United States District Court, S.D. New York
OPINION AND ORDER
KATHERINE POLK FAILLA, District Judge.
This is the second opinion stemming from the restructuring of the debt of Education Management Corporation, Education Management L.L.C., and Education Management Finance Corporation (collectively, "EDMC" or "Defendants"). Defendants, in negotiations with the Steering Committee for the Ad Hoc Committee of Term Loan Lenders of Education Management (the "Steering Committee" or "Intervenors"), agreed to a debt restructuring in which bondholders would receive partial recovery in the form of debt and/or equity. Marblegate Asset Management, L.L.C., and Marblegate Special Opportunities Master Fund, L.P. (collectively, "Marblegate" or "Plaintiffs"), dissented from the restructuring plan, as a result of which, under the restructuring as originally conceived, they would retain their original claims but be left with no assets as security for those claims. Marblegate sought a preliminary injunction under the Trust Indenture Act of 1939 (the "Trust Indenture Act" or the "Act"), 15 U.S.C. §§ 77aaa-77bbbb; the Court denied the request for injunctive relief in Marblegate Asset Management v. Education Management Corp., ___ F.Supp. 3d ___, No. 14 Civ. 8584 (KPF), 2014 WL 7399041 (S.D.N.Y. Dec. 30, 2014) (" Marblegate I "). EDMC subsequently carried out the restructuring, while leaving in place mechanisms to pay Marblegate's claims if necessary. Marblegate now seeks declaratory, monetary, and potentially injunctive relief. EDMC counterclaims for declaratory relief allowing it to remove the mechanisms put in place to preserve Marblegate's rights. The Court, having converted the preliminary injunction hearing into a bench trial at the request of the parties and having received supplemental exhibits and briefing, now rules in favor of Plaintiffs for the reasons set forth in this Opinion and Order.
A. Factual Background
The Court assumes familiarity with its prior Opinion denying Marblegate's request for a preliminary injunction, but briefly retraces the relevant facts. The case arises out of EDMC's decision to restructure roughly $1.5 billion in debt. Marblegate I, 2014 WL 7399041, at *3. EDMC, a for-profit education company, was inhibited from restructuring through bankruptcy by its reliance on federal funds distributed through Title IV of the Higher Education Act of 1965, 20 U.S.C. §§ 1079-1099. Marblegate I, 2014 WL 7399041, at *1-2. Declaring bankruptcy would have rendered EDMC ineligible for Title IV funds, depriving it of nearly 80% of its revenue. Id.  Accordingly, EDMC negotiated an agreement with a group of its largest creditors to carry out the Proposed Restructuring. Id. at *6-7.
Prior to the since-consummated restructuring, EDMC's debt consisted of $1.305 billion in secured debt (divided between $220 million drawn from a revolving credit facility and $1.085 in secured term loans) and $217 million in unsecured notes (the "Notes"), for a total debt of $1.553 billion. Marblegate I, 2014 WL 7399041, at *3. The instant case focuses on the unsecured Notes, which were qualified under the Trust Indenture Act (Indenture §§ 6.07, 12.01). Although the Notes were unsecured and issued by a subsidiary, Education Management LLC, they were guaranteed by EDMC (the "Parent Guarantee"). Id. at *3-4 The Parent Guarantee recited, however, that it could be released either by majority vote of the Noteholders (Indenture § 9.02) or by a corresponding release of the Parent Guarantee by the secured lenders (Indenture § 10.06),  and accordingly the Notes' offering circular cautioned investors not to assign any value to the Parent Guarantee. Id.
The Ad Hoc Committee of Term Loan Lenders with which EDMC negotiated consisted of creditors holding 80.6% of EDMC's secured debt and 80.7% of the Notes; the negotiations were primarily carried out by the Steering Committee, which collectively held 35.8% of EDMC's secured debt and 73.1% of the Notes. Marblegate I, 2014 WL 7399041, at *6. EDMC and the Steering Committee arrived at the Proposed Restructuring, which would provide secured term loan lenders debt and equity in EDMC amounting to roughly a 55% recovery; holders of Notes would receive equity amounting to roughly a 33% recovery of value. Id.
The Restructuring Support Agreement anticipated 100% voluntary participation by creditors, but contained a stick that would come into effect if any creditors did not consent. That stick, the Intercompany Sale, would involve several steps:
(i) the secured lenders would release EDMC's parent guarantee of their loans..., thus triggering the release of EDMC's parent guarantee of the Notes under Indenture § 10.06; (ii) the secured lenders would exercise their rights under the 2014 Credit Agreement and Article 9 of the Uniform Commercial Code to foreclose on "substantially all the assets" of Defendants; and (iii) the secured lenders would immediately sell these assets back to a new subsidiary of EDMC. This new subsidiary would then distribute debt and equity to the creditors who had consented to the Restructuring Support Agreement in accordance with that document's terms.
