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Marblegate Asset Management, LLC v. Education Management Finance Corp.

United States Court of Appeals, Second Circuit

January 17, 2017

MARBLEGATE ASSET MANAGEMENT, LLC, MARBLEGATE SPECIAL OPPORTUNITIES MASTER FUND, L.P., Plaintiffs-Counter-Defendants-Appellees,
v.
EDUCATION MANAGEMENT FINANCE CORP., EDUCATIONMANAGEMENT, LLC, Defendants-Appellants, EDUCATION MANAGEMENT CORPORATION, Defendant-Counter-Claimant-Appellant, STEERING COMMITTEE FOR THE AD HOC COMMITTEE OF TERM LOAN LENDERS OF EDUCATION MANAGEMENT, LLC, Intervenor-Appellant.

          Argued: May 12, 2016

         Defendant-appellant Education Management Corporation ("EDMC") and its subsidiaries appeal from a judgment following a bench trial before the United States District Court for the Southern District of New York (Failla, J.). The District Court held that a series of transactions meant to restructure EDMC's debt over the objections of certain noteholders violated Section 316(b) of the Trust Indenture Act of 1939, 15 U.S.C. § 77ppp(b). The transactions at issue, the District Court determined, stripped the non- consenting noteholders, plaintiffs-appellees Marblegate Asset Management, LLC and Marblegate Special Opportunity Master Fund, L.P. (together, "Marblegate"), of their practical ability to collect payment on notes purchased from EDMC's subsidiaries. As a result, the District Court ordered EDMC to continue to guarantee Marblegate's notes and pay them in full. On appeal, EDMC argues that it complied with Section 316(b) because the transactions did not formally amend the payment terms of the indenture that governed the notes. We agree with EDMC and conclude that Section 316(b) prohibits only non-consensual amendments to an indenture's core payment terms. We therefore VACATE the judgment and REMAND to the District Court for further proceedings consistent with this opinion.

          Sean E. O'Donnell (Christopher W. Carty, Lucy C. Malcolm, Stewart R. Gilson, Pratik A. Shah, Hyland Hunt, on the brief), Akin Gump Strauss Hauer & Feld LLP, New York, NY, for Plaintiffs- Counter-Defendants-Appellees.

          Emil A. Kleinhaus (Alexander B. Lees, on the brief), Wachtell, Lipton, Rosen & Katz, New York, NY, for Defendants- Appellants and Defendant-Counter- Claimant-Appellant.

          Antonia M. Apps (Aaron L. Renenger, on the brief), Milbank, Tweed, Hadley & McCloy LLP, New York, NY, for Intervenor-Appellant.

          Before: CABRANES, STRAUB, and LOHIER, Circuit Judges.

          LOHIER, Circuit Judge

         Defendant-appellant Education Management Corporation ("EDMC") and its subsidiaries appeal from a judgment following a bench trial before the United States District Court for the Southern District of New York (Failla, J.). The District Court held that a series of transactions meant to restructure EDMC's debt over the objections of certain noteholders violated Section 316(b) of the Trust Indenture Act of 1939, 15 U.S.C. § 77ppp(b). The transactions at issue, the District Court determined, stripped the non- consenting noteholders, plaintiffs-appellees Marblegate Asset Management, LLC and Marblegate Special Opportunity Master Fund, L.P. (together, "Marblegate"), of their practical ability to collect payment on notes purchased from EDMC's subsidiaries. As a result, the District Court ordered EDMC to continue to guarantee Marblegate's notes and pay them in full.

         On appeal, EDMC argues that it complied with Section 316(b) because the transactions did not formally amend the payment terms of the indenture that governed the notes. We agree with EDMC and conclude that Section 316(b) prohibits only non-consensual amendments to an indenture's core payment terms. We therefore VACATE the judgment and REMAND to the District Court for further proceedings consistent with this opinion.

         BACKGROUND

         1. Facts

         EDMC is a for-profit higher education company that relies heavily on federal funding through Title IV of the Higher Education Act of 1965, 20 U.S.C. §§ 1070-1099. EDMC is the parent company of defendants-appellants Education Management, LLC and Education Management Finance Corporation (together, the "EDM Issuer").

