On January 17, 2017, in the Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Fin. Corp. litigation (No. 15-2124-cv(L), (2d Cir. 2017), the U.S. Court of Appeals for the Second Circuit in Manhattan ruled in favor of the defendant, Education Management Corporation (EDMC), overturning the decision of the U.S. District Court for the Southern District of New York in the EDMC restructuring outside of a Chapter 11 bankruptcy filing.1
Section 316(b) of the Trust Indenture Act of 1939, as amended provides that, subject to certain exceptions, the right of a holder of an indenture security to receive principal and interest payments, or to institute suit to enforce such payments after they become due, shall not be impaired or affected without such holder’s consent. However, the District Court in New York expanded the interpretation of Section 316(b) of the Trust Indenture Act to also prohibit transactions that result in an impairment of a non-consenting bondholder’s practical ability to receive payments, not just its legal right to receive payments, even where the transaction does not specifically modify any of the indenture’s payment terms.
This expanded interpretation by the District Court became the subject of a great deal of uncertainty which had an adverse impact on the debt capital markets.2
As previously reported, 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 had 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. 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.
On October 2014, 90 percent ($196.6 million) of the noteholders and 99 percent ($1.292 billion) of the secured lenders consented to the restructuring.
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 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 with the District Court in New York to block the restructuring citing violation of Section 316(b) of the Trust Indenture Act.3
Second Circuit Appeals Court Ruling
The Second Circuit Appeals Court’s majority ruling stated that Section 316(b) is ambiguous and expressed concern that a broad ruling would effectively hobble consensual workouts by “transform[ing] a single provision of the Trust Indenture Act into a broad prohibition on any conduct that could influence the value of a note or a bondholder’s practical ability to collect payment.”
It should be noted that the Second Circuit Appeals Court majority opinion was accompanied by a dissent. The dissenting judge would have upheld Marblegate, writing that an out-of-court debt restructuring impairs or affects a non-consenting bondholder’s right to receive payment when it is designed to eliminate a non-consenting bondholder’s ability to receive payment, and when it leaves bondholders no choice but to accept a modification of the terms of their bonds.4
- Kashar, Gary, Owen Pell, and Andrew Weisberg, “Second Circuit Court of Appeals Overturns District Court Decision in Marblegate Regarding Section 316(b) of Trust Indenture Act,” Publications & Events, White & Case LLP, January 18, 2017.
- Pellegrino, Jeffrey, Michael Chernick and Kevin Logue, “Marblegate Decision Overturned by the Second Circuit Court of Appeals,” Insights, Paul Hastings LLP, January 18, 2017. Hals, Tom, “Appeals court rules for Education Management on debt-cutting plan,” Reuters, January 17, 2017.
- Peluso, Romano I., “Bondholder Protections Resulting From Out-Of-Court Restructurings,” Perkins Coie LLP, corporatetrustinsider.com, September 30, 2016.
- Dorchak, Joshua and P. Sabin Willett, “Second Circuit Reverses Marblegate Holding on TIA Section 316(b),” Lawflash, Morgan, Lewis & Bockius LLP, January 18, 2017.