Marblegate I, 2014 WL 7399041, at *7 (internal footnotes and citations omitted). As EDMC explicitly warned the Noteholders in its Exchange Offer, the result of the Intercompany Sale would be that "substantially all of our assets will have been transferred to New EM Holdings and will not be available to satisfy the claims of [dissenting Noteholders]. As a result, we anticipate that such Holders will not receive payment on account of their Notes." Id. (quoting Exchange Offering Circular 3). Thus, although the Intercompany Sale would not formally alter the dissenting Noteholders' right to payment on their Notes, it was unequivocally designed to ensure that they would receive no payment if they dissented from the debt restructuring.
B. The Preliminary Injunction Hearing
Marblegate, which held roughly $14 million of Notes, declined to participate in the Exchange Offer, and on October 28, 2014, filed a motion for a temporary restraining order and a preliminary injunction. Marblegate I, 2014 WL 7399041, at *8. The parties agreed to halt both the Proposed Restructuring and Marblegate's motion to allow for expedited discovery and briefing prior to a hearing on November 18 and 19, 2014. Id.  In advance of the hearing, the parties provided the Court with over 400 exhibits, in addition to the affidavits and deposition testimony of six fact witnesses and six experts. After hearing cross-examination and redirect of these witnesses on November 18, and oral argument on November 19, the Court issued its opinion in Marblegate I on December 15, filing it publicly on December 30, 2014. The Court denied the motion for a preliminary injunction due to the adequacy of Plaintiffs' remedies at law, but found that they would likely succeed on the merits of their claims under the Trust Indenture Act. See id. at *10-21.
C. Subsequent Developments
On January 5, 2015, EDMC proceeded with the Intercompany Sale, subject to certain alterations to protect the rights of Marblegate in the event of a final ruling in Plaintiffs' favor. ( See Dkt. #60). The secured creditors foreclosed on the assets of Education Management LLC and sold them to Education Management II LLC, thus reducing EDMC's debts from $1.5 billion to $400 million. ( Id. ). However, EDMC refrained from removing the Parent Guarantee from Marblegate's Notes, and amended the Indenture to so allow. ( Id. ). EDMC then filed its answer to the Complaint, counterclaiming for declaratory relief enabling it to release the Parent Guarantee from the Notes. (Dkt. #61). Due to these steps, as Plaintiffs allow, injunctive relief is no longer necessary, as a final ruling concerning the legal status of Marblegate's claims will allow it to recover on the Notes to whatever extent is legally warranted. ( See Pl. Supp. Br. 19).
The parties subsequently entered into a stipulation, endorsed by the Court, retroactively consolidating the preliminary injunction hearing and the record thereof into a trial on the merits pursuant to Federal Rule of Civil Procedure 65(a)(2), and granting an additional period to supplement the record and the briefing. (Dkt. #70). Pursuant to this stipulation, the parties jointly filed 13 supplemental exhibits with the Court on February 3, 2015. Defendants and Intervenors then filed a joint supplemental brief on February 9, 2015 (Dkt. #71), and the briefing was complete with the filing of Plaintiffs' supplemental reply brief on March 11, 2013 (Dkt. #73). The Court now considers whether Section 316(b) of the Trust Indenture Act, 15 U.S.C. § 77ppp(b), entitles Plaintiffs to full payment on their Notes, or whether EDMC may release the Parent Guarantee and leave Plaintiffs to attempt collection from the now asset-free Education Management LLC.
The question put before the Court is straightforward: does a debt restructuring violate Section 316(b) of the Trust Indenture Act when it does not modify any indenture term explicitly governing the right to receive interest or principal on a certain date, yet leaves bondholders no choice but to accept a modification of the terms of their bonds? Examining the text, history, and purpose of the Trust Indenture Act, the Court concludes that the answer is yes.
A. Section 316(b) of the Trust Indenture Act
Section 316(b) of the Trust Indenture Act reads in relevant part:
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[.]
15 U.S.C. § 77ppp(b). The text poses two questions: what does the "right... to receive payment" consist of, and when is it "impaired or affected" without consent? Read narrowly, Section 316(b) protects bondholders only against involuntary modification of their payment terms or their right to sue for payment; read broadly, it protects bondholders against being forced to accept a lesser payment than they bargained for, absent a restructuring in bankruptcy.
At least two courts have found that Section 316(b) protects only the legal right to demand payment, rather than any substantive right to receive it, and thus that only formal modification of the right to sue or the payment terms impairs or affects the right to demand payment. See YRC Worldwide Inc. v. Deutsche Bank Trust Co. Am., No. 10 Civ. 2106 (JWL), 2010 WL 2680336, at *7 (D. Kan. July 1, 2010) ("TIA § 316(b) does not provide a guarantee against the issuing company's default or its ability to meet its obligations. Accordingly, the fact that the deletion of section 5.01 might make it more difficult for holders to receive payment directly from plaintiff does not mean that the deletion without unanimous consent violates TIA § 316(b)[.]"); In re Nw. Corp., 313 B.R. 595, 600 (Bankr. D. Del. 2004) ("[S]ection 316(b) applies to the holder's legal rights and not the holder's practical rights to the principal and interest itself... there is no guarantee against default." (emphases in original)).