         In 2014 EDMC found itself in severe financial distress. Its enterprise value had fallen well below its $1.5 billion in outstanding debt. But restructuring its debt by resorting to bankruptcy court was not a realistic option for EDMC, which, the parties agree, would lose its eligibility for Title IV funds if it filed for bankruptcy and discontinued as an ongoing concern. See 20 U.S.C. § 1002(a)(4)(A).[1] EDMC therefore had to cooperate with its creditors outside of the bankruptcy process if it hoped to restructure its debt and persist as a viable entity.

         EDMC's outstanding debt consisted of both secured debt (roughly $1.3 billion) and unsecured debt ($217 million). The secured debt was governed by a 2010 credit agreement between the EDM Issuer and secured creditors (the "2010 Credit Agreement"). The 2010 Credit Agreement gave EDMC's secured creditors the right, upon default, to deal with the collateral securing the loans "fully and completely" as the "absolute owner" for "all purposes." The collateral securing the debt consisted of virtually all of EDMC's assets.

         The unsecured debt, to which we will refer as the "Notes, " was also issued by the EDM Issuer and governed by an indenture executed in March 2013 and qualified under the Trust Indenture Act of 1939 (the "Indenture"). The Notes were guaranteed by EDMC as the parent company of the EDM Issuer (we refer to this guarantee as the "Notes Parent Guarantee") and carried a high effective interest rate-nearly 20 percent per year-to compensate for the riskier nature of the unsecured debt. Both the Indenture and the offering circular relating to the Notes informed lenders who had purchased them (the "Noteholders") about their rights and obligations as junior, unsecured creditors. For example, the offering circular explained that the Notes Parent Guarantee was issued solely to satisfy EDMC's reporting obligations, that it could be released solely by operation of the release of any later guarantee EDMC issued to secured creditors, and that Noteholders should therefore not assign any value to the Notes Parent Guarantee. Marblegate holds Notes with a face value of $14 million but never held any secured debt.

         As EDMC's financial position deteriorated, its debt burden became unsustainable. After negotiating with EDMC, a majority of secured creditors agreed in September 2014 to relieve the EDM Issuer of certain imminent payment obligations and covenants under the 2010 Credit Agreement. The resulting agreement was a new amended credit agreement entered in the fall of 2014 (the "2014 Credit Agreement"). As consideration for these changes, EDMC agreed to guarantee the secured loans (the "Secured Parent Guarantee").

         Around the same time, a group of creditors formed an Ad Hoc Committee of Term Loan Lenders (the "Ad Hoc Committee") and established a Steering Committee, which is an intervenor-appellant in this appeal, to negotiate with EDMC.[2] The Steering Committee and EDMC eventually devised two potential avenues to relieve EDMC of its debt obligations.

         The first option, which obtained only if creditors unanimously consented, was designed to result in (1) most of EDMC's outstanding secured debt being exchanged for $400 million in new secured term loans and new stock convertible into roughly 77 percent of EDMC's common stock, and (2) the Notes being exchanged for equity worth roughly 19 percent of EDMC's common stock. EDMC estimated that this first option would amount to roughly a 45 percent reduction in value for secured lenders and a 67 percent reduction in value for Noteholders.

         The second option would arise only if one or more creditors refused to consent. Under that circumstance, a number of events would occur that together constituted the "Intercompany Sale." Secured creditors consenting to the Intercompany Sale would first exercise their preexisting rights under the 2014 Credit Agreement and Article 9 of the Uniform Commercial Code (UCC) to foreclose on EDMC's assets. In addition, the secured creditors would release EDMC from the Secured Parent Guarantee. That release in turn would effect a release of the Notes Parent Guarantee under the Indenture. With the consent of the secured creditors (but without needing the consent of the unsecured creditors), the collateral agent would then sell the foreclosed assets to a subsidiary of EDMC newly constituted for purposes of the Intercompany Sale. Finally, the new EDMC subsidiary would distribute debt and equity only to consenting creditors and continue the business.

         The Intercompany Sale was structured to incentivize creditors to consent. While non-consenting secured creditors would still receive debt in the new EDMC subsidiary, that debt would be junior to the debt of consenting secured creditors. Non-consenting Noteholders would not receive anything from the new company: though not a single term of the Indenture was altered and Noteholders therefore retained a contractual right to collect payments due under the Notes, the foreclosure would transform the EDM Issuer into an empty shell. In offering to exchange the Notes for equity in the new EDMC subsidiary, therefore, EDMC and the Ad Hoc Committee explicitly warned Noteholders that they would not receive payment if they did not consent to the Intercompany Sale.

         Except for Marblegate, all of EDMC's creditors (representing 98 percent of its debt) eventually consented to the Intercompany Sale.

