Debt Dialogue: October 2016

This month’s issue of Debt Dialogue address the consequences in bankruptcy of allegations of insider trading, rights of trustees and noteholders to bring suit against third parties, the use of warrants to bridge valuation gaps in restructuring, and other recent cases of interest to the debt community.

Topics covered in this issue include:

• Ending the 10b-5 Hold-up: Aéropostale Rejects Debtor’s Attack on Traders
  In a recent decision in the Aéropostale bankruptcy case, the court rejected the debtors’ claims that allegations of insider trading against a creditor were grounds for equitably subordinating the creditor’s claims and denying its right to credit bid. If followed, the decision would eliminate the sometimes extortionate practices employed by issuers, under the guise of enforcing the anti-fraud provisions of the securities laws, to frustrate the exercise of creditor rights in the bankruptcy process.
• Non-Contractual Claims of Noteholders: Who Can Bring Them and How Must They Be Brought?
  A recent decision of the Appellate Division First Department of the New York Supreme Court held that, under standard indenture language, a trustee has the authority to bring claims for fraudulent conveyance, unlawful corporate distribution and unjust enrichment against a third party. Both the decision of the Appellate Division and certain questions that it leaves unanswered highlight the deceptive complexity of bringing non-contractual claims by or on behalf of noteholders under the seemingly boilerplate remedies provisions in trust indentures.
• Avoiding Illusory Recoveries: The Importance of Black-Scholes Protections for Warrants Issued Under a Bankruptcy Plan
  Allowing junior creditors to participate in market recovery through the use of long-term, out-of-the-money warrants has the potential to provide significant value for those creditors, but is not without risk. To mitigate risk and preserve value for junior creditors, those creditors need to ensure that the warrant value is protected in the event of a squeeze-out merger or other similar transaction in which the minority shareholders are cashed out. The recently concluded Arch Coal bankruptcy offers an example of how this may be successfully accomplished.
• Compelling Redemption of Notes With a Make-Whole Premium as a Remedy for Breach
  In Wilmington Savings Fund Society v. Cash America International, a Southern District of New York court held that, in cases of voluntary default, the trustee may compel an issuer to redeem its indenture debt and pay a make-whole premium, rather than accelerate and receive par. If the holding stands up on appeal, trustees and noteholders would be afforded another weapon in their arsenal of enforcement against actual or prospective breaches of indentures. Left open are the precise contours of those indenture breaches that are considered “voluntary” for these purposes.
• Caveat Redemptor — Chesapeake Energy Must Pay Full Make-Whole for 2013 Redemption of Senior Notes
  In its second go-around before the Court of Appeals for the Second Circuit, Chesapeake Energy Corp. was required to pay noteholders the full amount of the make-whole in its failed attempt to redeem notes at par. Although it proceeded in reliance on a District Court opinion that was later overturned, its reliance did not excuse strict compliance with the make-whole provisions of the indenture.
• Blocking the Blocking Provision in the Intervention Energy Case
  Rated and other debt issuances are often structured with borrowers that are special purpose entities, whose governance provisions are designed to inhibit bankruptcy filings. A recent District of Delaware bankruptcy court case, while not directly on point, throws into question the premises underlying the efficacy of such provisions.