Cliffs Natural Resources Inc.: SDNY Limits Broad View of Section 316(b) of the Trust Indenture Act

Practical Law Legal Update w-005-0176 (Approx. 6 pages)

Cliffs Natural Resources Inc.: SDNY Limits Broad View of Section 316(b) of the Trust Indenture Act

by Practical Law Bankruptcy & Restructuring

Background

Cliffs Natural Resources Inc. (Cliffs or Defendant), a mining and natural resource firm, had $2.898 billion of funded debt, as of the end of 2015, through a series of seven classes of notes with varying interest rates and due dates, which were governed by a March 17, 2010 indenture (Base Indenture) and a series of supplemental indentures. On January 27, 2016, Cliffs announced an exchange offer (Exchange Offer) to holders of six note classes, to exchange their existing notes for new ones at a higher interest rate and ranking between the first and second lien notes (1.5 Lien Notes).

The Exchange Offer was only open to qualified institutional buyers (QIBs) and holders who were not US persons (see Rule 144A and Regulation S under the Securities Act). Gary Waxman and Leonard Hammerschlag, individually and on behalf of all other similarly situated noteholders (collectively, Plaintiffs), owned varying classes of notes and were not eligible to participate in the Exchange Offer because they were neither QIBs nor non-US persons, and, on March 14, 2016, filed a putative class action complaint in the SDNY against Cliffs.

Plaintiffs argued, among other claims, that the Exchange Offer was barred by section 316(b) of the TIA, which states that "the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security . . . shall not be impaired or affected without the consent of such holder." (15 U.S.C. § 77ppp(b)). Plaintiffs alleged they were injured by the Exchange Offer because, if Cliffs filed for bankruptcy, Plaintiffs would stand to recover less than they would have had Cliffs not issued the 1.5 Lien Notes, which in bankruptcy would subordinate Plaintiffs' notes.

Outcome

SDNY Dismisses Plaintiffs' TIA Claim

The SDNY held that section 316(b) of the TIA did not bar the Exchange Offer. In the SDNY's analysis, the Court noted that there are two lines of cases interpreting section 316(b), which are:

The narrow interpretation, which holds a note's core payment provisions, such as the repayment term, the interest rate, and the amount of principal, cannot be altered without consent of the noteholder.
The broad interpretation, which protects a noteholder's practical ability to receive principal and interest by prohibiting out-of-court workouts that constitute quasi-bankruptcy reorganizations even if they do not amend a core payment term.

Noting that the Plaintiffs did not dispute that their claims must be dismissed if the Court adopted the narrow, traditional view of section 316(b) of the TIA, the SDNY analyzed the broad interpretation and determined that no indicia of an involuntary, out-of-court pseudo-bankruptcy existed to support the Plaintiffs' case.

The SDNY analyzed existing case law in-line with the broad interpretation, and summarized the holdings as follows:

Federated Strategic Income Fund v. Mechala Group Jamaica Ltd.: The elimination of inter-corporate guarantees and the disposal of all assets violated the statute because the company had taken steps to preclude noteholders from any recovery ( (S.D.N.Y. Nov. 2, 1999)).
Marblegate Asset Management, LLC v. Education Management Corp.: The exchange offer stripped non-exchanging bondholders of guarantees and left them with bonds issued by a company that no longer had any assets, triggering a violation of the statute (75 F.Supp.3d 592 (S.D.N.Y. 2014); see Legal Update, Marblegate Asset Management v. Education Management Corp: SDNY Broadly Interprets Trust Indenture Act to Limit Non-consensual Out-of-Court Restructurings).
Marblegate Asset Management, LLC v. Education Management Corp.: Modifications to indentures that do not explicitly alter a core term but that impair or affect a bondholder's right to receive payment violate the TIA when those modifications effect an involuntary debt restructuring (111 F. Supp. 3d 542 (S.D.N.Y. 2015); see Legal Update, Marblegate Asset Management v. EDMC: TIA Provision Read Broadly to Protect Bondholder in Restructuring).
MeehanCombs Global Credit Opportunities Funds, LP v. Caesars Entertainment Corp.: Transfer of assets out of operating subsidiary that had issued the debt, and tender offer to sufficient holders of the issuing subsidiary's notes, in exchange for a premium and consent to release parent guarantees to allow further transfers of the subsidiary's assets, was sufficient to state a claim under section 316(b) of TIA (80 F. Supp. 3d 507 (S.D.N.Y. 2015)).
BOKF, N.A. v. Caesars Entertainment Corp.: An out-of-court debt reorganization that "leav[es] some noteholders with an unaltered formal right to payment, but no practical ability to receive payment" violates section 316(b) of TIA (144 F. Supp. 3d 459, 473 (S.D.N.Y. 2015)).

