In October, the New York Court of Appeals (the “Court”), in a 4-3 decision, upheld the legal right of noteholders to payment or suit, notwithstanding the purported cancellation of their notes after the Trustee, at the direction of the majority noteholders, conducted a strict foreclosure on the collateral. The decision focused on the relationship between provisions of the Indenture governing the rights of noteholders to receive payment of principal and interest on their notes and the authority of a majority of noteholders to direct the Trustee’s exercise of remedies, which both tracked the provisions in Sections 316(a) and 316(b) of the Trust Indenture Act of 1939 (the “TIA”).
In their breach of contract and breach of guaranty suit, noteholders representing approximately 3% of the outstanding principal of the notes issued and guaranteed by the defendants (collectively, the “Minority Noteholders”) argued that, in connection with the strict foreclosure undertaken by the Trustee at the direction of approximately 96% of the noteholders (the “Majority Noteholders”) following the Issuer’s payment default on the notes, their right to (and right to sue for) payment of principal and interest on the notes had been terminated in violation of provisions of the New York law governed Indenture. The Minority Noteholders’ argument relied on section 6.07 of the Indenture, which tracked Section 316(b) of the TIA providing that “[n]otwithstanding any other provision of [the] Indenture, the right of any Holder to receive payment … on a Note, on or after the respective due dates …, or to bring suit for the enforcement of any such payment …, shall not be impaired or affected without the consent of such Holder.”
The Court in its opinion noted that this language limited the majority action authorized by other provisions of the Indenture. Although the Court’s opinion noted that “[t]he Majority Noteholders were empowered to act, without the consent of all Noteholders, in directing a specific remedy – the strict foreclosure – and the Trustee was authorized to follow that directive,” the Court concluded that the purported cancellation of the notes could not extinguish the Minority Noteholders’ rights to (and right to sue for) payment of principal and interest on the notes under Section 6.07 of the Indenture. Accordingly, the Court held that the purported cancellation of the notes without the Minority Noteholders’ consent violated that provision.
It remains to be seen what impact this decision may have on holders, in particular the ability of minority holders to affect or frustrate the actions of majority holders in out of court restructurings or enforcement actions. It should be noted that this decision makes a distinction between the impairment of minority holders’ practical ability to recover payment (which can be impaired in many ways) and their actual legal right to recover payment, the latter of which was at issue in this case. Market participants, including trustees, will likely closely follow future developments in New York and the Second Circuit in connection with newly emboldened minority holders’ ability to exert pressure on issuers and majority holder groups negotiating out of court restructurings that contemplate a cancellation of non-consenting holders’ notes.
For more information regarding this case, see CNH Diversified Opportunities Master Account, L.P., et al. v Cleveland Unlimited, Inc., et al., Case No. 42 (October 22, 2020), in the Court of Appeals of New York.
If you would like further information about this or any other matter, please feel free to contact any member of the Global Bank and Institutional Finance & Restructuring Group.