The Gate Swings Shut: Second Circuit Ruling Narrows Restructuring Limitations

After a 2014 decision in the Southern District of New York holding that section 316(b) of the Trust Indenture Act ("TIA") barred any non-consensual restructuring that impaired a creditor's actual ability to receive payment, issuers, creditors and the financial markets more generally have been uncertain as to the contours of permissible out-of-court restructurings.1 The recent decision by the Second Circuit Court of Appeals in Marblegate Asset Management, LLC v. Education Management Finance Corp., 2017 WL 164318 (2d. Cir 2017) reversed the 2014 ruling and held that section 316(b) only bars restructurings that that impact a creditor's core payment right, which is different from the practical ability to demand payment. The Second Circuit's Marblegate ruling will help resolve the disquiet among practitioners and issuers and restore expectations as to the ability of companies to conduct out-of-court restructurings without being hamstrung by non-consenting creditors.

Background of the Marblegate Rulings:

The Second Circuit's decision arose from the restructuring of the debt of Education Management Corporation ("EDMC"). EDMC is a for-profit higher education company that had: (i) $1.3 billion in secured obligations that were collateralized by virtually all of EDMC's assets, and (ii) $217 million of unsecured notes (the "Notes") that were issued by a subsidiary of EDMC and governed by an indenture qualified under the TIA (the "Indenture"). The Notes were guaranteed by EDMC, but the guarantee was basically worthless as it had been issued solely to satisfy EDMC's reporting obligations and would be automatically released if any secured creditor provided a release of any separate guarantee of EDMC (a fact that was clearly disclosed to potential Noteholders in the offering circular for the Notes).

Cash-strapped EDMC entered into negotiations with its secured creditors that resulted in a restructuring proposal.2 Under the proposed restructuring, the secured lenders would exercise their rights under their credit agreement and Article 9 of the Uniform Commercial Code to foreclose on all of EDMC's assets and release EDMC from their guarantee (thereby automatically releasing EDMC from the Note guarantee). The secured lenders' collateral agent would then transfer all of the foreclosed assets to a newly created subsidiary of EDMC that would then issue new secured debt and stock to the secured lenders and any unsecured lenders that consented to the...