Relevant Documents:
Opinion
Plaintiffs-Appellants Brief
Defendants-Respondents Brief
Plaintiffs-Appellants Reply
Oral Argument Transcript
Today, the Court of Appeals for the State of New York issued a 4-3 opinion in
CNH Diversified Opportunities v. Cleveland Unlimited, a case related to how indenture provisions and acts of a collateral trustee are bounded by prohibitions against nonconsensual impairment under the Trust Indenture Act, or TIA. The case raises analogous considerations as were considered in the
Marblegate Asset Management LLC v. Education Management Corp. decision issued by the U.S. Court of Appeals for the Second Circuit in 2017.
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Reversing trial court and the Appellate Division court decisions below that relied on
Marblegate, the Court of Appeals for the State of New York, or Court of Appeals, in the majority opinion written by Associate Judge Michael J. Garcia, determined that the right to sue for deficiency payments of the plaintiffs-appellants, the dissenting minority noteholders, “survived” after the indenture trustee, at the direction of the majority noteholders, undertook a strict foreclosure under the Uniform Commercial Code that resulted in a debt-for-equity exchange and purportedly extinguished the dissenting minority’s rights to seek any further payment on the notes. Chief Judge Janet DiFiore and Associate Judges Leslie E. Stein and Paul Feinman concurred with Judge Garcia.
However, in a dissent, Associate Judge Eugene M. Fahey, who would affirm the lower court’s ruling, observes that the majority’s decision “needlessly disconnects the law of the two courts most relevant to the markets in which these securities are traded,” warning that “[c]onfusion will surely follow.” According to Judge Fahey, “At bottom, the majority’s approach - in which it effectively ignores the collateral trust agreement, mistakenly applies the TIA to what should be a pure, direct contractual analysis, and then is mistaken in its application of the TIA within that review - needlessly injects uncertainty into a multi-trillion-dollar corporate debt market.” The dissent argues that the majority’s opinion “ultimately strikes a chord of disharmony in undermining what should be the prevailing rule in both this Court and the Second Circuit that agreements of collective design should be read as one.” Judges Jenny Rivera and Rowan D. Wilson concurred with Judge Fahey’s ruling.
Jim Millar of Faegre Drinker Biddle & Reath represented plaintiffs-appellants CNH Diversified Opportunities Master Account LP and related accounts. James M. McGuire of Holwell Shuster represented the defendants-respondents Cleveland Unlimited Inc. and its affiliates.
A video of the argument is available
HERE.
Marblegate and Case Background
In
Marblegate, the Second Circuit overturned the district court’s ruling that an out-of-court restructuring violated the TIA by precluding nonconsenting noteholders’ ability to collect payment on their notes by transferring collateral from the obligated entity via a foreclosure and sale to a newly formed subsidiary, or NewCo. Shares in the NewCo would only be transferred to the consenting majority, with the minority left with their undisturbed but now valueless legal right to repayment by the initial obligor under the subject notes. In a 2-1 majority opinion, adopting a narrow interpretation of the TIA, the Second Circuit concluded that section 316(b) of the TIA “prohibits only non‐consensual amendments to an indenture’s core payment terms.” Judge Chester Straub’s dissenting opinion considered the practical effect of the restructuring transaction and would have upheld the district court’s determination that the TIA would bar a transaction that is “collusively engineered to ensure that certain minority bondholders receive no payment on their notes, despite the fact that the terms of the indenture governing those notes remain unchanged.”
The dispute in
CNH also involved a restructuring that the minority noteholders say violates an indenture provision barring nonconsensual impairment of rights to payment, which mirrors section 316(b) of the TIA. Following a breakdown in negotiations, a majority group of noteholders forced a debt-for-equity exchange by the indenture trustee through the collective action provisions of the indenture and security agreement. Following the exchange, the company obtained a senior secured loan from the majority noteholders on favorable terms in which the minority noteholders were not invited to participate.
Like in
Marblegate, the
CNH decision is likely to impact the leverage dynamics between majority and minority creditors in the context of out-of-court restructurings. The Second Circuit’s reversal of the 2015 district court decision was generally
viewed as a reversion to the prior state of play, in which out-of-court restructurings were facilitated by a greater ability of majority creditors to bind holdouts.
CNH now tracks in the opposite direction, potentially requiring a greater use of the bankruptcy process to bind an objecting minority to the terms of restructurings that implicate the core rights to payment.
