Indenture Trustees in Out-of-Court Restructuring Transactions: Proceed with Caution

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By Howard Seife and Marian Baldwin Fuerst of Chadbourne & Parke LLP

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The recent decision of the United States District Court for the Southern District of New York (the “S.D.N.Y.”) concerning the restructuring efforts of Caesars Entertainment Operating Company, Inc. (“OpCo”), the large United States casino operator which is currently in bankruptcy, should be on all indenture trustees’ radars.  See MeehanCombs Global Opportunity Funds, LP v. Caesars Entertainment Corp., 14- cv-7091, 2015 WL 221055 (S.D.N.Y. Jan. 15, 2015). The case arises from an August 2014 transaction, in which OpCo restructured certain of its unsecured obligations resulting in the elimination of guarantees by OpCo’s parent, Caesars Entertainment Corporation (the “Parent,” together with OpCo, “Caesars”). Caesars moved to dismiss a lawsuit brought forth by certain OpCo unsecured noteholders. After heavily scrutinizing the August 2014 transaction, US District Court Judge Scheindlin held that the noteholders could proceed with a majority of their claims for breaches of the Trust Indenture Act of 1939, as amended (the “TIA”), and state law. The court’s decision, entered right on the heels of a December S.D.N.Y. decision addressing a similar situation, establishes a clear precedent that out-of-court restructurings eliminating parent guarantees are disfavored in this influential District. The decision cautions indenture trustees to closely review any changes to core terms even when acting under the direction of noteholders.

To read more, click here.

For two related pieces discussing the Trust Indenture Act, see here and here.

Fixing the Trust Indenture Act to Allow Restructuring Votes

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By Mark J. Roe, Harvard Law School

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The Trust Indenture Act of 1939 bars binding bondholder votes on core payment terms. The inability of deal proponents to get a binding vote can lead the debtor to file for an otherwise unnecessary bankruptcy. To get a deal done when there are economically-important holdouts, deal proponents often seek exit consents to induce enough holdout bondholders to reluctantly tender into a deal they don’t otherwise like, by stripping the bond indenture of those covenants on which bondholders can vote.
Exit consent transactions have generally been upheld, despite that in analogous corporate settings such distortions induce doctrinal and deal structure issues. Recent decisions indicate that exit consents that oust the bondholders from an effective individual choice ran afoul of the Trust Indenture Act, which may well have been the intent of the 1930’s drafters of the law.
Regardless, the anti-voting provision is anachronistic. It was passed when bankruptcy law did not respect bondholder votes without a judge’s substantive approval of the deal, but the Code was updated in 1978 to allow binding votes. Bondholders should also be free to agree in advance to a binding vote in an out-of-court workout. More restructurings will succeed and avoid bankruptcy. And proponents will have less reason to resort to arm-twisting with exit consents. Similar individualized consent difficulties and holdout issues have hobbled sovereign debt restructurings, with sovereign debt issues moving in recent years to include majority vote provisions.
For my analysis of the incentives and structure of bond restructurings in light of the TIA, see 97 Yale L.J. 232 (1987).

SDNY Issues Novel Opinion Holding that Out-of-Court Restructurings May Violate Noteholder Rights Under the Trust Indenture Act

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By Alan F. Denenberg, Joseph A. Hall, Michael Kaplan, Jeffrey M. Oakes, Richard D. Truesdell, Jr., and Sarah Ashfaq of Davis Polk & Wardwell LLP

Companies have long relied upon out-of-court restructurings to keep them afloat during times of financial distress. In Marblegate Asset Management v. Education Management Corp. (S.D.N.Y. 2014), the Southern District of New York found that a proposed out-of-court restructuring, objected to byminority creditors, likely violated provisions of the Trust Indenture Act of 1939 (TIA), a Depression-era federal statute intended to protect rights to payment under a TIA-qualified indenture, which governs debt securities offered in any U.S. public offering. Unlike earlier TIA cases, a critical element of the proposed restructuring in Marblegate was explicitly permitted by the governing indenture, and no consent of the objecting creditors was required by the indenture. Nonetheless, the Court read the TIA to give creditors a substantive right to protection against out-of-court restructurings that they did not consent to on an individual basis, although it ultimately did not grant the plaintiffs’ motion for a preliminary injunction. But the potential for a minority creditor to obstruct a company’s ability to restructure, especially in light of indenture provisions the creditor knowingly accepted at the time it purchased its securities, could have serious consequences. While the debtor company’s actions in Marblegate were certainly aggressive, the Court’s view, if adopted by other courts, could have the potential to create an overriding ability for any creditor to block a restructuring — even when permitted by the indenture — directly leading to more court-administered bankruptcies. If followed to that conclusion, the opinion would be a potentially material and unwelcome change to the legal landscape.

