Although there has been much discussion of the Second Circuit’s recent decision in Marblegate, this article addresses a question other commentators have yet to tackle:  namely, how the Second Circuit’s decision impacts the Trust Indenture Act’s protection of guarantee obligations included in an indenture. Below we provide our view on how Marblegate affects indenture guarantees. More specifically, we discuss how the decision is consistent with provisions of the TIA that expressly protect a noteholder’s payment rights under a guarantee.

Synopsis

In its Marblegate decision, the Second Circuit held that a series of transactions designed to restructure EDMC’s debt over the objections of a non-participating noteholder did not violate section 316(b) of the Trust Indenture Act of 1939 (TIA).¹ The court concluded that the transactions—which consisted of an intercompany sale effectuated through a foreclosure on all assets by the holders of senior secured bank debt together with certain other steps—were permissible because the transaction as a whole did not amend any “core payment terms” or prevent the objecting noteholder from suing the issuer for payment. It thus rejected the noteholder’s argument that impairment of its practical ability to recover its principal and interest from the issuer constituted a violation of Section 316(b).

In reaching its decision, the court accepted the proposition that the guarantee of the notes by the issuer’s parent company was properly released pursuant to the terms of the indenture. The operative indenture provision stated that the parent’s guarantee of the notes could be released when the parent’s guarantee of the bank debt was released. While the court did not highlight its conclusion on this point, it necessarily held that the release of the guarantee of the notes pursuant to that indenture provision did not, in and of itself, violate the Trust Indenture Act.

The Marblegate decision does not address a fact pattern seen in other recent cases—where a majority of noteholders use (or attempt to use) a collective action provision (i.e. a majority-vote provision) or an indenture amendment to strip a guarantee from non-consenting noteholders. There is substantial reason to believe that releasing a guarantee in this manner would violate Section 316(b). The TIA and the Securities Act of 1933 together define a guarantee to be an “indenture security,” and Section 316(b) expressly prohibits an issuer from impairing a noteholder’s receipt of principal and interest under any “indenture security.” Thus, under the express language of the TIA and the Second Circuit’s decision in Marblegate, a collective action provision in an indenture that purports to permit release of a guarantee based on a majority vote or a majority amendment to an indenture may well run afoul of the TIA, and stripping a guarantee pursuant to such a provision would not be binding on non-consenting holders.

Facts

In 2014, Education Management Corporation (EDMC), a for-profit higher education company that relied on federal funding under Title IV, was in financial distress.² Because it could not file for bankruptcy without losing its eligibility for Title IV funds,³ EDMC sought a solution through an out-of-court restructuring.⁴

EDMC’s subsidiary, Education Management Finance Corporation (“EDM Issuer”), owed approximately $1.3 billion on bank debt issued under a 2010 credit agreement.⁵ The bank debt was secured by a lien over substantially all of EDM Issuer’s assets.⁶ EDMC (the parent) had not guaranteed the bank debt.⁷

EDM Issuer also had outstanding approximately $217 million of unsecured notes issued under an indenture that was qualified under the TIA.⁸ The unsecured notes were guaranteed by its parent, EDMC.⁹ The indenture governing the notes provided that EDMC’s guarantee of the notes could be released when a parent guarantee issued to the bank debt holders was released.¹⁰

In September 2014, a majority of the bank debt holders agreed to relieve EDM Issuer of certain imminent payment obligations under the 2010 credit agreement by entering into a new credit agreement (the “2014 Credit Agreement”).¹¹ As part of this arrangement, EDMC guaranteed the amounts owed under the 2014 Credit Agreement.¹² Around the same time, EDMC and a steering group of its creditors—creditors that held over 80 percent of each of the bank debt and the unsecured notes—negotiated and undertook the final phase of EDMC’s financial restructuring.^{13 14}

To complete the restructuring, the bank debt holders (through their agent) would foreclose on substantially all of the assets of EDM Issuer, leaving EDM Issuer with essentially nothing.¹⁵ The agent would then sell those assets to a new EDMC subsidiary.¹⁶ That subsidiary would issue new debt and other securities to most of the creditors.¹⁷ Noteholders that did not consent, however, would receive nothing.¹⁸

As part of the restructuring, the bank debt holders would voluntarily release EDMC from its guarantee under the 2014 Credit Agreement of the bank debt.¹⁹ Under the indenture, the release of EDMC’s guarantee of the bank debt would allow for a release of EDMC’s guarantee of the notes.²⁰ EDMC and its consenting creditors sought to effectuate the restructuring over Marblegate’s objection.²¹ Marblegate sued for violation of the TIA.²²  

Marblegate’s Argument

Section 316(b) of the TIA provides in relevant part:

(b) Prohibition of impairment of holder’s right to payment

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 . . . .²³

Marblegate argued that, although the restructuring did not change any terms of the indenture, its right to receive payment was “impaired or affected” because its “practical ability to receive payment would be completely eliminated” by virtue of the restructuring.²⁴ Specifically, EDM Issuer would be left with no assets to satisfy Marblegate’s claim and EDMC would be relieved of its guarantee obligations under the release provisions of the indenture. Because Marblegate did not consent to the restructuring, it argued that its rights under Section 316(b) of the TIA were violated and that EDMC should continue to be obliged on the guarantee.

