Litigation involving two recent out-of-court restructurings have focused on interpreting broadly bondholder protections under the Trust Indenture Act of 1939, as amended.
The two cases in the United States District Court for the Southern District of New York are:
- Marblegate Asset Management v. Education Management Corp.
- MeehanCombs Global Opportunity Funds, LP et al. v. Caesars Entertainment Corp. et al.
Education Management Corporation (EDMC), along with its subsidiaries Education Management LLC and Education Management Finance Corporation, (collectively the Company) is one of the country’s largest for-profit providers of college and graduate education, with approximately 120,000 students and 20,000 employees. The Company has outstanding debt of $1.522 billion consisting of $1.305 billion in secured debt and $217 million in unsecured notes, both guaranteed by EDMC. The unsecured notes are governed by an indenture that is qualified under the Trust Indenture Act.
Section 6.07 of the indenture expressly incorporates the protections provided in Section 316(b) of the Trust Indenture Act, stating that “the right of any holder of a note to receive payment of principal, premium…and interest on the note…or to bring suit for the enforcement of any such payment…shall not be impaired or affected without the consent of such holder.” 1
In May 2014, EDMC informed its creditors that it was experiencing significant financial distress.
Over 75 percent of EDMC’s net revenues in 2014 were derived from federal student aid programs under Title IV of the Higher Education Act of 1965. Eligibility for such funding would be eliminated if EDMC filed for Chapter 11. As such, a bankruptcy filing for EDMC was not a feasible option.
EDMC decided to effectuate the restructuring outside of a Chapter 11 bankruptcy filing and started negotiations with its creditors. The negotiations resulted in a restructuring support agreement (RSA) memorializing a proposed out-of-court restructuring whereby a portion of the Company’s debt would be converted into equity.
The RSA provided that if the Company could not obtain unanimous creditor consent to the proposed restructuring, the parties thereto would be obligated to effectuate the restructuring through an intercompany sale transaction. Prior to the restructuring, the Company held substantially all the assets.
The intercompany sale was structured as follows:
- The EDMC guarantee pledged to the secured lenders would be released thereby triggering the automatic release of the guarantee provided the noteholders pursuant to the terms of the indenture.
- The secured lenders would exercise their rights under the term loan to foreclose on all the assets of EDMC and the operating subsidiaries.
- The secured lenders would then immediately sell those assets back to a new subsidiary of EDMC (Newco) which would distribute equity in Newco only to consenting creditors.
Non-consenting noteholders would no longer have the benefit of the parent guarantee and would only be left with claims against the operating subsidiaries, neither of which would have any material assets or sources of recovery.2
On October 2014, 90 percent ($196.6 million) of the noteholders and 99 percent ($1.292 billion) of the secured lenders consented to the RSA.
Marblegate Asset Management, LLC, Marblegate Special Opportunities Master Fund, L.P., Magnolia Road Capital LP, and Magnolia Road Global Credit Master Fund L.P., the Plaintiffs, the holders of approximately 9 percent ($20.3 million) of the notes did not consent to the proposed restructuring and filed a motion for a temporary restraining order and a preliminary injunction to block the restructuring citing violation of Section 316(b) of the Trust Indenture Act.3
It was largely accepted that Section 316(b) of the Trust Indenture Act protected a holder’s legal right to payment under the indenture, not the holder’s practical ability to recover. However, the District Court in New York found that the Trust Indenture Act is meant to protect noteholders from out-of-court restructurings that are designed to impair their practical ability to recover the principal and interest on their notes. It also found that Section 316(b) is intended to prevent evasion of judicial scrutiny of the fairness of debt-readjustment plans and to prevent out-of-court debt restructurings from being forced upon minority noteholders. The District Court went on to note that the intercompany sale is precisely the type of debt restructuring that the Trust Indenture Act is intended to prevent.4
The District Court in New York similarly held with respect to Caesars Entertainment Corporation that Section 316(b) of the Trust Indenture Act should protect not only the legal right to recovery but the practical right to recovery as well.
