The United States Court of Appeals for the Second Circuit held in Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Fin. Corp., No. 15-2124-CV(L), 2017 WL 164318 (2d Cir. Jan. 17, 2017) that Section 316(b) of the Trust Indenture Act (“TIA”) prohibits only non-consensual amendments to an indenture’s core payment terms, overturning the decision from the United States District Court for the Southern District of New York, which had taken a more expansive view of the TIA in holding that Section 316(b) prohibited impairing the practical ability to collect payment under an indenture.


In 2014, Education Management Corporation (“EDMC”), a for-profit higher education company, experienced severe financial distress. As a higher education company that relied on federal funding through Title IV of the Higher Education Act of 1965, bankruptcy was not a realistic option because EDMC would lose its eligibility for Title IV funds. Pursuant to the credit agreement between EDMC’s subsidiary and its secured creditors, the secured creditors had the right, upon default, to become the owners of the collateral securing the debt under the credit agreement, which included substantially all of EDMC’s assets. In addition to the secured debt, EDMC’s subsidiary had also issued unsecured notes guaranteed by EDMC. EDMC negotiated with an ad hoc committee of its subsidiaries’ secured creditors under the credit agreement to restructure its debt through two options: (1) if all of the subsidiaries’ creditors unanimously consented, the secured debt would be exchanged for US$400 million in new secured term loans and new stock convertible into approximately 77 percent of EDMC’s common stock and the notes would be exchanged for equity worth approximately 19 percent of EDMC’s common stock; (2) if at least one creditor refused to consent, then the secured creditors would foreclose on EDMC’s assets, release EDMC from its guarantee under the credit agreement, which would automatically release its guarantee under the notes, and then sell the foreclosed assets to a new subsidiary of EDMC, which would distribute new debt and equity to consenting creditors. Under the second scenario, while non-consenting secured creditors would receive debt in the new EDMC subsidiary junior to the debt of consenting secured creditors, non-consenting noteholders would receive nothing, although their contractual right to payment of the notes from the empty shell company would remain. All of the creditors except for Marblegate consented to the second scenario.


At issue in Marblegate was the meaning of the Trust Indenture Act’s prohibition on impairing or affecting a holder’s “right . . . to receive payment” under an indenture.[1] The Second Circuit agreed with the District Court that this language was ambiguous because it “lends itself to multiple interpretations.”[2] The Second Circuit thus focused on the legislative purpose and history of Section 316(b) to determine the meaning of this provision. Relying in large part on a 1936 SEC Report that led to the enactment of the TIA, the 1938 testimony of then-SEC Chairman William O. Douglas, and the 1939 testimony of future SEC Commissioner Edmund Burke, Jr., the Second Circuit concluded that the “TIA’s legislative history exclusively addressed formal amendments and indenture provisions like collective-action and no-action clauses”, and did not “prohibit foreclosures even when they affect a bondholder’s ability to receive full payment.” The Second Circuit determined that Congress sought to prohibit formal modifications of core payment rights through the enactment of Section 316(b), but did not intend to go further by banning other well-known signs of reorganization, such as foreclosures. Additionally, the Second Circuit criticized the position of Marblegate (and, by inference, the District Court holding) that Section 316(b) requires a court to determine in each case whether a challenged transaction constitutes an out of court restructuring designed to eliminate a non-consenting holder’s ability to receive payment. The court stated that this analysis would turn on subjective intent of the issuer or majority bondholders, and the court noted that the Second Circuit has a particular distaste “interpreting boilerplate indenture provisions based on the ‘relationship of particular borrowers and lenders’ or the ‘particularized intentions of the parties to an indenture,’ both of which undermine ‘uniformity in interpretation.'” The Second Circuit left open the possibility that a non-consenting bondholder will be able to pursue other state and federal remedies.


Because the Southern District of New York has been the primary forum for dissenting bondholders’ suits, predicated on claims under Section 316(b) of the Trust Indenture Act, the Second Circuit’s decision should provide distressed issuers with greater certainty that they may modify terms other than core payment terms in Indentures, or otherwise engage in consensual out of court restructurings, with less than unanimous noteholder support without the fear of being found in violation of Section 316(b) of the TIA.


[1] Section 316(b) of the TIA provides that “Notwithstanding any other provision of the indenture to be qualified, the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such holder, except as to a postponement of an interest payment consented to as provided in paragraph (2) of subsection (a) of this section, and except that such indenture may contain provisions limiting or denying the right of any such holder to institute any such suit, if and to the extent that the institution or prosecution thereof or the entry of judgment therein would, under applicable law, result in the surrender, impairment, waiver, or loss of the lien of such indenture upon any property subject to such lien.” 15 U.S.C. § 77ppp(b).

[2] The dissent applied a plain meaning analysis to hold that because the term “impair” means “to diminish the value of” and the term “affect” means “to produce an effect on; to influence in some way”, the “right . . . to receive payment” can be diminished or affected without actual modification of the indenture’s payment terms. The dissent thus held that “an out-of-court debt restructuring ‘impairs’ or ‘affects’ a non-consenting noteholder’s ‘right to receive payment’ when it is designed to eliminate a non-consenting noteholder’s ability to receive payment, and when it leaves bondholders no choice but to accept a modification of the terms of their bonds.”