Here, the SDNY found that the Exchange Offer did not give rise to a claim under section 316(b) of the TIA as an out-of-court bankruptcy reorganization. The Court determined:

The Plaintiffs were not forced to relinquish claims outside of the Bankruptcy Code's protections or left without a practical ability to receive payment.
The exchange offer did not dispose of any assets, amend any terms of the indentures, or modify or remove any guaranty.
The Plaintiffs were not left holding a worthless right to collect principal and interest.

The SDNY dismissed Plaintiffs' claim that the TIA barred the Exchange Offer.

SDNY Dismisses Plaintiffs' Other Claims

The SDNY dismissed the Plaintiffs' other claims because:

Under Article III, Plaintiffs lacked standing to bring claims because they suffered no injury-in-fact. Relying on Lujan v. Defense of the Wildlife, to be injured-in-fact, harms, including economic harms, must be imminent or actual, not merely possible (504 U.S. 555, 560 (1992)). The SDNY rejected the Plaintiffs' arguments, as follows:
- subordination of Plaintiffs' claims to the 1.5 Lien Notes if Cliffs were to enter a potential bankruptcy was speculative because there was no allegation of imminent bankruptcy;
- Plaintiffs did not allege willingness and readiness to participate in the Exchange Offer if they were allowed to participate; and,
- subordination of Plaintiffs' notes to the 1.5 Lien Notes was not a harm in and of itself. The SDNY noted that Plaintiffs' notes, in wake of the Exchange Offer, actually increased in value.
Under New York state law, Plaintiffs failed to comply with the Base Indenture's no-action clause, which required Plaintiffs to:
- notify the trustee of a default;
- marshal support of investors holding at least 25% of the interests in the Class Notes and request that the trustee sue;
- offer the trustee indemnification for costs incurred in that law suit; and
- wait 60 days for the trustee to evaluate the requested suit.
The Plaintiffs did not allege compliance with the no-action clause, and the SDNY rejected the Plaintiffs' arguments that they were excused. The SDNY noted that even if the Plaintiffs had a plausible excuse for ignoring the no-action clause, they still needed to comply with the 25% requirement.
The Plaintiffs' claim of breach of contract of section 6.8 of the Base Indenture, which mimics section 316(b) of the TIA, failed for the same reasons given by the SDNY for the failure of its claims that the TIA barred the Exchange Offer.
An implied covenant of equal treatment of bondholders did not exist under the Base Indenture, and parties could have included a provision barring differential treatment of bondholders in exchange offers. Without an explicit provision in support, there was no implied covenant that was breached for the differentiated treatment among bondholders.
The Plaintiffs' unjust enrichment claim, which merely duplicated the breach of contract claim, failed because it was not available as a cause of action, as it is only available in unusual circumstances, not when it simply duplicates a conventional contract claim.
Declaratory judgment claim that sought interpretation rights under the TIA was dismissed because it was identical to claims seeking breach of the TIA.

Practical Implications

This decision limits earlier broad interpretations of section 316(b) of the TIA by the SDNY. It clarifies that section 316(b) of the TIA restricts out-of-court restructurings only if they amount to a de facto bankruptcy by rendering payment to non-consenting noteholders actually or practically impossible, such as through a transfer of assets or removal of security interests. Noteholders and issuers should take note that a claim under section 316(b) of the TIA cannot be based on an out-of-court restructuring just because it involves an exchange offer to a limited number of noteholders and effectively subordinates non-participating noteholders, such as in the Cliffs Exchange Offer. Rather, the dissenting noteholders must show an actual or imminent risk that the out-of-court restructuring will render payment impossible.

Cliffs Natural Resources Inc.: SDNY Limits Broad View of Section 316(b) of the Trust Indenture Act | Practical Law