Restructuring

Contributed by Doron P. Kenter.

How many ages hence / Shall this our lofty scene be acted o’er, / In states unborn, and accents yet unknown!
– William Shakespeare, Julius Caesar

Yesterday, we began our analysis of Judge Scheindlin’s recent decision in the Caesars parent guarantee litigation.  Our initial discussion is available here.  Today, we bring you the next exciting chapter of our review of the other questions considered by the court, together with an assessment of the critical issues facing courts considering modifications of noteholders’ rights.  We return to our regularly scheduled programming, at question #2 before the court…. 
What Types of Impairment Violate the Trust Indenture Act?
After concluding that the CEC guarantee was a meaningful provision in the CEOC indenture, the court turned to whether the TIA specifically precludes the release of such a guarantee issued pursuant to an indenture.  The court rejected the indenture trustee’s suggestion that any impairment violates the TIA, noting that Marblegate specifically recognized that a guarantee release could, “in some contexts,” be consistent with section 316(b) of the TIA.  If, on the other hand, the TIA were read to bar any actions that could affect noteholders’ right to payment, courts could be forced to interfere excessively with “ordinary business practice.”  What, then, rises to the level of an impermissible impairment pursuant to the TIA?
Looking to the language of section 316(b), the court observed that the provision includes a disjunctive “or” – namely, that it bars two separate actions: (i) actions that impair noteholders’ right to sue for payment and (ii) the substantive right to receive such payment.  Based on the language of the TIA, as well as the legislative history, the court concluded that corporate flexibility must be maintained while, at the same time, protecting minority bondholders from being forced to relinquish their claims outside a formal debt restructuring.  (Formal debt restructurings – in bankruptcy court – carry certain protections for all noteholders.  In the absence of that court-supervised process, the TIA bars wholesale debt restructurings, which could otherwise be imposed by majority noteholders on the unlucky minority.)  Therefore, section 316(b) is not only a bar to informal debt restructurings (as CEC would have it), but also to nonconsensual amendments to “core terms” of debt instruments.  The issue of whether any of the CEOC/CEC transactions had risen to either of these levels was not before the court, but the court did recognize that one or more of the transactions may have risen to the level of an impermissible out-of-court debt restructuring – for example, when CEOC took on new debt, a condition to which was an alteration of the rights of existing bondholders.
Were the Guarantee Transactions an “Out-of-Court” Restructuring?
In its last substantive point on the matters before it, the court considered whether the CEOC/CEC transactions constituted an impermissible out-of-court restructuring.  Although the issue was principally a disputed one that required factual inquiry, the court concluded that the transactions could rise to that level in the event that CEOC was insolvent (and the CEC guarantee was therefore critical) as of the date the payment would be due to the noteholders.  However, rather than examine the effect of any single transaction on the noteholders as of a later payment date (which could result in courts having to second-guess even ordinary corporate actions taken without any inkling of a potential insolvency), the court suggested that section 316(b) requires courts to look to a debt issuer’s transactions as a whole to determine whether they collectively constituted an impermissible out-of-court debt restructuring.
In light of the foregoing, the court concluded that the indenture trustee had not yet shown that the transactions as a whole constituted an impermissible out-of-court restructuring.  Instead, further factual inquiry would be required for the court to determine whether the CEOC/CEC transactions, taken together, were undertaken to strengthen CEOC’s financial condition or to accomplish an out-of-court restructuring of its debt.
Interestingly, the court seemed to suggest that CEOC’s intent in undertaking the challenged transactions would be material to understanding whether they violated the TIA.  But the court did not state so explicitly, and its holding appears to turn on whether the transactions themselves constituted an impermissible outcome.  Should the litigation proceed, it will be interesting to see how the court will articulate CEOC and CEC’s actions, and what facts will be relevant to its analysis.
A Word About the Conflicts Among the Courts
Finally, the court recognized that the interpretation of section 316(b) of the TIA is a murky issue, and that courts are, at the moment, divided – even within the same judicial district – regarding the types of transaction barred by section 316(b).  Although Judge Scheindlin sided with the courts that have held that the TIA protects noteholders’ practical right to payment, other courts – including courts in Delaware and Kansas, as well as the United States Court of Appeals for the Tenth Circuit and and a different judge in the Southern District of New York – have held that section 316(b) only protects noteholders’ legal rights, and not their practical right to payment of principal and interest pursuant to a note issuance.  Moreover, because so much is at stake in Caesars, because the interpretation of that provision is a pure matter of law, and because the interpretation of section 316(b) of the TIA is so important to the market as a whole, the court certified an immediate interlocutory appeal to the United States Court of Appeals for the Second Circuit to consider the correct interpretation of section 316(b) of the TIA. In the court’s words:

First, what rights does section 316(b) of the TIA protect? Does it protect noteholders’ practical rights to principal and interest, as this court and several others have held, or only their legal rights, as other courts have concluded?

Second, assuming that section 316(b) protects more than a bare legal right, what is the appropriate standard to assess impairment? Must plaintiffs show that a nonconsensual out-of-court restructuring occurred? If so, must there be an amendment to the debt instrument itself?

Third, as of when (and how) should the impairment be evaluated? Must a court evaluate each transaction separately at the time it was undertaken? Or is the impairment to be evaluated as of the date for demand of payment? May a court consider multiple transactions collectively?

Interestingly, if the Second Circuit agrees with Judge Scheindlin, it will only deepen the existing division within the courts on this issue – which may require Supreme Court review.  If it disagrees with Judge Scheindlin, and sides with the other courts mentioned above, it could (conceivably) resolve the existing circuit split by overruling Judge Scheindlin and the Marblegate decisions.  We are, of course, very interested to see how this one turns out.
[Note: Judge Scheindlin will continue with the Caesars litigation while the appeal continues, given that the parties are prepared to proceed and because the certified matter may not turn out to be determinative of the litigation in Caesars itself.]