Majority Opinion
In the majority opinion written by Judge Garcia, the court upheld the minority noteholders’ action for breach of contract and breach of guaranty for payment of principal and interest on the underlying notes on the grounds that the strict foreclosure had “impermissibly terminated” the right to payment without their consent.
The Court of Appeals began its analysis by interpreting the indenture and other loan documents “as a matter of basic contract law.” However, while the indenture was not “qualified under the TIA,” it intentionally incorporated provisions from section 316 of the TIA, such that the Court of Appeals would “look to the TIA for guidance as to the intended application of those Indenture provisions.”
In his review of the TIA, Judge Garcia reviewed the interplay between provisions for majority action to pursue remedies upon default and prohibitions against the nonconsensual impairment of right to payment. Although there was “no question that, here, the Trustee was authorized to act,” the Court of Appeals focused on whether the minority noteholders’ rights “were extinguished … by the purported cancellation of the Notes.” Rejecting reliance “on language in
Marblegate that … limits the scope of [section 316(b) of the TIA] to protection against ‘formal amendments’ of ‘core payment terms’” by the majority-defendants and the lower courts, Judge Garcia distinguished
Marblegate as involving the “practical ability,” not the “legal right … to receive payment.” Without
Marblegate’s limitation on the scope of the TIA’s prohibitions against the nonconsensual alteration of payment terms, the Court of Appeals found that the specific provisions in the indenture affording individual noteholders the “absolute legal right to bring suit on its own behalf for payment of principal or interest” were violated by the “purported cancellation of the Notes without the dissenting Minority Noteholders’ consent.” Consequently, the minority-plaintiffs were entitled to partial summary judgment on the right-to-payment issue considered below.
Judge Garcia then remitted the case to the lower court to consider whether a trial on damages is required and if claims against the guarantor that was the actual owner of the collateral subject to the strict foreclosure should be dismissed.
Dissent
In the dissent, Judge Fahey observes that the majority “strikes at the consistency” between the law of this Court of Appeals and the Second Circuit “with respect to the rules by which disputes related to an indenture of this nature are to be resolved,” explaining that the matter is one that “should be governed by basic principles of contract interpretation.”
Judge Fahey acknowledges that the case involves two agreements “that, when properly read as one, govern that review: the indenture, for which the majority accounts, and the collateral trust agreement, which the majority does not meaningfully consider.” The dissent points out that such agreements were executed simultaneously, “and, when read together, they support the strict foreclosure course chosen by the trustee following the default of defendant Cleveland Unlimited, Inc. (Cleveland Unlimited) with respect to the notes in question.”
The dissent criticizes what it characterizes as the majority’s decision to “brush[] the collateral trust agreement aside” and “elevate[] the importance of [the TIA] to a place of undue prominence in determining this case,” explaining that the majority’s decision to do so comes “[a]t the expense of both our rules of contract interpretation and the symmetry of such principles with those of the Second Circuit.”
Stressing the importance of “[c]ertainty of the law,” which the dissent explains is “an essential underpinning of financial dealings such as this one,” Judge Fahey concludes that “[t]he prudent, common-sense approach here would be to maintain that sureness and to avoid creating space between the rules of this Court and the rules of the Second Circuit governing the interpretation of indenture agreements.” As a result, the dissent reasons that the Court of Appeals should conclude that its “steady rules of contract interpretation applied to the plain language of the contract in question authorize the strict foreclosure here at issue.”
As the dissent observes, the indenture “left open” the possibility that “a codicillary agreement - such as the collateral trust agreement - would modify the indenture,” explaining that this was “precisely what occurred here.” The dissenting opinion points out that “the adjustment of the indenture by operation of the collateral trust agreement provided the consent of the minority noteholders required in the indenture to allow the majority noteholders to authorize the foreclosure in question here.”
Oral Argument Highlights
Judge Garcia began his questioning by commenting that the actions taken in the
Marblegate case were “very different” but noting that the case had “dicta” that “seems to indicate that foreclosure actions, whatever the effect, that have the ultimate effect of terminating the rights you're about to describe, do not qualify as actions that would violate [section] 316(b) of the TIA.”
In response to Judge Garcia’s prompt, Millar factually distinguished the cases. Millar emphasized the classes of secured debt and unsecured debt in
Marblegate, which allowed the senior secured debtholders to foreclose on their collateral while the junior unsecured noteholders’ “rights were left in place” albeit at an “empty shell.”