         2. Procedural History

         Marblegate, the sole holdout, sued to enjoin the Intercompany Sale on the ground that it violated Section 316(b) of the Trust Indenture Act of 1939 (the "TIA"), 15 U.S.C. § 77ppp(b). Marblegate Asset Mgmt. v. Educ. Mgmt. Corp., 75 F.Supp.3d 592 (S.D.N.Y. 2014) ("Marblegate I"). Section 316(b) of the TIA, entitled "Prohibition of impairment of holder's right to payment, " provides as follows:

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) (emphasis added).

         Before the District Court, EDMC argued that "the right . . . to receive payment" is necessarily defined by the payment terms in the Indenture itself, such that Section 316(b) prohibits only non-consensual amendments to an indenture's core payment terms. Therefore, EDMC asserted, the Intercompany Sale complied with Section 316(b) because it did not amend any Indenture term and because Marblegate's right to initiate suit against the EDM Issuer to collect payment remained intact.

         In response, Marblegate contended that although the contractual terms governing Marblegate's Notes had not changed, its practical ability to receive payment would be completely eliminated by virtue of the Intercompany Sale, to which it did not consent. Section 316(b), Marblegate warned, would be rendered meaningless if issuers and secured creditors could collaborate to restructure debt without formally amending any payment terms.

         The District Court initially declined to grant a preliminary injunction but believed that Marblegate was likely to succeed on the merits of its TIA claim. Marblegate I, 75 F.Supp.3d at 615-17. After reviewing the text and legislative history of Section 316(b), the District Court concluded that the TIA "protects the ability" of the Noteholders "to receive payment in some circumstances." Id. at 612-15. Even where the payment terms of an indenture are not explicitly modified by a transaction, the District Court held, Section 316(b) is violated whenever a transaction "effect[s] an involuntary debt restructuring." Id. at 614.

         The Intercompany Sale occurred in January 2015. The foreclosure sale took place, the secured creditors released the Secured Parent Guarantee, the new EDMC subsidiary was capitalized with the EDM Issuer's old assets, and consenting bondholders participated in the debt-for-equity exchange. But Marblegate continued to hold out. And in light of the District Court's decision, EDMC and the Steering Committee refrained from releasing the Notes Parent Guarantee. Instead, they filed a counterclaim against Marblegate, seeking a declaration that the Notes Parent Guarantee could be released without violating the TIA.

         Since the bulk of the Intercompany Sale was already completed, the subsequent bench trial focused on whether the District Court should permanently enjoin release of the Notes Parent Guarantee and thereby force EDMC to continue its guaranteed payment on Marblegate's Notes. On that question, the District Court ultimately sided with Marblegate by reiterating that the release of the Notes Parent Guarantee would violate Section 316(b). Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 111 F.Supp.3d 542, 556-57 (S.D.N.Y. 2015) ("Marblegate II").

         This appeal followed. At present, because EDMC was able to reduce its debt burden through the very transaction to which Marblegate objected, it currently has the assets to pay on Marblegate's Notes. Marblegate, as the owner of Notes that had been poised to receive only limited additional payments because of EDMC's pending insolvency, is now the only creditor receiving full payouts according to the original face value of its Notes.

         DISCUSSION

         EDMC appeals the judgment on the ground that the District Court misinterpreted Section 316(b) of the TIA. We review the District Court's conclusions of law de novo. See Process Am., Inc. v. Cynergy Holdings, LLC, 839 F.3d 125, 141 (2d Cir. 2016).

         To determine whether the release of the Notes Parent Guarantee would violate Section 316(b) of the TIA, we start first with the text of that provision. See N.Y. State Psychiatric Ass'n, Inc. v. UnitedHealth Grp., 798 F.3d 125, 132 (2d Cir.), cert. denied sub nom. UnitedHealth Grp., Inc. v. Denbo, 136 S.Ct. 506 (2015). If resorting to the plain text alone fails to resolve the question, we test the competing interpretations against both the statutory structure of the TIA and the legislative purpose and history of Section 316(b). See United States v. Epskamp, 832 F.3d 154, 162-66 (2d Cir. 2016); Doe v. Cuomo, 755 F.3d 105, 110 (2d Cir. 2014).

