Is it premature for lawyers who are asked to give closing opinions on complex debt restructurings to breathe a complete sigh of relief now that the Second Circuit’s decision in Marblegate Asset Management, LLC v. Education Management Corp., 846 F.3d 1 (2d Cir. 2017) has confirmed the narrow scope of section 316(b) of the Trust Indenture Act of 1939, as amended (TIA)?
The Second Circuit held that section 316(b) protects only bondholders’ formal legal right to the payment of principal and interest and not their practical ability to collect principal and interest, reversing a decision by the SDNY that had created great uncertainty among practitioners concerning out-of-court bond workouts. (For prior discussions of the Marblegate litigation, see “Current Opinion Practices in Connection with Section 316(b) of the Trust Indenture Act―The Marblegate and Caesars Decisions,” WGLO Addendum (Spring 2016 Legal Opinion Seminar Summaries), In Our Opinion (Summer 2016, vol. 15, no. 4) at A-8–A-10; “Opinion White Paper (§ 316(b), Trust Indenture Act,” In Our Opinion (Spring 2016, vol. 15, no. 3) at 28, and the Addendum thereto (the Opinion White Paper).) Two Marblegate funds had challenged a complex restructuring of Education Management Finance Corp. (EMFC) (to which they did not consent) based on the argument that it violated section 316(b), which provides that “. . . the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security . . . shall not be impaired or affected without the consent of such holder.” The district court had held that, even though the restructuring did not change the terms of the indenture, it violated section 316(b) because it completely eliminated nonconsenting bondholders’ “practical ability to receive payment.”
The Second Circuit, in a 2-1 decision, concluded that the restructuring was permissible because the transaction as a whole neither amended any “core payment terms” of the indenture (i.e., the amount of principal and interest owed or the maturity date) nor prevented the objecting bondholders from suing the issuer for payment:
To summarize, we hold that Section 316(b) of the TIA does not prohibit the [challenged restructuring] in this case. The transaction did not amend any terms of the Indenture. Nor did it prevent any dissenting bondholders from initiating suit to collect payments due on the dates specified by the Indenture. Marblegate retains its legal right to obtain payment by suing the EDM Issuer, among others. Absent changes to the Indenture’s core payment terms, however, Marblegate cannot invoke Section 316(b) to retain an ‘absolute and unconditional’ right to payment of its notes.
The majority agreed with the district court that the text of section 316(b) was ambiguous, but then looked to the legislative history and concluded that section 316(b) protects only against formal amendments of core payment terms. Judge Straub dissented because he viewed the restructuring as “annihilating” the bondholders’ rights to recover on their bonds in violation of the plain language of the statute.
The legal opinion most directly affected by Marblegate is that the transaction does not violate section 316(b), which is given most frequently to indenture trustees as part of an opinion letter confirming that that the issuer has validly authorized an indenture amendment, and all conditions precedent under the indenture to execution of the amendment by the trustee have been satisfied. This is a uniform requirement in indentures, and opinion preparers have little to no flexibility to change the wording of the opinion or add assumptions or qualifications. The lower court’s decision had extended the reach of section 316(b), whereas the Second Circuit restored the traditionally narrow interpretation, holding that it only “prohibits non-consensual amendments of core payment terms (that is, the amount of principal and interest owed, and the date of maturity) [and] bars ‘collective action clauses’—i.e., indenture provisions that authorize a majority of bondholders to approve changes to payment terms and force those changes on all bondholders.”
Although we are back to pre-Marblegate with respect to giving standard section 316(b) opinions to indenture trustees, those are not the only opinions that address the legality of a debt restructuring affecting the rights of holders of indenture securities. Many restructurings require opinions to: (i) lenders under existing, new, or amended loan agreements that often include as closing conditions modifications to the terms of outstanding debt, (ii) dealer-managers acting for the issuer in connection with the solicitation of consents to indenture amendments (including so-called exit consent to strip out of the indenture, to the detriment of nonparticipating holders, covenant, and other protections) or exchange offers in which new securities are to be issued in exchange for outstanding bonds, and (iii) typical closing opinions and negative assurance letters to underwriters or placement agents for offerings of new equity or debt securities. Thus, a complex debt restructuring often involves many different agreements and multiple steps affecting different creditors, intermediaries, and agents, where the order of the steps matters and each step builds upon prior ones. Opinions often cover due authorization, validity, receipt of all necessary consents, no breach of other agreements, and no violation of law, all issues that are too inter-related for the opinion preparers not to look to all the opinions taken together, including under the misleading opinion rubric with respect to reliance on assumptions, not just to each opinion within its four corners.
Although the Second Circuit’s opinion in Marblegate provided welcome clarity with respect to the meaning of section 316(b), the court, in dicta, cast a potential cloud over its ruling:
Limiting Section 316(b) to formal indenture amendments to core payment rights will not leave dissenting bondholders at the mercy of bondholder majorities. . . . By preserving the legal right to receive payment, we permit creditors to pursue available state and federal law remedies. . . . The foreclosure in this case may be challenged by creditors under state law. . . . [C]reditors may be able to sue the new entity [that foreclosed on the debtor’s collateral pursuant to the reorganization] under state law theories of successor liability or fraudulent conveyance. . . . We obviously take no view on the potential merit of any state law or federal law claims in the context of [the restructuring transaction] at issue here.
