Contributed by Brian Wells
As energy prices continue in their trough and volatile markets fuel speculation of credit deterioration, more and more investors, companies, and professionals find themselves scouring documents to find room for a capital structure adjustment (or, alternatively, for potential threats to their credit support).  A recent decision by the District Court for the Southern District of New York in the Norske case serves as a reminder that enforcement and legal process issues are critical considerations in this analysis.  In Norske, a trustee sued to enjoin a proposed exchange offer, claiming it violated a restrictive debt incurrence covenant in its indenture.  The trustee successfully obtained a temporary restraining order from the New York state court before the case was removed to the federal system, where, notably, the district court found that the trustees’ claims regarding the indenture violation were likely to succeed on the merits.  Nonetheless, the district court found that the trustee had failed to prove “irreparable harm” and declined to grant a preliminary injunction, allowing the exchange to move forward.  As more distressed exchange offers come to the board room and the market, the reasoning and implications of this hot-off-the-presses decision are worth a close look.

The issuer of the securities in issue, Norske Skog, has taken a number of recent steps to address financial difficulties and upcoming debt maturities.  Among these is the issuance, in February 2015, of €290 million in “Senior Secured Notes.”  The Senior Secured Notes benefited from, among other things, guarantees from entities throughout the company’s corporate structure and liens over nearly all of the assets of certain “Subsidiary Guarantors.”  Although the Subsidiary Guarantors’ European assets and bank accounts remained unencumbered, their stock had been pledged to the Senior Secured Notes and, through the equity interest, the noteholders had the highest priority claims against the unencumbered assets out of the company’s various debt issuances.  As is common for high-yield debt, the Senior Secured Notes indenture included a restrictive covenant limiting Norske’s ability to incur future indebtedness.
Norske’s financial troubles continued notwithstanding the issuance, and the maturities of two series of unsecured notes (due in both 2016 and 2017) loomed ever closer.  In December 2015, Norske launched an exchange offer and consent solicitation for these notes seeking to extend their maturities.  In exchange, consenting holders would receive a package of new securities including, among others, “Exchange Notes” that were secured by the unencumbered assets of the Subsidiary Guarantors (i.e., the European assets and bank accounts).  Holders of the Senior Secured Notes, however, were displeased by the possibility of their interests in the unencumbered assets becoming structurally subordinated to the Exchange Notes.
Procedural Posture
One day before the exchange offer was set to close, the trustee for the Senior Secured Notes filed a complaint in New York state court (1) alleging that the exchange offer was in breach of the indenture and (2) seeking injunctive relief to prevent the exchange from going forward.  The state court promptly granted the TRO.  In response, the issuer extended the closing date for the exchange offer.  Meanwhile, the lawsuit was removed to federal district court.
Decision and Analysis
The district court first had to decide whether to replace the state court’s TRO with a lengthier preliminary injunction.  To obtain a preliminary injunction, the trustee had to demonstrate “irreparable harm,” i.e., an actual and imminent injury that could not subsequently be remedied by an award of monetary damages.  If the trustee demonstrated irreparable harm, then it needed to prove either that (1) it has a likelihood to succeed on the merits of its claim or (2) the merits of its claims raise sufficient questions to make them fair for litigation (and, to satisfy this alternative prong, that the balance of hardships tip decidedly in favor of the plaintiff).  Both elements must satisfy the somewhat stringent “clear showing” burden of persuasion.
Although the district court found that the trustee had not demonstrated irreparable harm, it also considered whether the trustee had a likelihood of succeeding on its claims that the issuer had violated the indenture.
Likelihood of Success
The likelihood of success prong requires an assessment of the merits of the plaintiffs’ claims, albeit with a loose standard requiring only that the court find the probability of success is better than 50 percent (a standard requiring decidedly less than certainty as to the outcome).