The Second Circuit’s Decision

The Second Circuit held that Section 316(b) of the TIA “prohibits non-consensual amendments of core payment terms (that is, the amount of principal and interest owed, and the date of maturity).”²⁵ It also bars “collective action clauses”—i.e. “indenture provisions that authorize a majority of bondholders to approve changes to payment terms and force those changes on all bondholders.”^{26 27}

The court, however, rejected Marblegate’s argument that impairment of its practical ability to get paid by the issuer constituted a TIA violation.²⁸ As it explained, “the history of the TIA, and of Section 316(b) in particular, shows that it does not prohibit foreclosures even when they affect a bondholder's ability to receive full payment. Rather, the relevant portions of the TIA’s legislative history exclusively addressed formal amendments and indenture provisions like collective-action and no-action clauses.”²⁹

Application of the TIA to a Guarantee

The Second Circuit did not explicitly address whether or how the TIA applied to the release of EDMC’s guarantee in the restructuring. Rather, it simply stated in passing that the bank debt holders voluntarily released EDMC from its guarantee under the 2014 Credit Agreement of the bank debt.³⁰ Under the indenture, upon the release of EDMC’s guarantee of the bank debt, EDMC would be released from its guarantee of the notes.³¹ The court did not discuss—and indeed, Marblegate did not contest—whether this release of EDMC’s guarantee of the notes, standing alone, was permissible under the TIA.

To analyze the application of the TIA to a guarantee, we again look at the text of Section 316(b), but this time we focus on two specific words: “indenture security.”  As we see, Section 316(b) protects the right of a holder to receive principal and interest on an “indenture security.”

(b) Prohibition of impairment of holder’s right to payment

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 . . . .³²

Of critical importance, a guarantee is an “indenture security” under the TIA.  The TIA defines an “indenture security” as “any security issued or issuable under the indenture to be qualified.”³³Although the TIA does not specifically define the term “security,” TIA Section 303 instructs that “[a]ny term defined in section 2 of the Securities Act of 1933 [15 U.S.C. § 77b, the “Securities Act”] and not otherwise defined in this section shall have the meaning assigned to such term in section 2 [of the Securities Act].”³⁴ Section 2 of the Securities Act defines the term “security” to “mean [] any note, . . . bond, debenture, evidence of indebtedness . . . or . . . guarantee of . . . any of the foregoing.”³⁵ Notably, while the TIA exempts particular categories of securities from its protection, it explicitly includes guarantees of notes.³⁶ The TIA also specifically includes a guarantor in the definition of “obligor.”³⁷ Thus, a guarantee of notes under a qualified indenture is an “indenture security” under the plain language of the TIA and is subject to the provisions of the TIA just the same as the underlying notes.³⁸

Because EDMC’s guarantee of the notes is an “indenture security” under the TIA (and because EDMC is an “obligor”), we next consider why the release of EDMC’s guarantee of the notes did not violate the TIA. As we discussed above, the Second Circuit held that the TIA prohibits non-consensual amendments of the indenture’s “core payment terms.” Since the EDMC restructuring did not involve any amendment whatsoever to the indenture, this type of TIA violation did not apply.

But what about the other method of violating the TIA identified by the Second Circuit—majority action through a collective action clause? Didn’t the efforts by a majority of creditors to effectuate the restructuring, which included a release of EDMC’s guarantee of the notes over Marblegate’s dissent, involve prohibited use of a collective action clause? The Second Circuit’s answer to that is “no.” Let’s unpack it.

In the first instance, the release of the guarantee certainly affected “core payment terms” of the guarantee because it eliminated all payment obligations on the guarantee. Another way of looking at it is that release of the guarantee reduced the principal and interest on the guarantee to zero. The end result is that the holder lost its legal right—not just its practical ability—to collect from the guarantor.

That said, the indenture provision at issue simply provided that EDMC would be released of its guarantee obligation on the notes when it was released from any guarantee on the bank debt.  The provision on its face did not turn on the vote or consent of a majority (or super-majority) of the noteholders. Rather, the condition precedent for release of EDMC’s guarantee of the notes was something quite independent from majority noteholder action—i.e. the release of EDMC’s bank guarantee. Thus, the operative provision that provided for the release of the guarantee was not a “collective action clause” that would be proscribed under the TIA.

One can also draw the conclusion that the collective action clauses prohibited by the TIA are those that provide for a change in payment terms through action taken by a majority of the noteholders of the indenture—not the majority of creditors generally or a majority elsewhere in the capital structure. The fact that a majority of bank debt holders (as opposed to noteholders) took the action to cause the condition for release of the EDMC guarantee of the notes to occur seems to be immaterial. The Second Circuit’s opinion leads to the conclusion that the TIA is concerned with action by majority noteholders under an indenture against the minority of noteholders under that same indenture.³⁹

We note that the EDMC indenture did in fact contain another potentially operative provision that purported to allow a majority vote of noteholders to release EDMC’s guarantee of the notes.⁴⁰ In our view, the TIA would prohibit operation of that provision because it is a prohibited collective action clause. Counsel for EDMC expressly—and wisely—did not rely on that provision during argument before the Second Circuit.

