Are There Limits to the Remedial Powers of an Indenture Trustee?

In the recent case of Cortlandt St. Recovery Corp. v. Bonderman  (NY Ct. Ap. Feb. 20, 2018), the New York Court of Appeals addressed the question of the limits on the authority of an indenture trustee to pursue remedial causes of action on behalf of noteholders. The Court held that so long as a trustee is acting on behalf of all noteholders pro rata, the trustee can pursue virtually any cause of action, against any party. What a trustee cannot do, however, is  assert claims that are shared by only a subset of noteholders, such as claims for fraud in the inducement to purchase notes issued under the indenture. The Court’s holding may also have implication for the application of standard no-action clauses.

The Case

The case concerned the leveraged acquisition in 2005 by Apax Partners and TPG Capital Management of TIM Hellas Communications, at the time the third-largest cellular telephone company in Greece. Apax and TPG created an interlocking family of shell companies to acquire TIM Hellas. Following the acquisition, at the end of 2005, the Hellas group of companies had debt of €1.6 billion, compared with equity of €38 million. By mid-2006, long-term debt increased to €1.94 billion, while equity dropped to €11 million.

In 2006, a finance company in the Hellas group issued €200 million principal amount of PIK notes. At the same time, as part of a recapitalization, the Hellas group redeemed so-called convertible preferred equity certificates held by affiliates of Apax and TPG in the amount of €973.7 million. Two months after the redemption, Apax and TPG sold the Hellas group.

Less than three years later, in 2009 during the global financial crisis, the Hellas group defaulted on the PIK notes. Wilmington Trust Company, as successor to the original trustee under the indenture governing the PIK notes, brought an action in New York state court against several entities in the Hellas group, as well as against entities affiliated with Apax and TPG. The trustee alleged that the 2006 recapitalization was intended to “bleed” money out of the Hellas group. The complaint asserted causes of action for breach of contract, fraudulent conveyance, unlawful corporate distribution and unjust enrichment. In addition, the complaint included an action for piercing the corporate veil, claiming that the Apax and TPG defendants were alter egos of the Hellas group and responsible for its debt. The complaint sought payment of the €268 million owed at the time on the PIK notes, plus interest, fees and costs.

• Proceedings Below

The trial court dismissed the complaint, holding that Wilmington Trust lacked standing to bring the action. The court reasoned that the indenture did not permit the trustee to sue the Apax and TPG defendants on causes of action that were “entirely separate claims” and that could have been brought even prior to the default under the PIK notes. On the same ground, the lower court dismissed the action predicated upon veil piercing, but noted as well that the claim was inadequately pleaded and duplicative of the fraudulent conveyance claims.

On appeal, the intermediate New York appellate court reversed and denied the motion to dismiss. The appellate court held that the indenture conferred standing on the trustee to pursue fraudulent conveyance and other claims for the purpose of recovering amounts due under the notes for all noteholders pro rata. The court also held that veil piercing was adequately pleaded. An appeal to the New York high court followed.

The Court of Appeals Decision

In its decision, the Court of Appeals began with the basics: the interpretation of an indenture is a matter of basic contract law, and “a written agreement that is complete, clear, and unambiguous on its face must be enforced according to the plain meaning of its terms.”

Applying these principles, the Court found the indenture to be unambiguous. The  indenture stated in relevant part — as is common — that “if an event of default occurs and is continuing, the Trustee may pursue any available remedy to collect the payment of principal, premium, if any, and interest on the notes or to enforce the performance of any provision of the Notes or this Indenture.” According to the Court of Appeals, the authorization to pursue “any available remedy includes all remedies available at law and in equity.” The Court  rejected the contention of the defendants that the trustee was limited to bringing claims only for payments due under the notes, and only such claims as were against the issuer and any guarantors, and held that the trustee could also assert causes of action against third parties. 

