On 17 January 2017, the federal appeals court based in New York held that the prohibition in the Trust Indenture Act of 1939 on impairing a bondholder's right "to receive payment" without the bondholder's consent applies to just the "core payment terms" of a debt agreement, but not to debt restructurings that otherwise affect the bondholder's practical ability to recover. The appeals court thus vacated the lower court's ruling that had held that a restructuring of Education Management Corporation ("EDMC") debt violated the Trust Indenture Act because it limited the practical ability to recover of the sole company creditor that did not agree to the restructuring.

EDMC is a for-profit educational company that in 2014 was in need of restructuring its $1.5 billion in debt, approximately $1.3 billion of which was held by secured creditors and approximately $200 million of which was held by unsecured creditors. The company could not file for bankruptcy because doing so would have prevented it from qualifying for certain government subsidies for educational institutions. EDMC reached an out-of-court restructuring agreement with all of its creditors except Marblegate, which was an unsecured creditor representing just two percent of the company's total debt. This restructuring involved a foreclosure on EDMC's assets that did not affect the "core payment terms" of Marblegate's notes—i.e., the amount of principal and interest owed and the date of maturity—but limited Marblegate's practical ability to recover by transforming the entity responsible for those payments into an empty shell company.

Section 316(b) of the Trust Indenture Act prohibits the impairment of a bondholder's right "to receive payment" under qualifying notes without the bondholder's consent. The court here determined that the statutory language was inconclusive as to whether that prohibition applied to just "core payment terms" or also to a bondholder's practical ability to recover. The court considered the extensive legislative history of the statute. Based on this analysis, the court concluded that Section 316(b) prevents nonconsensual amendments to just the "core payment terms" of a debt agreement (such as amendments adopted by a majority of bondholders), but not to debt restructurings—such as the foreclosure transaction that took place here—that affect only the practical ability to recover. But the court was careful to point out that nonconsenting creditors could still pursue other avenues of relief, such as challenging the restructuring arrangement under fraudulent conveyance law, the Uniform Commercial Code, or successor liability principles.

In a dissent, one of the judges on the panel reasoned that the language of Section 316(b) clearly prohibited transactions that impair a nonconsenting creditor's practical ability to obtain payment. According to this judge, even if "[c]ertain undesirable consequences might well arise from the fact that Section 316(b) prohibits actions such as those taken by EDMC in this case," the "[r]esolution of the pros and cons of whether a statute should sweep broadly or narrowly is for" the legislature rather than the courts to decide. The majority opinion nevertheless establishes that the law, at least in New York and the two other states covered by decisions of this court, allows for the kind of debt restructuring that EDMC engaged in. This decision returns the law to where much of the business community had understood it to be until the lower court's decisions in this case. Individual bondholders can accordingly no longer singlehandedly hold up necessary debt restructurings.

For more information on the Marblegate case, you may refer to our client note at:

http://www.shearman.com/en/newsinsights/publications/2017/01/appeals-court-overturns-marblegate

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