Exchange Offers May Be Limited to Qualified Institutional Investors

May 1, 2017

By: Alan Kolod, Jonathan B. Ross, and Kent C. Kolbig

Under New York law, absent an express indenture covenant requiring that an exchange offer be open equally to all holders pro rata, there is no prohibition on an offer limited to a class of holders.  In re Loral Space & Commc’ns Inc., 2008 WL 4293781 (Del. Ch. Sept. 19, 2008); see also Bank of NY Mellon v. Realogy Corp., 979 A2d 1113, 1117 (Del. Ch. 2008).

However, following the federal District Court decisions in Marblegate1 and Caesars2, class action counsel have sought to construct a new basis for challenging such restricted exchange offers.  The first effort, Waxman v. Cliffs Natural Resources Inc., 2016 WL 7131545 (S.D.N.Y. Dec. 6, 2016), an action against the issuer, was not successful.  A copy of the decision is accessible here.

In Cliff Resources, a federal District Court rejected a challenge by non-institutional holders to an exchange offer that had been limited by Cliffs Natural Resources Inc. (“Issuer”) to non-U.S. persons who were qualified institutional buyers (“QIBs”).  The Court found no merit to plaintiffs’ attempt to shoe-horn themselves into the reasoning of the Marblegate and Caesars line of decisions (before Marblegate was reversed by the Second Circuit Court of Appeals).3  Those decisions had held that out-of-court restructurings involving amendments to an indenture that defeated the practical ability of non-consenting holders to obtain payment violated section 316(b) of the Trust Indenture Act (“TIA”). 

The Issuer sought to reduce its outstanding debt through a voluntary exchange offer limited as noted above.  Qualified holders were offered new bonds of a substantially lower face amount, but the new bonds were secured, ranking ahead of the plaintiffs’ bonds.  The exchange offer did not involve exit consents amending the old notes.  The plaintiffs, who held less than 25% of the note issuance, claimed the exchange offer violated their rights under section 316(b) of the TIA, as well as the indenture, and also breached the implied covenant of good faith and unjustly enriched the Issuer, by subordinating the plaintiffs’ notes to the newly issued bonds, without their consent. 

The District Court dismissed all claims.   First, the Court found the plaintiffs lacked standing because they had suffered no injury from the exchange offer.  The fact that the old notes had been subordinated to secured senior notes did not, by itself, constitute actionable injury because any potential harm from the subordination was entirely speculative.  The plaintiffs would only be harmed if their recovery in the event of a future hypothetical insolvency was impaired.  They also had suffered no immediate harm from the exchange, because the market value of their notes had increased substantially after the exchange offer was announced and even more after it was consummated.  Since they could not point to any injury they had suffered, the plaintiffs had no standing to challenge the exchange offer. 

Secondly, the Court found no violation of section 316(b) of the TIA because the exchange offer had not involved any amendment to the old notes and there had been no majority vote approving any transfer of assets, release of guarantees or covenant changes.  The indenture for the old notes already permitted the issuance of senior secured notes, so that no noteholder approval was required to authorize that.  In short, no out-of-court restructuring of the notes had occurred that implicated section 316(b) of the TIA or Marblegate in any way.  For the same reasons, the indenture provision quoting section 316(b) had not been breached.

Third, the Court dismissed the claim for breach of an implied covenant to treat all holders equally or pro rata.  The indenture contemplated that the notes in question might be subordinated by the issuance of secured debt.  It also did not contain any covenant that required that all holders be treated pro rata or equally in an exchange offer or that prohibited exchange offers limited to qualified investors.  Since the risk of such exchange offers was generally known to investors prior to the exchange offer in question, the Court refused to imply a covenant that could have been, but was not, negotiated for.  

Fourth, the Court found that the action was barred by the “no action” covenant in the indenture.  The plaintiffs failed to meet the requirement of holding 25% of the issuance, and that could not be cured by bringing a class action.  The Court also refused to excuse plaintiffs’ failure to make demand on the indenture trustee before suing.  The fact that the exchange offer would close prior to the 60 day demand period did not mean that the action would be mooted by the passage of sixty-days, as shown by the fact that plaintiffs continued to pursue their claims after the exchange closed.   Furthermore, the indenture trustee was not conflicted by reason of its service as trustee for the new bonds, where there was no showing that the fees from its other relationships with the issuer were so material as to suggest they would influence the trustee’s conduct. 

The decision is a reminder to noteholders and trustees of several important points. First, the “no action” provision in indentures has teeth to protect the issuer and indenture trustee against suits by minority holders who fail to comply.   Second, there are no implied covenants to protect holders from conduct by the issuer that could have been, but is not, prohibited by the express indenture covenants.  Finally, holders should not proceed with a suit if they cannot prove that a violation of the indenture actually caused them injury. 


1Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 75 F. Supp. 3d 592 (S.D.N.Y. 2014); Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 111 F. Supp. 3d 542 (S.D.N.Y. 2015).

2MeehanCombs Global Credit Opportunities Funds, LP v. Caesars Entm't Corp., 80 F. Supp. 3d 507 (S.D.N.Y. 2015); BOKF, N.A. v. Caesars Entm't Corp., 144 F. Supp. 3d 459 (S.D.N.Y. 2015).

3Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 846 F. 3d 1 (2d Cir 20175).

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