Since Marblegate was decided in 2014, the only court to address claims under §316(b) of the Trust Indenture Act (“TIA”) in the context of a corporate restructuring transaction is CaesarsCaesars and Marblegate interpreted §316(b) broadly, finding that it protects not only the legal right to payment but also the practical ability to receive principal and interest where an out-of-court restructuring renders repayment a practical impossibility.  This week’s decision by the Southern District of New York in Cliffs Natural makes clear that the holdings in Marblegate and Caesars are limited to comprehensive restructurings that amount to de facto bankruptcies in which two factors, at least, are present: (1) an asset transfer; or (2) the removal or material modification of inter-company guarantees or security interests. The court’s characterization of Marblegate and Caesars, and their progenitor Mechala, emphasized that in each, noteholders were left with “no practical ability to receive payment.”
Cliffs Natural had seven classes of notes outstanding, representing nearly $2.9 billion of debt. Like many other companies that have been roiled by the protracted downturn in oil and gas prices, Cliffs Natural sought to reduce its significant bond debt through a voluntary exchange offer (the “Exchange Offer”). Eligible noteholders were offered the opportunity to exchange their existing notes for new notes that bore a higher interest rate and were ranked higher in terms of secured priority. In return, the exchanging noteholders agreed to at least a 60% reduction in principal. The Exchange Offer was open only to qualified institutional buyers (“QIBS”) and to holders who were not “U.S. persons.”
Plaintiffs filed their claims on behalf of a class of all noteholders who had been excluded from the Exchange Offer. Their complaint asserted claims for violations of §316(b) and breach of the corresponding indenture covenant; breach of the covenant of good faith and fair dealing; and unjust enrichment.   Plaintiffs also sought a declaratory judgment that the Exchange Offer resulted in an event of default under the indenture and was null and void. The court rejected these claims.
The key rulings are:

  • The Exchange Offer is not barred by §316(b) or the corresponding indenture covenant:
    • 316(b) sprang from concerns about majorities abusing minority holders, which did not occur here. There was no vote and no majority action of any kind: “only $219 million out of the potential $710 million in new notes issued, and none of the six bond classes exchanged more than 40%”.  None of the indicia of “an involuntary, out-of-court pseudo-bankruptcy” outlined in Marblegate and Caesars is present here. The Exchange Offer did not entail a transfer of assets, amendment of the indentures, or the modification or removal of a guaranty.
  • Plaintiffs have no Article III standing because they failed to allege injury-in-fact:
    • The harm alleged by plaintiffs—holders of unsecured notes—was that their notes would be effectively subordinated in a bankruptcy. This harm is entirely hypothetical because there is no allegation that a bankruptcy is imminent.
    • Plaintiffs did not allege that they would have accepted the Exchange Offer. Absent an allegation that plaintiffs “stand ready and willing to accept the Exchange Offer on the same terms as the QIBs who accepted it, there can be no injury-in-fact because [p]laintiffs would be in the exact same position as that in which they currently stand.”
    • Plaintiffs’ notes increased in value after the Exchange Offer. Where plaintiffs “point to no concrete harm that actually has occurred or is imminent, and, moreover, the challenged transaction produced an economic benefit, they have not suffered the kind of injury-in-fact that is a prerequisite to invoking the limited jurisdiction of an Article III court.”
  • The state law claims fail because plaintiffs did not comply with the indenture’s no action clause:
    • Plaintiffs did not notify the trustee of an alleged default, offer the trustee indemnification, wait the requisite 60 days for the trustee to evaluate whether to take action, or marshal support from the holders of 25% of the notes.
    • The court rejected plaintiffs’ contention that they were excused from these threshold contractual requirements because the Exchange Offer was scheduled to close in less than 60 days. The relief they sought—damages and a declaration that the Exchange offer was “invalid”—was still available even today. Nor are plaintiffs permitted to circumvent the no-action clause’s 25% requirement by bringing their claims as a class action. Only in suits for past due principal and interest are noteholders excused from the 25% requirement.

Because this is not a final order, it is not immediately appealable.  While the court allowed 20 days to replead, plaintiffs are unlikely to satisfy the no-action clause’s 60-day notice requirement within 20 days.
Following Marblegate, a number of actions have been filed challenging out of court restructurings under §316(b) – a statutory provision which, in the 70 years since the TIA’s passage, was rarely asserted by noteholders until recently.   The restructuring community has been monitoring these cases to see whether courts will expand Marblegate and Caesars beyond their unusual facts to make out-of-court restructurings more difficult.  Until the Second Circuit Court of Appeals decides the pending Marblegate appeal, Cliffs Natural is a useful guidepost for counseling distressed companies which are considering debt exchange offers, including those that are open only to QIBs, non-US investors or accredited investors.
If the reasoning in Cliffs Natural is followed in other cases, it should help reinstate much needed certainty in this area of the law. In particular, the court’s emphasis that (i) the cases which found a §316(b) breach involved a complete destruction of the practical right to receive payment and a transfer of assets or removal or material modification of inter-corporate guarantees or security interests; and (ii) parties asserting hypothetical risks when bankruptcy is not imminent lack Article III standing, could deter similar type noteholder actions. Absent other covenant breaches, a restructuring which entails an exchange offered only to some noteholders should not give rise to a violation of §316(b) or an event of default under the comparable indenture provisions, even if objecting noteholders are subordinated in the new capital structure.