Millar also contrasted the situation in
Marblegate with the facts at issue where the junior noteholders’ payment rights extend to both the operating and the holding company level and the junior noteholders’ deficiency claims should survive any foreclosure sale. Judge Wilson then asked, “[I]sn’t [] that effectively the same economically as what happened here?” Millar identified the distinction as centering on the resulting direct effect on the junior noteholders' legal rights, which were preserved in the transaction at issue in
Marblegate. Responding to a hypothetical raised by Judge Rivera regarding whether those rights could be waived by the indenture trustee through a settlement, Millar stated that a trustee cannot settle the “unequivocal” right to payment under the loan documents. According to Millar, it would be permissible for a trustee to pursue a foreclosure that would allow the junior noteholders to “maintain their deficiency judgment.”
Judge Fahey then turned to the subject of bankruptcy, and Millar denied that bankruptcy would have necessarily yielded more value to the shareholders. At the conclusion of his argument, Millar then responded to another of Judge Fahey’s questions, explaining that CNH did not seek to enjoin the restructuring transaction due to the adequate remedy at law in the judgment for failure to pay currently being sought in the proceedings at hand.
Rejecting Judge Fahey’s characterization of the majority noteholders’ argument that the juniors are “really seeking to cut the line,” Millar explained that there was really no line to cut because the majority noteholders “voluntarily took equity … so that they could take over the company, put themselves in as directors, make a sweetheart loan, pay themselves interest, and then take the rest of the money for themselves.” It is “precisely the policy” behind the TIA to prevent such actions, and the junior noteholders were solely focused on enforcing their “pre-eminent right” to payment under the loan documents, not any ancillary actions against the indenture trustee, to recover the collateral or other matters, said Millar.
For the respondents, McGuire referenced
Marblegate’s rule, which he characterized as prohibiting formal indenture amendments, right out of the gate. Judge Garcia responded by questioning the relevance of the Second Circuit’s decision, saying that “it couldn’t be a
Marblegate type of resolution for you” given the number of guarantees in place and that the foreclosing creditors in that case had the “exclusive rights to the collateral” with the junior creditors “who didn’t then have a practical right to collect.” Judge Garcia then asked McGuire to explain why remedies under the collective action provisions of the loan documents would not be subject to the indenture’s prohibition against nonconsensual alteration of the noteholders’ rights to payment. McGuire argued that reading the loan documents together and the policy background of the TIA was to “invigorate” previously “powerless” trustees to exercise remedies upon default clearly authorized the trustee to pursue the strict foreclosure for the benefit of all noteholders despite the lack of unanimous consent.
Judge Garcia responded by questioning whether the “active” role of the trustee would be “completely undermined” if the “majority bondholders direct the trustee to take a certain action and indemnify the trustee specifically for any resulting breaches of fiduciary duty claims.” McGuire asserted that the indemnification was limited in scope. McGuire then transitioned to contrasting the “active” trustee with counterfactual scenario under the minority’s position, which he asserted would lead to the absurd outcome of where a trustee “can’t settle … no matter how great a deal for all bondholders.” “[I]t’s crazy to think that you can be granted [the right] to sue and yet you can’t settle,” reiterated McGuire.
According to McGuire, the prohibition of any non-consensual modification of an indenture’s payment provisions would preclude the majority of creditors from adding acceleration provisions or providing for a release of guarantors in the event of a sale of all assets. The interpretation of section 316(b) of the TIA to strictly preclude non-consensual rights to payment would shunt restructuring proceedings into bankruptcy proceedings, even in cases “in which there’s a vast gulf between the value that a strict foreclosure and a bankruptcy can deliver,” argued McGuire.
In the equity exchange at issue, the junior noteholders’ rights were enforced by a “vigorous trustee” with a result where value was “maximized and [] distributed pro rata to all noteholders,” under the agreed terms of the indenture, concluded McGuire.
During rebuttal, Millar explained that the policy change to empower a vigorous trustee under the TIA did not “override” individual noteholders’ core right “to payment of principal and interest.” Millar also contested the proposition that CNH’s approach results in a bankruptcy-only option, pointing to the option to “sell the assets and get money” through a foreclosure sale, and further noted that a shift toward bankruptcy restructurings was an intended result of the TIA. Concluding his argument, Millar emphasized that a ruling allowing indenture trustees to “compromise the noteholders’ right to payment against the issuer” would work as a “sea change” under New York law and the TIA.
Editor’s Note: This story has been updated to correctly identify the plaintiffs-appellants's firm as Feagre Drinker Biddle & Reath.