As is typical for high-yield indentures, the Senior Secured Notes’ indenture includes a restrictive covenant that generally precludes the issuer from incurring additional debt unless certain conditions are satisfied or the incurrence falls within one of several enumerated carve-outs.  The dispute in Norske focused on what transactions could fit within the various carve-outs.  The trustee contended that, when reading the carve-outs, it was necessary to distinguish between a permitted “financing” and “refinancing.”  The exchange – which would replace Parent Notes with newly-incurred Exchange Notes – was decidedly a refinancing, the trustee claimed, and, therefore, must satisfy an express carve-out in the indenture governing the incurrence of “permitted refinancing indebtedness.”  Because, as the trustee argued, the exchange would not satisfy the carve-out, it would result in a breach of the indenture.
The issuer conceded that the exchange would not satisfy the refinancing carve-out, instead taking issue with the purported distinction between a “financing” and a “refinancing.”  The issuer argued that the term “refinancing” was subsumed as a type of “financing,” and not an entirely different concept.  As support, the issuer pointed to a relatively standard provision in the indenture allowing the issuer, in its sole discretion, to classify indebtedness between the various carve-outs at the time it is incurred or thereafter.  The issuer went on to argue that the exchange, and concomitant incurrence of the Exchange Note indebtedness, was a “qualified securitization financing” permitted under a separate carve-out.
The court focused heavily on its view of the plain meaning of “financing” and “refinancing,” and the usage of such terms throughout the indenture.  Siding with the trustee, the court also reasoned that if the issuer could use a different carve-out to refinance indebtedness that would be precluded under the refinancing carve-out, the refinancing carve-out would be rendered meaningless.  Although notable, this aspect of the decision was arguably dicta as the court decided not to grant an injunction based on the lack of proof of irreparable harm.
Irreparable Harm
The indenture trustee further argued that it satisfied the irreparable harm prong because, if the exchange went forward, the company’s diminished cash position would prevent it from making payments on the Senior Secured Notes, and the noteholders would lose priority in the unencumbered assets granted as collateral for the Exchange Notes.
The court was not persuaded by either argument.  First, the court noted that the trustee had essentially accepted that, without the exchange offer, the issuer would be promptly forced into bankruptcy and in an immediately worse financial condition.  The court was not satisfied that the proposed “cure” was any better than the “disease” and accordingly found that irreparable harm had not been shown.  Second, the court dismissed notions of harm based upon the potential for a bankruptcy following the exchange.  The parties had offered conflicting post-exchange scenarios (the issuer’s did not involve bankruptcy), and the court found that whether a bankruptcy filing would occur was far too remote and theoretical to constitute irreparable harm.  Moreover, even if bankruptcy were a certain outcome, the harm was not – the issuer’s unrebutted valuation of the notes’ collateral showed that enough value remained to pay the notes.
Moreover, although the prospect of monetary damages generally is not considered “irreparable harm,” the trustee invoked the “insolvency exception,” pursuant to which the availability of monetary damages is only sufficient to preclude a preliminary injunction where someone actually would be able to pay them.  However, the court declined to apply this exception to the irreparable harm prong because (1) the trustee had taken the position that Norske already was insolvent (precluding any argument that Norske would be rendered insolvent by the exchange), and (2) it determined that sufficient collateral existed to satisfy the notes in full.  More fundamentally, the court held that the insolvency exception was not designed prevent transfers of liens or otherwise to preserve the priority of claims in a speculative bankruptcy, but instead was meant to address dissipation of assets to third parties (e.g., where assets are sold and the cash proceeds are used to make payroll or pay down debt).  Intercreditor disputes over competing priorities to assets are appropriately resolved by a bankruptcy court, the court concluded – not through a preliminary injunction granted under the insolvency exception.
Although TROs and preliminary injunctions are in theory powerful litigation tools, Norske shows that putting a stop to an exchange offer can be difficult, particularly where the alleged harm is a potential bankruptcy or an intercreditor dispute over priority.
Brian Wells is an Associate at Weil Gotshal & Manges, LLP in New York.