Caesars Entertainment Corporation (the Parent)) owns, manages, and operates dozens of casinos throughout the United States. Caesars Entertainment Operating Company (OpCo) is a direct operating subsidiary of the Parent. In January 2008, OpCo together with the Parent (Caesars), was acquired by Apollo Global Management Inc. and TPG Capital LP in a leveraged buyout. Caesars then engaged in a number of transactions that, according to certain creditors, would transfer assets away from OpCo to affiliates and leave OpCo holding company debt.
OpCo, pursuant to indentures dated September 28, 2005 and June 9, 2006, issued two series of senior unsecured notes: $750 million due 2016 and $750 million due 2017, both guaranteed by the Parent (the Unsecured Notes).
In August 2014, Caesars engaged in a transaction with holders of a majority of the outstanding principal amount of the Unsecured Notes with the alleged goal of putting OpCo into bankruptcy while protecting the Parent. Pursuant to a note purchase and support agreement, OpCo repurchased the Unsecured Notes held by the participating noteholders for par plus accrued interest and transactional fees and costs (which equated to a large premium over market). In exchange, the participating noteholders agreed to:
- Vote their Unsecured Notes in favor of removing the Parent’s guarantees.
- Consent to the modification of a covenant that restricted disposition of “substantially all” of OpCo’s assets.
- Support any future restructuring of OpCo.
OpCo entered Chapter 11 bankruptcy on January 15, 2015, triggering the automatic stay, but the Parent did not, and the action proceeded against the Parent only.
Not all of the holders of the Unsecured Notes approved of the August 2014 transaction. Certain of these nonconsenting noteholders filed lawsuits against Caesars in the District Court in New York alleging that the August 2014 transaction violated:
- Section 316(a) of the Trust Indenture Act because Caesars either controlled or owned the Unsecured Notes of the participating holders and should not have been counted toward the majority needed to direct the indenture trustee.
- Section 316(b) of the Trust Indenture Act because elimination of the Parent’s guarantee impaired the nonconsenting holders’ right to payment of principal and interest.
- The indentures (giving rise to state law claims including breach of contract) because the redemption of only the participating holders’ notes provided those holders with priority or preferences over the nonconsenting holders in violation of the terms of the indenture.
Caesars filed a motion to dismiss. The District Court disagreed.
The District Court found that the nonconsenting noteholders adequately alleged a violation of Section 316(b) of the Trust Indenture Act. Following recent favorable decisions of the District Court, the Court found that Section 316(b) protects noteholders’ more substantive right to payment. Elimination of the Parent’s guarantees left the nonconsenting noteholders “with an empty right to assert a payment default from an insolvent issuer.”
The indenture trustees have brought a separate action to enforce the Parent guarantees, asserting that the purported release of the guarantees violated Section 316(b).
In two separate opinions, the District Court in New York, largely tracking the reasoning outlined in the Marblegate opinions, adopted the broader reading of Section 316(b). The court reiterated that Section 316(b)’s purpose is to provide judicial scrutiny of debt readjustment plans to ensure equity— i.e., a nonconsensual debt adjustment must occur in bankruptcy. 5
On September 27, 2016, Caesars Entertainment’s creditors and private equity owners – Apollo Global and TPG Capital – agreed to terms of a hard fought debt restructuring that will hopefully allow it to emerge from Chapter 11 bankruptcy.6
- Client Alert Commentary, “A New Tool for Holdout Bondholders: The Trust Indenture Act,” Latham & Watkins LLP, January 22, 2015.
- Goffman, Jay M., “Lessons from Marblegate, Caesars for Distressed Investors,” Skadden Arps, Slate, Meagher & Flom LLP, Turnaround Management Association, January 2006.
- Endnote 1.
- Endnote 2.
- Client Alert, “Indenture Trustees in Out-of-Court Restructuring Transactions: Proceed with Caution,” Chadbourne & Parke LLP, March 16, 2015 and Endnote 2.
- de la Merced, Michael J., “Caesars Entertainment to Emerge From Chapter 11,” The New York Times, September 28, 2016 and Indap, Sujeet, “Caesars agrees debt restructuring with bondholders,” Financial Times, September 28, 2016.