Keeping Marblegate in Perspective: Implications for Debt Restructurings, Indenture Amendments and New Bond Issues
Involuntary debt restructurings that lead to impairing a bondholder’s to receive payment may violate the Trust Indenture Act. It was lately locked in the Marblegate/Education Management Corp. bondholder litigation. An initial read from the situation suggests potentially problematic implications. A much deeper analysis shows a less troubling decision. The situation can also be relevant for that 144A for existence market that’s technically not susceptible to the statute.
– Involuntary debt restructurings may violate the Trust Indenture Act when they lead to impairing a bondholder’s to receive payment, while they leave that right formally intact. Which was lately held through the court within the Marblegate/Education Management Corp. bondholder litigation. The SDNY’s recent opinion around the merits (Marblegate II) confirmed its earlier waiting on hold a request an initial injunction to bar the restructuring (Marblegate I).
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CAPITAL MARKETS CLIENT PUBLICATION
July 17, 2015
Keeping Marblegate in Perspective: Implications for Debt
Restructurings, Indenture Amendments and New Bond
Involuntary debt restructurings that have the effect of
impairing a bondholder’s right to receive payment may
violate the Trust Indenture Act. This was recently held in the
Marblegate/Education Management Corp. bondholder
litigation. A first read of the case suggests potentially
problematic implications. A deeper analysis shows a less
troubling decision. The case is also relevant for the 144A for
life market that is technically not subject to the statute.
Involuntary debt restructurings may violate the Trust Indenture Act if they have the
effect of impairing a bondholder’s right to receive payment, even though they leave
that right formally intact. That was recently held by the court in the
Marblegate/Education Management Corp. bondholder litigation. The
SDNY’s recent opinion on the merits (Marblegate II)1 confirmed its earlier holding
on a request for a preliminary injunction to block the restructuring (Marblegate I)2.
A first read of the Marblegate decisions (and another recent SDNY decision involving
Caesars Entertainment Corp.)3 may suggest broad-reaching and potentially
problematic implications for debt restructurings and indenture amendments. A
deeper analysis shows a less troubling case.
While the case is unlikely to drive issuers from the SEC-registered market, it may be a
factor in the decision of whether to access the 144A for life market. Many US 144A
for life indentures contain a provision that tracks the statutory provision at issue in
Marblegate, so issuers may consider removing this provision in new bonds.
This may spark a discussion about modifying the amendment provisions in US 144A
for life bond indentures to allow for greater flexibility than would be permitted by the
Trust Indenture Act.
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Robert Evans III
In Marblegate, the defendant (EDMC) was a for-profit operator of colleges and professional schools. A bankruptcy filing
was neither a viable alternative nor a credible threat for EDMC because upon a filing it would have lost access to the
federal student aid programs on which it depended for the vast majority of its net revenues. To avoid that result, while
still achieving a significant debt restructuring, the subsidiary of EDMC that issued the bonds launched an exchange offer
and consent solicitation, pursuant to which bondholders would receive different treatment depending on the acceptance
rate of the exchange/consent. If there were 100% participation by bondholders, the bonds would be exchanged into equity
that then would be convertible into common stock of the parent guarantor of the bond issuer. If that level of participation
could not be achieved, the company would implement an alternative restructuring in which all of its assets would be
transferred to another subsidiary of the parent guarantor via a foreclosure sale by the company’s secured lenders, the
parent guarantee would be released, and non-consenting bondholders would be left only with recourse against a bond
issuer that would have become an empty shell. Consenting bondholders would receive equity in a distribution from the
Marblegate was a holder of unsecured bonds that challenged this restructuring on the basis that it violated Section 316(b)
of the Trust Indenture Act, which provides in pertinent part that the right of any bondholder “to receive payment of the
principal of and interest on such indenture security, on or after the respective due dates” or “to institute suit for the
enforcement of any such payment” shall not be “impaired or affected” without the consent of that holder.
The issuer argued that the provision was not implicated because Marblegate’s legal right to receive payment would not be
affected, even though the restructuring would render that right effectively worthless. Marblegate asserted that the statute
would be violated, even if as a matter of form its payment right was not affected, because as a matter of substance, the
restructuring resulted in the elimination of its ability to receive payment. After concluding in Marblegate I that the
likelihood of success on the merits weighed in favor of Marblegate (though the court denied the request for injunctive
relief on other grounds), in Marblegate II, after a detailed analysis of the legislative history of Section 316(b), the court
found in favor of Marblegate.
Keeping Marblegate in Perspective and Limiting It to Its Facts
In reaching its opinion in Marblegate I, the court indicated that:
Practical and formal modifications of indentures that do not explicitly alter a core term “impair  or affect ” a
bondholder’s right to receive payment in violation of the Trust Indenture Act only when such modifications effect
an involuntary debt restructuring.
Involuntary debt restructurings. In further defining the scope of an involuntary debt restructuring, the court in
Marblegate I distinguished indenture amendments that eliminated important protective covenants from a reorganization
“that seeks to involuntarily disinherit the dissenting minority,” finding only the latter to violate the “fundamental purpose
of the Trust Indenture Act.” It also characterized the reorganization as effecting “a complete impairment of dissenters’
right to receive payment” and a “wholesale abandonment” of that right. The opinion concluded that Section 316(b) did not
allow companies “to effectively eliminate the rights of non-consenting bondholders.”
