Restructuring

Contributed by Dana Hall
“No-action” or “collective action” clauses – common fixtures in most indentures and credit agreements – limit the rights of lenders to commence actions against borrowers independently.  No-action clauses generally require a certain threshold percentage of lenders (usually 25% or more) to direct the indenture trustee to pursue remedies.  Such clauses serve a channeling function, aim to prevent the commencement of meritless or unpopular actions, and ensure that all noteholders share in any eventual recovery.  Although no-action clauses may vary somewhat across indentures, most contain certain limited exceptions, including exceptions for actions commenced as a result of non-payment of principal and/or interest and actions commenced after making a demand upon the indenture trustee in accordance with the terms of the indenture following which the trustee refuses to take such action.  Unsurprisingly, most independently commenced noteholder actions are either framed as fitting within a no-action clause’s narrow exceptions or falling outside the scope of such clause altogether.  In Akanthos Capital Mgmt, L.L.C., et al. v. CompuCredit Holdings Corp., et al., the United States Court of Appeals for the Eleventh Circuit determined that certain noteholders’ fraudulent transfer actions under state law were barred by the governing indenture’s no-action clause.
In Akanthos, the plaintiffs, a collection of hedge funds owning a majority of outstanding unsecured notes of CompuCredit (a subprime lender), asserted an action against CompuCredit and certain of its officers and directors under the Georgia Uniform Fraudulent Transfers Act (substantially similar in form and substance to the Uniform Fraudulent Transfer Act).  With CompuCredit on the brink of insolvency, the defendants had issued a dividend to themselves (as the primary shareholders) and also planned to spin off CompuCredit’s most profitable business and distribute shares of the spun-off subsidiary ratably to CompuCredit’s shareholders (primarily directors and officers). The plaintiff noteholders asserted that the defendants were intentionally plundering CompuCredit’s remaining assets, thereby driving down the price of CompuCredit’s notes and threatening CompuCredit’s ability to redeem those notes in accordance with the terms of the indenture.  The defendants moved to dismiss the noteholders’ fraudulent transfer actions on a number of grounds, including, among other things, that such claims were contractually barred by a no-action clause contained in the governing indenture.  After finding that the no-action clause did not bar the plaintiffs’ fraudulent transfer actions under the circumstances of the case, the District Court for the Northern District of Georgia denied the defendants’ motion to dismiss.  That court subsequently certified for interlocutory appeal the question of whether, under New York law, the noteholders could pursue the fraudulent transfer action.
The fairly standard no-action clause at issue in Akanthos prohibited noteholders from pursuing any remedy (except in the event of a default due to non-payment) unless, among other things, (a) the noteholders provided the indenture trustee with notice of a default, (b) 25% of noteholders in aggregate principal amount made a demand on the trustee to pursue the remedy, (c) the trustee failed to comply with such demand within 60 days, and (d) the majority of noteholders in aggregate principal amount did not give the trustee a direction inconsistent with the demand.
On appeal, the Eleventh Circuit disagreed with the district court and concluded that the noteholders’ fraudulent transfer actions were barred by the no-action clause.  As a preliminary matter, the court rejected the noteholders’ argument that the officers and directors could not rely on the no-action clause because those individuals were not parties to the indenture.  The court stated that the scope of the no-action clause – which barred pursuit of “any remedy with respect to th[e] [i]ndenture . . . ” – was premised on the nature of the claims asserted, not the identity of the defendants.
The Eleventh Circuit also rejected the plaintiffs’ three primary arguments supporting the noteholders’ position that the no-action clause did not bar their state-law fraudulent transfer claims.  First, the noteholders argued that their fraudulent transfer claims were extra-contractual because the no-action clause only contemplated lawsuits predicated on a default.  Courts applying New York law, however, have consistently held that, in the absence of evidence of trustee misconduct or conflict of interest, no-action clauses serve as a bar to noteholder fraudulent transfer actions.  The no-action clause in Akanthos, as is common with most no-action clauses, barred all actions “with respect to” the indenture.  Because fraudulent transfer actions “‘arise from transactions by issuers of bonds and assert injuries arising from the bondholder status of the plaintiffs[,]’” the noteholders’ injury is derivative and the indenture trustee is, therefore, the appropriate party to pursue such claims on behalf of all noteholders (quoting Feldbaum).  Accordingly, because the noteholders raised no allegation of trustee misconduct or a conflict of interest, the Eleventh Circuit refused to deviate from the well-established rule that no-action clauses bar independent noteholder fraudulent transfer actions.
Second, the plaintiffs argued that because they held a majority in principal amount of CompuCredit’s notes, the underlying purpose of the no-action clause – to prevent suits not in the majority’s best interest – was necessarily satisfied.  The Eleventh Circuit also flatly rejected this argument.  Even though the noteholders held a majority in principal amount of the outstanding notes, the court stated that the unambiguous text of the clause provides no evidence of any “intent to allow noteholders to fall within an exception if they have not satisfied all the stated pre-conditions to that exception.”  The Eleventh Circuit also looked to the purpose of no-action clauses and found that, although deterrence of minority lawsuits is one purpose of such clauses, no-action clauses also serve the purposes of preventing “rash” or “precipitate” lawsuits and “protecting the issuer from a multiplicity of lawsuits.”  The mere fact that a fraudulent transfer action is commenced by a majority of noteholders offers no guarantee that all of the underlying purposes of a no-action clause are fulfilled.  Accordingly, the court rejected the noteholders’ “novel proposition that a party to a contract should be excused from complying with a condition precedent merely because it was capable of compliance.”
Third, the noteholders argued that because CompuCredit had announced its intent to pay a dividend on less than 60 days’ notice, CompuCredit had made it impracticable for the noteholders to comply with the no-action clause’s 60-day waiting period.  This argument, the “prevention doctrine,” also failed to persuade the reviewing court.  The so-called prevention doctrine provides that a party cannot insist upon performance of a condition precedent when that party has itself wrongfully prevented the performance of such condition.  Although conceding that CompuCredit’s issuance of the dividend on less than 60 days’ notice did in fact make it impossible for the noteholders to comply with the 60-day waiting requirement established under the no-action clause, the court found that the noteholders had assumed the risk that fulfillment of that condition might be prevented under certain circumstances.  Moreover, the indenture itself required CompuCredit to give only 20 days’ notice prior to issuing a dividend.  Accordingly, CompuCredit’s actions were not “wrongful” and were in fact specifically contemplated under the terms of the indenture.  The court also noted that, by issuing the dividend on less than 60 days’ notice, CompuCredit had not escaped any contractual duty; instead, the 60-day waiting requirement was merely a precondition to complying with an exception to an agreed-upon contractual bar.
The Eleventh Circuit’s decision provides a sound reminder to investors to carefully review applicable indentures and credit agreements (including seemingly innocuous boilerplate language) and be aware that courts’ broad interpretation of no-action clauses may, among other things, limit such investors’ efforts to pursue fraudulent transfer actions.