Can a Trustee prosecute fraudulent transfer and tortious interference claims if no event of default on the notes it oversees has yet occurred? This was the question of first impression (at least in New York) recently considered in UMB Bank, N.A., as Trustee for the 8% Senior Cash Pay Notes Due 2021 and for the 8.750%/9.500% Senior PIK Toggle Notes Due 2021 v. Neiman Marcus Grp., Inc. et al. Citing legal, practical, and policy considerations, the New York County Supreme Court found that the Trustee could not prosecute such claims under the indentures at issue in the case and therefore dismissed the action.

In 2013, Ares conducted a leveraged buyout of Neiman Marcus. Ares funded the buyout in part through more than $1.5 billion of Cash Pay and PIK Notes set to mature in 2021 (together, the “Notes”). Later, in 2014, Neiman Marcus acquired German luxury retailer MyTheresa. That acquisition outperformed the rest of the company. So, in 2017, Ares “sought to strip [Neiman Marcus] of MyTheresa —its most valuable asset—to keep it out of reach” of creditors. To that end, Neiman Marcus changed the ownership of MyTheresa to unrestricted subsidiaries, thus enabling a transfer of assets that restrictive covenants in the Notes’ Indentures would have prohibited.

Roughly one year later, in 2018, Neiman Marcus “conveyed the MyTheresa subsidiaries to its parent for no consideration, insulating the lucrative assets from the Noteholders as a source for repayment.” Further to the point, Neiman Marcus “was allegedly insolvent at the time of those conveyances and has remained insolvent ever since.” Indeed, Neiman Marcus is one of the recent retail casualties accelerated by the COVID-19 pandemic, having filed for chapter 11 bankruptcy protection in the U.S. Bankruptcy Court for the Southern District of Texas on May 7, 2020.

Also in 2018, a Noteholder filed an action in Texas state court challenging the MyTheresa transfer. That action was dismissed for lack of standing. Shortly thereafter, though, Ares and Neiman Marcus solicited Noteholders’ ratification of the transfers “in exchange for new notes with a partial lien on the stock of MyTheresa and preferred equity in its parent company as part of an exchange transaction that would extend the Notes’ maturity date to 2024.” Ares and Neiman Marcus proposed effectuating these transactions through amendments to the Notes’ Indentures “that would eliminate many of the covenants and events of default” and would waive past breaches and defaults.

In June 2019, Noteholders overwhelmingly approved the deal. (More than 90% consented, in fact.) And yet, two months later the Trustee filed suit challenging the MyTheresa conveyance and claiming that Ares tortuously interfered with the Indentures. Importantly, the Notes were not in default when the Trustee filed suit. Ares moved to dismiss the action, arguing that Section 6.3 of the Indentures required that an Event of Default have occurred for the Trustee to commence an action. In response, the Trustee argued that Section 6.5 of the Indenture granted it the “ability to take action at the direction of [a majority] of Noteholders without the default prerequisite.”

The Court found that the Indentures’ “unambiguous terms” favored Ares’s position. First, the Court stressed that “[t]he words actually used in the Indentures are ultimately dispositive.” Further to this point, citing Cortland St. Recovery Grp. v. Bonderman, 31 N.Y.3d 30, 44 (2018), which considered identical indenture provisions, the Court wrote that “[a] trustee’s power and authority is . . . limited to that which is provided in the indenture.” Because a trustee tends to play an “extremely limited” role prior to an event of default, the Court noted, indentures typically adorn trustees only with post-default avoidance powers “to remedy an injury common to all noteholders” arising from the default.

Next, the Court wrote that the parties did not clothe the Trustee in prophylactic powers to unwind conveyances absent an Event of Default. The authority the Trustee cited, Section 6.5 of the Indentures, merely detailed how Noteholders could direct the Trustee to exercise powers it already had available to it. Another provision of the Indentures, Section 6.3, established what powers the Trustee had and when it had them. Notably, the Court found, the “Indentures only permit Trustee actions after an Event of Default.” The Indentures did not contemplate any pre-Event-of-Default actions.

Finally, the Court noted that public policy supported Ares’s argument. The dispute involved “sophisticated parties engaged in a sophisticated transaction involving a Trustee with authority stemming solely from their own intricate agreements.” The Court therefore stressed the need to enforce those agreements “in the most predictable manner consistent with their clear terms.” Further to this point, the Court wrote that “general notions of equity” could not override this obligation. The market priced the Indentures according to their terms; the Court felt that it wasn’t suited to “creat[e] new rules” for those Indentures “that do not comport with settled law and expectations.” The market, the Court went on, is better placed to address any issues that arise from the parties’ contractual terms.

For these reasons, the Court concluded that the Trustee lacked standing to commence a pre-Event-of-Default action and dismissed the complaint without prejudice “to the proper commencement of a new action.”