To read more, click here.

Revisiting the Voting Prohibition in Bond Workouts

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Author: Carlos Berdejó, Loyola Law School, Los Angeles

Economic theory suggests that corporate law should enable parties to contract freely in order to promote their best interests, leading to socially optimal arrangements.  This is particularly true for corporate bonds, which are governed by detailed indentures and held by large, sophisticated investors.  However, the Trust Indenture Act, which for 75 years has regulated the terms of U.S. public corporate debt, contains numerous mandatory rules, including a prohibition on collective action clauses (CACs).  A CAC allows a qualifying majority of bondholders to modify the interest rate, maturity and principal of an outstanding bond issue in a manner that binds all bondholders, including those who may prefer to hold-out to extract a larger payment.  This longstanding prohibition limits the ability of firms to restructure their debt via private workouts and can exacerbate the costs of financial distress by unnecessarily forcing issuers into bankruptcy.  Most countries other than the U.S. do not prohibit CACs and afford parties flexibility in choosing the qualifying majority that may amend the core terms of a bond issue.

My article, Revisiting the Voting Prohibition in Bond Workouts, examines contracting choices in Brazil, Chile and Germany, countries that have recently enacted reforms affecting their bond markets, including changes in restrictions on CACs.  I find that not only do market participants embrace increased flexibility with respect to CACs, but that interest rates decrease as a result, lowering the cost of capital for issuers.

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[Related Work Note: The work in Revisiting the Voting Prohibition in Bond Workouts provides evidence relating to the argument made in Mark Roe, The Voting Prohibition in Bond Workouts, 97 Yale L.J. 232 (1987), that the prohibition unwisely impeded out-of-bankruptcy recapitalizations and channeled some parties’ incentives towards coercive restructurings that would not have been needed if straight-forward votes were allowed.  That article can be found here.  More generally, academic bankruptcy theory has focused on the extent to which contract terms should be respected by law, inside and outside of bankruptcy.  See Alan Schwartz, Bankruptcy Workouts and Debt Contracts, 36 J. of L. & Econ. 595 (1993), available here.  –Stephen Adams, Editor]

Bankruptcy and Economic Recovery

Authors: Thomas Jackson & David Skeel

A striking feature of the recent economic crisis was the long period of subpar economic growth that continued even after the crisis had officially ended.  Although discussion about how to spur economic recovery has focused on the efficacy of Keynesian stimulus spending, this is only one of many factors that might plausibly encourage growth.  For a book entitled “Financial Restructuring to Sustain Recovery,” published by the Brookings Institution, we were asked to discuss the role that bankruptcy policy plays, or might play, in economic recovery.

After summarizing how bankruptcy posits a collective solution to a common pool problem of individual creditors and thereby improves the efficient use of assets, we consider two obstacles to its effectiveness.  The first is that bankruptcy proceedings often seem to begin too late.  The increased influence of debtors’ principal lenders probably counteracts this problem in part, but we suspect not fully.  We consider a wide range of strategies that lawmakers might use to encourage timely filing, some of which are fairly simple, while others are more speculative.

The second major issue is the relationship between bankruptcy and jobs.  The question whether bankruptcy should be used to protect jobs is a recurring theme that came to the fore most recently when the government used bankruptcy to bail out Chrysler, justifying its intervention as preserving jobs.  We caution that distorting the standard bankruptcy rules—focused on efficient use of assets—to save jobs in the short run may have more problematic effects overall.

The full-length article can be found here.

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