More Leeway for Out-of-Court Workouts Squeezing Minority Creditors

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By Daniel Gill

A split federal appeals panel approved an out-of-court restructuring agreement over the objection of a single creditor, interpreting and potentially eroding creditor protections found in the Trust Indenture Act of 1939 and giving debtors more options for restructuring ( Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Fin. Corp. , 2017 BL 12251, 2d Cir., No. 15-2141-cv(CON), 1/17/17 ).

Judge Raymond Lohier of the Second Circuit Court of Appeals wrote the Jan. 17 opinion for the majority, overruling the Southern District of New York and holding that the TIA did not bar agreements between Education Management Corp. and most of its creditors owed about $1.5 billion to restructure the company’s debts.

While the majority of the court decided the applicable TIA provision was ambiguous and required judicial interpretation, Judge Chester J. Straub, in dissent, found that language of the statute was clear and provided that the rights of indenture holders couldn’t be altered by the agreements.

The dissent condemned the out-of-court restructuring as “collusively engineered” to exclude the minority bondholders in violation of the TIA.

The agreement forced the company’s bond-holders to agree to a modification of the indenture’s “core payment terms” or receive no payment at all, Straub wrote, thereby violating the TIA.

One expert told Bloomberg BNA that the result of the decision reduces the leverage of minority bondholders and increases risk and costs associated with out-of-court restructurings.

The Deal

Finding itself unable to manage its $1.3 billion in secured and $217 million unsecured debt, EDMC and an ad hoc committee of its creditors worked out a deal that amounted to a restructuring of its debt obligations. The agreement was designed to incentivize creditors to consent to it, the court said, and provided that non-consenting unsecured creditors would receive nothing from the new company purchasing all EDMC’s assets.

Marblegate Asset Management, LLC was the sole non-consenting creditor. It sued to block the transaction in federal court, on grounds the agreement violated Section 316(b) of the TIA, which provides that the rights of indenture holders can’t be changed without their consent. The district court agreed and blocked the deal.

Staying Out of Bankruptcy Court

The case “would have been a non-event had EDMC been in a position to use the bankruptcy process to restructure,” Karol K. Denniston, a partner in the restructuring department of Squire Patton Boggs, San Francisco, told Bloomberg BNA by e-mail Jan. 18.

In Chapter 11, which protects companies (or individuals) from creditors while they seek to reorganize their debt or liquidate pursuant to a plan which must be approved by the bankruptcy court, EDMC could likely have achieved the same result by confirming a plan over Marblegate’s objection, essentially “cramming down” their interest, in the jargon of the Bankruptcy Code.

However, EDMC, a for-profit higher education company “that relies heavily on federal funding” would lose its eligibility for such funding if it filed for bankruptcy, the court explained.

Effect on Workouts

The decision “has reduced the leverage of non-consenting minority bondholders looking for better treatment,” Denniston told Bloomberg BNA. But it also opens the door for parties “now looking for ways to implement out-of-court restructurings through heavily negotiated restructuring and support agreements,” she said.

Denniston also said that the decision could lead to increased risk and costs associated with out-of-court workouts. She said that restructuring outside of bankruptcy court leaves fraudulent transfer and successor liability claims open to future litigation, where a Chapter 11 plan confirmation order would often resolve such issues with finality. “This kind of litigation is expensive and time consuming and something that most issuers and holders [of indentures] want to avoid or at least limit,” she said.

Judge José A. Cabranes joined in the decision.

Sean E. O’Donnell, Akin Gump Strauss Hauer & Feld LLP, New York, argued for Marblegate. EDMC was represented by Emil A. Kleinhaus, Wachtell, Lipton, Rosen & Katz, New York, and Antonia M. Apps, Milbank, Tweed, Hadley & McCloy LLP argued for an intervening committee of creditors in the case.

To contact the reporter on this story: Daniel Gill in Washington at

To contact the editor responsible for this story: Jay Horowitz at

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