The bottom line (as of now) is that a guarantee in a TIA-qualified indenture can be released if the condition for release does not turn on the vote or consent of something less than 100 percent of the noteholders. So if an indenture provides that the guarantee is automatically released if the Minnesota Vikings win the Super Bowl,⁴¹ such a provision presumably would be valid. But if the indenture allows the guarantee to be released upon a vote of a majority or a supermajority (such as 75 percent or even 95 percent) of noteholders, the TIA would prevent such a provision from taking away the right to payment under the guarantee of any non-consenting holders.

Finally, we again emphasize that the TIA applies to “indenture securities,” which include both notes and guarantees under TIA-qualified indentures. There is nothing in the statute to suggest that the underlying notes are entitled to better protection under the TIA than any attendant guarantee. So whatever the circuit courts (or perhaps the Supreme Court) ultimately conclude on the breadth of the TIA, that conclusion should apply equally to both notes and guarantees.

_{1 Marblegate Asset Mgmt., LLC. V. Ed. Mgmt. Fin. Corp., 2017 U.S. App. LEXIS 782 (2d Cir. Jan. 17, 2017).}

_{2 Id. at *3.}

_{3 Id. at *3-4.}

_{4 Id. at 4.}

_{5 Id.}

_{6 Id.}

_{7 Id.}

_{8 Id.}

_{9 Id.}

_{10 Id. at *5.}

_{11 Id.}

_{12 Id.}

_{13 Id. at *6.}

_{14 EDMC and its creditors agreed upon two different paths forward to complete the restructuring—one would be implemented if all creditors agreed and the other implemented if there were dissenting creditors. Given that Marblegate and another noteholder did not agree to the proposed restructuring, the path that relied upon consent from 100 percent of the noteholders was not undertaken.}

_{15 Id. at *6-7.}

_{16 Id. at *7.}

_{17 Id.}

_{18 Id.}

_{19 Id.}

_{20 Id.}

_{21 Id. at *8.}

_{22 Id.}

_{23 15 U.S.C. § 77ppp(b) (emphasis added).}

_{24 Marblegate , 2017 U.S. App. LEXIS 782 at *9.}

_{25 Id. at *14.}

_{26 Id. at *14.}

_{27 Section 316(b) also bars certain “‘no action clauses,’ which preclude individual bondholders from suing the issuer for breaches of the indenture.” *14, 15.}

_{28 Id. at*13.}

_{29 Id. at *19.}

_{30 Id. at *7.}

_{31 Id.}

_{32 15 U.S.C. § 77ppp(b) (emphasis added).}

_{33 15 U.S.C. § 77ccc(11).}

_{34 15 U.S.C. § 77ccc(1).} 

_{35 15 U.S.C. § 77b(a)(1) (emphasis added); see also Ret. Bd. of the Policemen’s Annuity and Ben. Fund of the City of Chicago v. Bank of New York Mellon, 775 F.3d 154, 168 (2d Cir. 2014) (indicating that the TIA adopts the definition of “security” provided in the Securities Act).} 

_{36  “The provisions of the [Trust Indentures] subchapter shall not apply to any of the following securities: (1) any security other than (A) a note, bond, debenture, or evidence of indebtedness, whether or not secured. . . or (C) a temporary certificate for, or guarantee of, any such note, bond, debenture, evidence of indebtedness, or certificate . . . .” 15 U.S.C. § 77ddd(a)(1) (emphasis added).}

_{37  See 15 U.S.C. § 77ccc(12) (“The term ‘obligor,’ when used with respect to any indenture security, means every person (including a guarantor) who is liable thereon . . . .”). Section 303 of the TIA was amended in 1987 expressly to confirm that guarantors are covered by the Act.  See S. Rep. No. 100-105 at 33 (1987).}                           

_{38  “Guarantees of securities are securities themselves for purposes of the Securities Act of 1933.” Financial Statements and Periodic Reports for Related Issuers and Guarantors, SEC Release No. 33-7878 (effective Sept. 30, 2000), https://sec.gov/rules/final/33-7878.htm#P124_6773.}  

_{39 It is true that many of the bank debt holders were also cross holders of the notes. The important fact is that they were acting as bank debt holders (not noteholders) when directing their agent to release EDMC’s guarantee of the 2014 Credit Agreement. In taking that action, any cross holdings in notes would be irrelevant.}

_{40 Marblegate Asset Mngt, LLC. V. Ed. Mngt Corp., 111 F. Supp. 3d 542, 544 (S.D.N.Y 2015).}

_{41 Such a provision is unlikely to be in any indenture and the satisfaction of such condition precedent even more unlikely.}