The Trust Indenture Act Of 1939 In Congress And The Courts In 2016: Bringing The SEC To The Table

Mark J. Roe

Harvard Law School

March 29, 2016


Distressed firms with publicly-issued bonds often seek to restructure the bonds’ payment terms to better reflect the weakened firm’s repayment capabilities. Depression-era securities law bars the bondholders from voting on whether or not to accept new payment terms, requiring individualized consent to the new payment terms. Yet, such votes that bind all bondholders are commonplace now in bankruptcy. Recent application of this securities law rule to bond recapitalizations has been more consistent than it had previously been, with courts striking down restructuring deals that twisted bondholders’ arms into consenting to apparently unwanted deals. These court decisions faithfully apply the securities law rules, reducing such coercive exchanges. But the bond market, and distressed firms, would be better served by adding an exemption to the securities rules, allowing binding bondholder votes to restructure payment terms. The Securities and Exchange Commission now has authority to exempt fair restructuring votes from this now out-of-date securities law.

The Trust Indenture Act Of 1939 In Congress And The Courts In 2016: Bringing The SEC To The Table – Introduction

This short article examines broad aspects of recent controversies and ongoing litigation arising from the Trust Indenture Act’s requirement that no bondholder can see his or her payment terms change without the bondholder’s own consent. The Marblegate court put forward the most persuasive interpretation of the Act’s application to so-called exit consent transactions, namely ruling that typical exit transactions run afoul of the Act. But no judicial interpretation can construct a stable, appropriate policy framework for the bond market, because the prohibition — a New Deal reaction to 1930s’ perceived bond market insider-driven irregularities — unwisely disrupts both sensible and coercive out-of-court distressed company restructurings. This and related decisions, the underlying transactions, and their potential impact on distressed debt have garnered an unusual level of mainstream media attention for what would normally be a technical matter for securities and bankruptcy lawyers. Indeed, in last-minute congressional budget negotiations in 2015, affected parties are reported to nearly have succeeded in sharply amending the Act, with retroactive effect.

I show here what legal tools can be used to build a sensible legal framework governing out-of-bankruptcy restructurings of public bond issues. Four points are to be made:

  1. Recent Southern District of New York decisions struck down exit consent transactions — a restructuring transaction to be explained and analyzed below — under the Trust Indenture Act.3 Underlying these decisions were transactions set up to seriously wound bondholders who did not accept the restructuring terms the issuer offered, because the deal would terminate bondholder protections in the bondholders’ loan agreement. The participating bondholders were no longer concerned that protections would be lost because they were accepting new bonds with new payment terms and new protections. The Trust Indenture bars changes in payment terms that are not accepted by each affected bondholder.
  2. The decisions eliminate one difficulty for restructurings: coercive exit consent offers. But they leave in place an equally difficult problem: how to restructure outside of bankruptcy when widespread bondholder consent is needed. The court decisions are not the cause of this difficulty; Section 316(b) of the Trust Indenture Act itself is the problem and courts alone cannot solve both problems. That Act clearly but mistakenly bars all votes that restructure bond payment terms; the best law reform here would be for Congress to repeal that provision. In today’s institutionalized bond market, there is little reason to bar uncoerced voting for restructurings.
  3. Two countervailing degradations of good business decisionmaking are embedded in bond restructurings, both emanating from the Trust Indenture Act’s voting ban. The first comes from the potential for holdouts (or earnest dissenters) to destroy a good deal that most bondholders sincerely want. But to combat the TIA’s voting ban (and sometimes to force an unsound restructuring), issuers use exit consent offers, which can impair bondholders’ indenture rights so severely that some, possibly many, reluctantly accept an offer whose terms they dislike. The court decisions, if upheld on appeal, will eliminate coercive exit consent offers. But they will leave in place the other problem: how to restructure outside of bankruptcy when widespread consent is needed. Courts interpreting Section 316(b) cannot reach the best policy result — which would deal with both distortions. Other lawmakers need to come to the table.
  4. The best result for the bond market is a legal framework that ends both degradations. In the absence of wise legislation from Congress, there is a way to construct sensible rules for bond workouts, one that has previously not been recognized. Since 1990, the Securities and Exchange Commission has had broad authority to exempt indentures and bond transactions from the full force of Section 316(b). Thus the SEC can, say, permit binding bondholder votes on payment terms by a two-thirds dollar majority (mimicking but not replicating the Bankruptcy Code standard), perhaps conditioned on the vote not being forced via an exit consent transaction and not otherwise coerced.

SEC exemptive rule-making thus provides a viable path to facilitate out-of-bankruptcy restructurings of bond issues going forward. Quick, efficient, noncoercive restructurings that save a company from an unnecessary bankruptcy are both in the public interest and the interest of the parties to the deal. The appellate courts can and should affirm the lower court decisions that the Trust Indenture Act bans exit consent degradation, and the SEC can and should then use its exemptive power to carve out uncoerced votes on payment terms from Section 316(b). Uncoerced binding votes would allow sound out-of-court restructurings to bind holdouts, but would disallow exit consent restructurings. Two degradations would be eliminated and sound restructurings could go forward. Win-win.

The next paragraphs expand on these issues. In Part I, I illustrate how even one holdout can stymie an otherwise sound restructuring. In Part II, I show how the exit consent transaction can overcome the holdout. I also show how it can induce consent from bondholders who otherwise think a proposed deal is unwise. In Part III, I briefly examine the recent court decisions concluding that exit consents are inconsistent with the Trust Indenture Act’s bar to changing payment terms without an affected bondholder’s consent. While the cases are correctly decided, a tighter standard ought to be articulated so as to avoid wide disruption to the bond market and beneficial restructurings. In Part IV, I show how, should these judicial decisions persist, as statutory fidelity would require, the SEC can and should resolve the persistent holdout difficulties via its modern exemptive power. In Part V, I discuss recently proposed legislation which could improve the restructuring setting we now have, but would be largely unnecessary if the SEC acts. Lastly, I conclude and recapitulate.

The Trust Indenture Act Of 1939 In Congress And The Courts In 2016

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