Indenture Terms Override Equitable Arguments of Subordinated Noteholders

November 15, 2016

By: Jonathan B. Ross

In a recent case in the Southern District of New York, the senior holder of defaulted collateralized notes moved for an order directing the indenture trustee to liquidate and distribute the issuer’s assets in accordance with the indenture.  The junior holders, who would not be paid if the relief were granted, objected and asked the Court either to rescind their notes or order a pro rata distribution pursuant to the equitable relief provisions of section 47(b) of the Investment Company Act of 1940 (“Act”).  They sought this relief, not because of any misconduct by the senior holders, but rather based on the allegation that the notes had been sold to the junior holders in violation of securities laws.  The alleged misconduct of the issuer did not entitle the junior holders to relief that would impair the rights of the senior holders.


The Court granted the senior holder’s motion for summary judgment and ordered liquidation and distribution of the issuer’s assets according to the waterfall provision in the indenture.  In so doing, the Court endorsed important principles of indenture practice and administration.


First, the Court confirmed that tranching of securities, such as the notes, gives holders of different tranches different rights, including with respect to rates of return and distributions on the notes.  The senior holders in this case held a majority of the “Class A-1” notes, whereas the junior holders held notes that received a higher rate of interest, but distribution rights that were junior to the Class A-1 notes.  

Second, the Court enforced the term contained in many indentures requiring an indenture trustee to follow the direction of a majority (or supermajority) of the holders of the most senior class of securities.  The Court noted that the indenture entitled a two-thirds’ majority of senior holders to trigger a liquidation of assets following a default.

Third, the Court found that, even if the notes had been sold to the juniors in violation of the securities laws, this would not make inequitable the enforcement of the senior holders’ contractual rights to distributions following a default in the payment of principal or interest.  Although the assets would be insufficient to pay the junior holders if the indenture’s waterfall distribution were applied, the Court concluded that the equitable relief provisions set forth in the Act “do not bar the liquidation of the Trust Estate and distribution of the corpus in accordance with the procedures and priorities established under the Indenture, and that denial of rescission is the more equitable result.”  The Court thereby concluded that the balance of equity favored enforcement of the post-default waterfall despite the consequent deprivation of distributions to the junior holders.

This decision confirms several important and common principles in indentures.  Most important, it holds that the rights allotted the various tranches of noteholders will be deemed equitable and will not readily be set aside under the equitable relief provisions of section 47(b) of the Act.

Lansuppe Feeder, LLC v. Wells Fargo Bank, N.A., 2016 WL 5477741 (S.D.N.Y. 9/29/16)

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