Meanwhile, at least two other courts, both in this District, have interpreted the right protected by Section 316(b) to be a broader right to receive payment, and thus held that a debt restructuring that deprives dissenting bondholders of assets against which to recover can violate the Trust Indenture Act. See MeehanCombs Global Credit Opportunities Funds, LP v. Caesars Entm't Corp., No. 14 Civ. 7091 (SAS), 2015 WL 221055, at *4-5 (S.D.N.Y. Jan. 15, 2015) (citing Marblegate I, 2014 WL 7399041); Federated Strategic Income Fund v. Mechala Grp. Jam. Ltd., No. 99 Civ. 10517 (HB), 1999 WL 993648, at *5-7 (S.D.N.Y. Nov. 2, 1999).
The Court, in adopting the latter position in Marblegate I, did not rely upon the text alone, finding that it "lends itself to multiple interpretations." 2014 WL 7399041, at *16. Rather, it looked also to the statutory history and purpose of the Trust Indenture Act, finding that they supported a broad reading meant to inhibit involuntary debt restructurings outside the formal mechanisms of bankruptcy. Id. at *18-19. Defendants and Intervenors now urge the Court to reconsider that evaluation, arguing that a more extensive analysis of the legislative history supports their narrow reading of Section 316(b). The Court, having considered the full legislative history provided by Defendants and Intervenors, continues to find that it supports Plaintiffs' broader reading of Section 316(b).
2. Legislative History
The impetus for the Trust Indenture Act was provided by a 1936 report of the Securities and Exchange Commission (the "1936 SEC Report") (Lees Decl. Ex. J), referenced repeatedly throughout the House and Senate deliberations. See 15 U.S.C. § 77bbb(a) (Section 302 of the Trust Indenture Act, citing to the 1936 SEC Report as a basis for the Act). The primary author of the 1936 SEC Report was William O. Douglas, who would subsequently become a commissioner and then Chairman of the SEC before being appointed an Associate Justice of the United States Supreme Court. He testified before the Subcommittee of the Senate Committee on Banking and Currency in 1937 in support of the proposed Trust Indenture Act of 1937 ( see Lees Decl. Ex. F ("1937 Senate Hearings")), and again before the Subcommittee of the House Committee on Interstate and Foreign Commerce in 1938 in support of the proposed Trust Indenture Act of 1938 ( see Lees Decl. Ex. B ("1938 House Hearings")). Neither version became law, and an amended version of the Trust Indenture Act was reintroduced in 1939, with substantial changes to the language of what became Section 316(b), and was signed into law on August 3, 1939. The Court now examines the relevant legislative history over this threeyear period, as well as a 1958 SEC manual that Defendants and Intervenors argue sheds light on the proper interpretation of the Act.
a. The 1936 Report
The SEC compiled its report - of which Part VI, entitled "Trustees Under Indentures, " is referred to as the "1936 SEC Report" - pursuant to the Securities Exchange Act of 1934. (1936 SEC Report at iii). The 1936 Report touches on issues relevant to Section 316(b) at two places: first, when discussing protection of minority bondholders ( id. at 61-66), and second, when discussing majority reorganizations ( id. at 143-51).
Defendants and Intervenors, discussing the 1936 SEC Report's section on minority protection, point out its highlighting of a 1926 Eighth Circuit case in which the terms of an indenture prevented a bondholder from bringing suit for payment at all in the face of a trustee's inaction. ( See 1936 SEC Report at 62 (discussing Allan v. Moline Plow Co., 14 F.2d 912 (8th Cir. 1926))). It is true that the Report, among multiple other sources of legislative history, makes clear that such "no-action clauses" were one of the evils that the Trust Indenture Act was intended to address. But the 1936 SEC Report goes on immediately to note that the problems of minority bondholders are at their height when confronting voluntary restructurings conducted by foreclosure sales outside the supervision of a judicial or administrative process, where the incentives of the majority would be to offer as little as possible in cash or new securities to dissenting bondholders. ( See id. at 63-64). The remedy prescribed by the Report in this section is a more active indenture trustee in reorganization negotiations, but as discussed infra, the Trust Indenture Act generally evolved over the course of its legislative history from strengthening the hands of trustees and the SEC to imposing mandatory indenture terms.
Debt restructurings are also discussed at Part B of Appendix C of the Report. ( See 1936 SEC Report at 143-51). The Report noted the problems stemming from requiring unanimous consent of bondholders to reorganize outside bankruptcy: "reorganizers would be faced with the necessity of dealing with a dissenting minority, with the consequences that foreclosure proceedings (and later on, [bankruptcy] proceedings) would be necessary." ( Id. ...