• Distinguishing Precedent

The Court of Appeals distinguished authority relied upon by the defendants from other jurisdictions to the effect that a trustee may not sue third parties. One case cited by the defendants concerned a suit brought by a trustee for fraudulent inducement, that is “misrepresentations and nondisclosures in the offering memorandum about the actual risks of the underlying technology in which the bondholders invested.” The Court of Appeals observed that the alleged fraudulent acts in that action were perpetrated to induce the purchase of the debt securities. Such a cause of action may not have uniformly affected the bondholders; for example, the effects of those fraudulent acts could have been different based upon whether a bondholder bought in the original offering or in the aftermarket. In contrast, the trustee in Cortlandt was seeking to remedy wrongs that occurred subsequent to the purchase of the PIK notes and to collect payment on the notes for the ratable benefit of all noteholders.

Other cases cited by the defendants were similarly distinguishable. One was brought against an underwriter for fraudulently representing an issuer’s financial condition and viability. Another was brought against a director of a bond guarantor for failing to disclose the guarantor’s financial condition. None of the cases relied upon by the defendants dealt with a trustee suing third parties for causes of action that arose subsequent to the issuance of the bonds and with respect to which all bondholders stood on equal footing.¹ 

The bottom line holding of the Court of Appeals was that a trustee is empowered under a standard indenture remedies provision to pursue causes of action, of whatever nature, to recover payment on the debt securities ratably for the benefit of all holders. In Cortlandt, this authority extended to claims against third parties, when the trustee “allege[d] bled dry the issuer and guarantor for defendants’ profit, to the detriment of the noteholders.”

• Piercing the Corporate Veil

In addressing the cause of action for piecing the corporate veil, the Court of Appeals applied the following New York law standard: 

Generally, a plaintiff seeking to pierce the corporate veil must show that (1) the owners exercised complete domination of the corporation in respect to the transactions attacked; and (2) such domination was used to commit a fraud or wrong against the plaintiff which resulted in plaintiff’s injury (citing Conason v. Megan Holding, LLC, 25 NY3rd 1 (2015)).

Noting the liberality with which pleadings are construed on a motion to dismiss, the Court concluded that the trustee had adequately pleaded the required elements. The trustee alleged that the defendants “‘forced’ the Hellas Corporations to ‘commit business suicide by paying borrowed funds to private equity defendants that the Hellas Defendants could not repay.’” In the circumstances of the case, that was sufficient to survive a motion to dismiss.

Concluding Thoughts

Cortlandt definitively settles the question under New York law of whether trustees may pursue third parties to recover payments under an indenture. A trustee may do so, the Court held, as long as recoveries will accrue to all noteholders pro rata. If the “ratable benefit” criterion is satisfied, then the nature of the cause of action matter does not matter, whether it be for fraudulent conveyance, a violation of Rule 10b-5 or otherwise. Left open is the question of whether a trustee may (although it would not be obligated to) pursue a third-party action even prior to the occurrence of an event of default, so long as the action will benefit all noteholders uniformly. 

There may be another important implication of the case. Since the trustee is not empowered under a standard remedies clause to bring suit against third-party actors for wrongful conduct in the purchase and sale of debt securities, a no-action clause should not foreclose suits of that nature by individual debt holders. This should be so notwithstanding that the no-action clause in a particular indenture extends to suits “with respect to the notes,” a formulation that was broadly interpreted in Quadrant Structured Prods. Co., Ltd. v. Vertin, 23 NY 3d 549 (2014). If a trustee cannot bring such a suit, it stands to reason that the individual noteholders may bring the action on their own behalf.²

¹ The Court of Appeals cited approvingly to two Delaware  Court of Chancery cases, Feldbaum v McCrory Corp. (Del. Ch. June 2, 1992) and Lange v Citibank, N.A. (Del. Ch. Aug. 13, 2002). These cases interpreted a standard no-action clause as prohibiting individual security holders from asserting fraudulent conveyance actions without complying with the no-action clause. The Court of Appeals inferred from these decisions that the Court of Chancery would have permitted the trustee to pursue those actions notwithstanding that they were against third parties.

² As for “veil piercing,” it is worth noting that the New York formulation is somewhat different from the standard generally employed by the Delaware courts. There, a plaintiff seeking to pierce the corporate veil must establish that (1) the parent and subsidiary operated as a single economic entity and (2) there exists an overall element of injustice or unfairness. Which criteria may be more readily satisfied will, of course, depend on the facts and circumstances in the particular case.