In a case closely watched by companies and investors alike, on January 17, 2016, the Second Circuit Court of Appeals overturned the decision of the District Court for the Southern District of New York in Marblegate Asset Management vs. Education Management Corp. The District Court had held that a series of debt restructuring transactions by Education Management Corp. violated Section 316(b) of the Trust Indenture Act of 1939, as amended. Section 316(b) of the Trust Indenture Act provides that “the right of any holder of any indenture security to receive payment of the principal and interest on such indenture …shall not be impaired or affected without the consent of such holder.” Reading this provision broadly, the District Court found that a restructuring that released a parent guarantee and effectively stripped most of the assets from the issuer of the debt without the consent of each bondholder violated Section 316(b), even though the particular indenture for the bonds in question was not amended in connection with the restructuring. The District Court concluded that Section 316(b) protects a bondholder’s practical ability to receive payment even where the indenture was not explicitly modified. The District Court’s decision, together with another similar decision in the Southern District of New York in the case of Meehancombs Global Opportunities Funds, LP v. Caesers Entertainment Corp., caused significant concern among practitioners that these decisions significantly limited companies’ ability to enter into negotiated debt restructurings without consent of 100% of all indenture bondholders. Because the requirement of 100% approval gives bondholders significant negotiating leverage and creates a real risk of “holdouts,” such a requirement could effectively prevent many debt restructurings outside of a bankruptcy court.
In a 2-1 decision, the Second Circuit overturned the decision of the District Court and held that Section 316(b) of the Trust Indenture Act did not prohibit the restructuring by Education Management Corp. The Second Circuit agreed with the District Court that Section 316(b) of the Trust Indenture Act is ambiguous, and therefore conducted its own review of the legislative history of the provision. After such review, the Second Circuit concluded that Section 316(b) was intended only to prohibit formal amendments to the core payment rights of an indenture without consent of each bondholder, and not to prevent restructuring that effectively reduced the issuer’s ability to repay the bonds.
There remain some steps the plaintiffs could take to challenge the Second Circuit’s decision in Marblegate, including seeking a rehearing in the Second Circuit or appeal to the U.S. Supreme Court. Unless and until any such challenge is successful, the Second Circuit’s decision is binding in the states of the Second Circuit, including New York, Connecticut and Vermont. Given that substantially all indentures are governed by New York law, the decision is likely to be influential outside of the Second Circuit as well. Assuming it stands, the Second Circuit’s decision gives comfort to issuers and practitioners that the Trust Indenture Act does not impose a requirement of 100% indenture bondholder approval for restructurings that do not involve affirmative amendment of core payment provisions of the indenture.