         1. Text

         The core disagreement in this case is whether the phrase "right . . . to receive payment" forecloses more than formal amendments to payment terms that eliminate the right to sue for payment. 15 U.S.C. § 77ppp(b). We agree with the District Court that the text of Section 316(b) is ambiguous insofar as it "lends itself to multiple interpretations" that arguably favor either side on that issue. Marblegate I, 75 F.Supp.3d at 611; see also Marblegate II, 111 F.Supp.3d at 547. Likewise, Marblegate conceded at oral argument that the interpretation it advances is not supported by reference to the plain text alone. See Oral Tr. 44:21-45:1.

         On the one hand, Congress's use of the term "right" to describe what it sought to protect from non-consensual amendment suggests a concern with the legally enforceable obligation to pay that is contained in the Indenture, not with a creditor's practical ability to collect on payments. Cf. F.C.C. v. NextWave Pers. Commc'ns Inc., 537 U.S. 293, 302-03 (2003) ("[T]he plain meaning of a 'right to payment' is nothing more nor less than an enforceable obligation . . . ." (quotation marks omitted)); Dennis v. Higgins, 498 U.S. 439, 447 n.7 (1991) (defining "right" as "[a] legally enforceable claim of one person against another, that the other shall do a given act, or shall not do a given act") (quoting Black's Law Dictionary 1324 (6th ed. 1990)). On the other hand, adding that such a right cannot be "impaired or affected" arguably suggests that it cannot be diminished, relaxed, or "otherwise affect[ed] in an injurious manner." See Humana Inc. v. Forsyth, 525 U.S. 299, 309-10 (1999) (quoting Black's Law Dictionary 752 (6th ed. 1990)).

         To be sure, Marblegate's broad reading of the term "right" as including the practical ability to collect payment leads to both improbable results and interpretive problems. Among other things, interpreting "impaired or affected" to mean any possible effect would transform a single provision of the TIA into a broad prohibition on any conduct that could influence the value of a note or a bondholder's practical ability to collect payment. 15 U.S.C. § 77ppp(b). Furthermore, if the "right . . . to receive payment" means a bondholder's practical ability to collect payment, then protecting the "right . . . to institute suit for the enforcement of any such payment" would be superfluous, because limiting the right to file a lawsuit for payment constitutes one of the most obvious impairments of the creditor's practical ability to collect payment. Id. The "right . . . to receive payment" is not, in other words, so broad as to encompass the "right . . . to institute suit." Id. If for no other reason than the "general rule" that different statutory phrases "can indicate that different meanings were intended, " Sebelius v. Auburn Reg'l Med. Ctr., 133 S.Ct. 817, 825 (2013) (quotation marks omitted), these two rights are best viewed as distinct from one another. The former right, it seems to us, prohibits non-consensual amendments of core payment terms (that is, the amount of principal and interest owed, and the date of maturity). It bars, for example, so-called "collective-action clauses"-indenture provisions that authorize a majority of bondholders to approve changes to payment terms and force those changes on all bondholders. See NML Capital, Ltd. v. Republic of Argentina, 699 F.3d 246, 253 (2d Cir. 2012). The latter right (to sue) ensures that individual bondholders can freely sue to collect payments owed under the indenture. So construed, the right to sue clearly bars so-called "no-action clauses, " which preclude individual bondholders from suing the issuer for breaches of the indenture, leaving the indenture trustee as the sole initiator of suit. See Cruden v. Bank of New York, 957 F.2d 961, 967-68 (2d Cir. 1992). An indenture that contains only a collective-action clause violates the "payment" right, not the "suit" right; an indenture that contains only a no-action clause violates the "suit" right, not the "payment" right.

         Regardless, we agree with the District Court that the plain text of Section 316(b) is ultimately ambiguous and fails to resolve the principal question before us.

         Nor does any party seriously contend that the structure of the TIA provides a clear answer to that question, as the dissenting opinion suggests.[3]At best, we have observed that "[n]othing in Section 316(b), or the TIA in general, requires that bondholders be afforded 'absolute and unconditional' rights to payment." Bank of New York v. First Millennium, Inc., 607 F.3d 905, 917 (2d Cir. 2010). So, for example, Section 316(a)(1) permits bondholder majorities to both waive past defaults and control the manner in which the indenture trustee pursues remedies. See 15 U.S.C. § 77ppp(a).[4] Our statement in First Millennium seems at odds with the broad protection of dissenting bondholders seeking to collect payment that Marblegate urges. But it does not really help us determine whether Congress intended Section 316(b) to protect a broad right to actual payment or merely a right to sue ...


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