Cliffs Natural Decision Offers Some Clarity Post-Marblegate to Issuers Planning Exchange Offers

December 19, 2016

On December 6, 2016, the United States District Court for the Southern District of New York (the “Court”) granted a motion to dismiss filed by Cliffs Natural Resources Inc. (“Cliffs Natural”) regarding causes of action under §316(b) of the Trust Indenture Act (“TIA”). The prior Caesars and Marblegate decisions interpreted §316(b) of the TIA broadly, finding that the provision protects not only the holder’s legal right to payment but also the practical ability to receive principal and interest. The Cliffs Natural opinion limits the holdings in Marblegate and Caesars to restructurings that amount to de facto bankruptcies in which there is at least: (1) a transfer of assets; or (2) the removal or material modification of inter-corporate guarantees or security interests.

Cliffs Natural conducted a voluntary exchange offer to reduce its bond debt in which certain holders of six different classes of bonds were offered new bonds with a higher interest rate secured by collateral which ranked higher in the capital structure in exchange for a significant reduction in principal. The exchange offer was open only to qualified institutional buyers, as defined by Rule 144A under the Securities Act, and to holders who were not “U.S. persons”. The plaintiffs fell into neither category, and therefore were not eligible to participate in the exchange offer, resulting in this litigation.

The Court held that the exchange offer did not violate the TIA, since “none of the indicia of an involuntary, out-of-court pseudo-bankruptcy outlined in the instructive cases is present here.” The exchange offer did not dispose of any assets, amend any terms of the Indentures, or modify or remove any guaranty.

The Court also held that the state-law claims failed because the plaintiffs failed to comply with the Indenture’s no-action clause, which required plaintiffs, before suing, to (1) notify the trustee of a default; (2) marshal support of noteholders holding at least 25% of the notes and request that the trustee sue; (3) offer the trustee indemnification; and (4) wait the required 60 days, during which time the trustee evaluates the requested suit.

Additionally, the Court ruled that the plaintiffs lacked standing. Plaintiffs alleged that they were injured because if Cliffs Natural were to enter bankruptcy, the amount Plaintiffs recovered in that potential bankruptcy may turn out to be less than it would have been if the new notes from the exchange did not exist. The Court ruled plaintiffs lacked standing because, among other reasons, their alleged harm was entirely hypothetical, as there was nothing in the complaint indicating a bankruptcy was imminent and, in any event, if they had been eligible to participate, they had not alleged they would have accepted the exchange offer.

If courts adopt the reasoning behind the Cliffs Natural opinion, there are two holdings worth highlighting. First, the requirements of the no-action clause, including the requirement for noteholders to wait 60 days after providing a proper direction and offer of indemnity to the trustee, cannot be ignored by noteholders even in the event that the exchange offer expires prior to the expiration of such required 60 day period. Second, without the indicia of an out-of-court quasi bankruptcy reorganization, an exchange offer that is open to only certain noteholders should not give rise to a violation of §316(b) of the TIA, even if non-participating noteholders are left holding notes that continue to be unsecured and payable only after the newly issued secured notes have been paid. The Court made it clear that §316(b) of the TIA may be violated in the event of either (1) a transfer of assets; or (2) the removal or material modification of inter-corporate guarantees or security interests.

Seward & Kissel is available to assist you with any inquiries regarding this client alert. Please contact Kal Das at (212-574-1391); John Ashmead at (212-574-1366); Ronald Cohen at (212-574-1515); Andrew Silverstein at (212-574-1383); or Gregg Bateman at (212-574-1436).