The Second Circuit’s dicta in Marblegate leave the door open for unhappy hold-outs in complex debt restructurings to convince a judge that the transaction violated their rights as creditors or was unlawful under state or federal law other than the TIA. Where courts will take the Second Circuit’s dicta is an open question. In May 2017, seizing upon the dicta in Marblegate, the holdouts in the EMFC restructuring shifted their focus to post-restructuring entities, demanding that the indenture trustee file a complaint asserting a claim for successor liability against those entities. Although the theories mentioned by the Marblegate court are not novel, the decision invites nonparticipating bondholders whose practical ability to recover principal and interest is impaired through out-of-court restructurings to pursue their grievances with new vigor. However, if no amendments to the indenture are needed to effect the restructuring, or any required amendments have been consented to by the requisite majority of bondholders without violating section 316(b), challenges based outside the TIA to the process of foreclosure on collateral by senior creditors are likely to face arguments that they are rendered moot as a result of the issuer itself having consented to the foreclosure. Claims for successor liability or fraudulent conveyance are always a matter of fact and equity. Many indentures include the same language as section 316(b) and therefore specify as a matter of contract that the right of any bondholder to receive payment of principal and interest shall not be impaired or affected without its consent. Issuers have begun not including this language in indentures. If an indenture is subject to the TIA, the language is automatically deemed to be part of the indenture, and issuers have no reason to include it. If an indenture is not subject to the TIA, issuers also have no reason to include the language, although purchasers of bonds may oppose omitting it. As practice evolves, differences in language may develop among indentures, opening the door for nonconsenting bondholders to argue that the parties intended the contract to mean something different from section 316(b).
Although the district court and the Second Circuit agreed that the language of section 316(b) is ambiguous, future courts should, to the extent that the “impair or affect” wording of an indenture tracks the text of section 316(b), interpret it the same way as the Second Circuit interpreted the statute. Interpreting the TIA, the Second Circuit in Marblegate reiterated its view that boilerplate indenture provisions are to be interpreted by courts as a matter of law in the interest of uniformity of interpretation. Courts applying state contract law to the same language should feel compelled to follow the same interpretation. Precedent exists for uniformity in interpreting under state contract law terms that under federal or state statutes (including the UCC) have an understood technical meaning, even when the statute does not apply as a technical matter. Going forward, however, as noted above, some indentures may omit section 316(b) language while others will include it, or investors may be successful in pushing for different language. Under rules of evidence, the facts of the case, or state law precedent (typically New York law), however, courts may not feel constrained to interpret the language the same way, particularly if the words are not exactly the same. An opinion is an expression of professional judgment as of the date of the opinion about what the highest court of the applicable jurisdiction would hold. Assuming the opinion letter covers New York law, the opinion preparers need not extrapolate from the Second Circuit’s dicta in Marblegate that the New York Court of Appeals (New York’s highest court) would interpret language mimicking section 316(b) more broadly than section 316(b) itself as interpreted by the Second Circuit. Moreover, the non-TIA-based avenues for recourse suggested by the Second Circuit for nonparticipating bondholders are not new or novel. Therefore, opinion givers have no more reason today than before to consider whether they can give opinions covering no breach or default and no violation of statutes, rules, or regulations other than the TIA.
Many lawyers believe that the Second Circuit’s decision heralds a permanent return to pre-Marblegate opinion practice because the novelty of the district court’s decision was to treat the language of section 316(b) as a far-reaching basis for challenging out-of-court debt restructurings. Those lawyers maintain that the Second Circuit definitively closed the book on attempts to interpret “impair or affect” broadly, and its dicta did nothing more than list existing non-TIA avenues for recourse by nonparticipating bondholders. Other lawyers point out that Marblegate can be limited to its facts, and too much ink was spilled while Marblegate, and other cases dealing with similar issues like Meehancombs Global Credit Opportunity Funds, LP v. Caesars Entertainment Corp. (Caesars I), 80 F. Supp. 3d 507 (S.D.N.Y. 2015), and BOKF, N.A. v. Caesars Entertainment Corp. (Caesars II), 144 F. Supp. 3d 459 (S.D.N.Y. 2015), wound their way to a final decision or settlement, including in Judge Straub’s dissenting opinion, for the book to be closed. If a debt restructuring involves a majority-approved amendment, nonconsenting bondholders can be expected to challenge the removal of important structural protections like guaranties or collateral or waivers through an exit consent in reliance on a collective action clause. For example, some lawyers have pointed out that subsidiary guaranties of bonds issued by the parent are separate indenture securities. In the meantime, cases based on fraudulent conveyance or other theories pointed to by the Second Circuit’s dicta will likely increase, which at a minimum argues for drafting the bankruptcy and equitable principles exceptions to apply generally to all opinions, not only to the enforceability opinion, which is what many opinion preparers already do and should not be a controversial step.
Debt restructurings are notoriously complex transactions where great time and attention are spent on structuring to overcome “blocking positions,” where investors at different levels in the capital stack wrestle for control, and where disclosure documents often caution about contingencies and uncertainties, including legal uncertainties, that could affect various parties adversely or cause the outcome to be different from what the letter of the transaction agreements provide. That is precisely the context in which Marblegate, Caesars I, and Caesars II arose. Against this backdrop, lawyers who are active in this segment of transactional practice should be vigilant, keep on top of evolving case law and practice, and exercise caution when giving closing opinions in complicated or controversial situations.