services’ counterclaim.” Moreover, the request for fees is barred by the so-called American Rule, which prevents fee-shifting in the absence of an applicable agreement, statute or court rule, none of which are present here, Judge Furman says.