The court expanded on this line of reasoning in Marblegate II. Citing from the offering circular for the exchange offer, the
court noted that the company itself had described the restructuring as one in which non-consenting holders would “not
receive payment on account of their Notes.” The court highlighted that although the reorganization “would not formally
alter the dissenting Noteholders’ right to payment [. . .] it was unequivocally designed to ensure that they would receive no
payment if they dissented from the debt restructuring.” (emphasis added) As the opinion put it in a different place, the
restructuring gave dissenting holders only the choice to take the stock offered in the exchange “or take nothing.” The court
found that the complaining bondholder had “bought a $14 million bond that the majority now attempts to turn into $5
million of stock, with consent procured only by threat of total deprivation.”
Stripping covenants from indentures. Typical covenant strips or other indenture amendments, through exit
consents or otherwise, that occur in the absence of a broader restructuring that removes significant assets from the
recourse of bondholders, should not be affected by the Marblegate decisions. In Marblegate I, the standard it adopted did
not prevent “majority amendments of a significant range of indenture terms, including many that can be used to pressure
bondholders into accepting exchange offers.” The court also approvingly quoted from a law review article stating that,
although the Trust Indenture Act prohibited alterations of “core” provisions, “bondholders can agree to eliminate other
important protective covenants – for example, covenants prohibiting the firm from paying dividends, covenants requiring
the firm to maintain a specified net worth, or covenants prohibiting the firm from incurring debt senior in any respect in
right of payment to the debt for which the exchange offer is made.”
A case of substance over form. Overall, Marblegate perhaps is best viewed as a case in which the court privileged
substance over form. In the eyes of the court, as a substantive matter, dissenting bondholders were being deprived of the
entirety of their recovery even if their legal rights remained intact. The court specifically highlighted that the company had
apparently assured its regulators that the structure of the transaction was “purely a formality.” The court also sided with
the plaintiffs in their contention that the right protected by the statute was “substantive” rather than “formalist,” and the
opinions contain several other examples of this “form over substance” rhetoric. Finally, the court was not persuaded by
the company’s argument that the asset strip was immune from attack because it was accomplished through foreclosure by
the secured lenders, rather than through a direct action by the company.
Earlier cases. In Marblegate, the defendant unsuccessfully relied on two earlier decisions by courts in other judicial
districts that, on different facts that did not involve a present intention of asset transfers, had held that Section 316(b)
protected only a holder’s legal right to receive payment, but not its ability to ultimately recover on its claim.4 The court
relied instead on Federated Strategic Income Fund v. Mechala Group Jamaica Ltd., a 1999 SDNY case that had found
that a restructuring plan under which the company would have transferred all of its assets to another entity, leaving
bondholders with an empty shell, violated the Trust Indenture Act.
Implications for the US 144A for Life Market?
US 144A for life indentures typically contain Section 316(b)-style provisions. Marblegate has implications
not just for SEC-registered bonds that are subject to the Trust Indenture Act, but potentially also for bonds that are issued
only to qualified institutional buyers under Rule 144A without registration rights in so-called “144A for life” transactions.
That is because, although not legally required, even in 144A for life issues the indenture typically contains a provision
similar to the one mandated by Section 316(b). Courts are likely to interpret those indenture provisions in a similar way,
even if the corresponding statutory provision on which those indenture provisions were modeled does not apply.
How to make 144A for life indentures “Marblegate-proof.” Issuers seeking to avoid Marblegate-style
bondholder actions in a future restructuring would therefore have to remove those Section 316(b)-style provisions from
their 144A indentures when issuing new bonds, or at least modify them so that they only protect a bondholder’s right to
sue for payment, but not its right to receive payment. (This distinction played a role in the analysis in Marblegate.)
However, given the prevalence of these provisions in US bond indentures, it is possible that attempts to issue new bonds
without them may meet with resistance from investors. Of course, even under indentures that do not contain Section
316(b)-style provisions, depending on the facts, bondholders may be able to advance other legal theories to attack a
Lowering consent thresholds for change of payment terms from 100% to 90%? The next step would be to
not only remove the Section 316(b)-style language from 144A for life indentures, but to also change the amendment
provision in those indentures so that it permits direct amendments to payment terms, without a need to resort to asset-
stripping. Having said this, the bond market may not be comfortable with moving from a rule of 100% to a rule of 51% for
such changes to “money terms.” In a restructuring, not all bondholders may have the same incentives, and the market
may well take the view that a greater percentage of principal amount that needs to consent to a restructuring will make it
more likely that that a deal is genuinely fair to all holders. While there is no magic number in this regard, 90% is a
percentage that we have seen in a recent US high yield transaction by a financial sponsor. In the European high yield
market, where local laws have traditionally not been as flexible as the US Bankruptcy Code in permitting a change of
payment terms through a cramdown, 90% has long been common. (In Marblegate, more than 90% of the principal had
agreed to the exchange.)
Would large long-term bondholders welcome a change? Minimizing the opportunity for free riders and
holdouts could be in the interest of large long-term bondholders. Those holders may have spent considerable time and
resources working with the company to come up with a plan for a restructuring that reduces debt to a sustainable level
and avoids a value-destroying bankruptcy. In addition, large holders often do not have the luxury of sitting on the
sidelines because the restructuring will not be feasible unless they participate. Large bondholders that have agreed to see
their claims reduced will generally not look favorably on investors that have purchased a relatively small amount of bonds
at a steep discount and now seek to extract value by holding up the consummation of the restructuring. It is also possible,
however, that the bond market will be wary, at least for now, of giving US issuers too much flexibility in that regard.
1 Marblegate Asset Management v. Education Management Corp. (SDNY 2015).
2 Marblegate Asset Management v. Education Management Corp. (SDNY 2014).
3 Meehancombs Global Credit Opportunities Funds, LP v. Caesars Entertainment Corp. (SDNY 2015).
4 In re Northwestern Corp., 313 B.R. 595 and YRC Worldwide Inc. v. Deutsche Bank Trust Co. Americas (D. Kan. 2010).
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