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The Trust Indenture Act Rider Is Not a "Clarifying Amendment"

posted by Adam Levitin

Ken Klee has argued that the Trust Indenture Act rider to the omnibus appropriations bill is just a "clarifying amendment":

The primary objection being made by those opposed to this amendment is that Congress needs to hold extensive hearings. But this is just a correction to a recent misinterpretation of the statute – not a wholesale revision of the Trust Indenture Act.

That's just not right. This isn't just a "clarifying amendment". The proposed amendment neuters the Trust Indenture Act as a protection for bondholders. 

Let's start with this. The "misinterpretation of the statute" alleged by Klee is that the Trust Indenture Act in some cases prevents the stripping of guaranties from bonds without bondholder consent. How do we know this is a misinterpretation? We don't have a lot to work with. We've got the statutory language, but little else with the Trust Indenture Act. There's little caselaw (none of it controlling), and it goes both ways, and the legislative history isn't very illuminating on specific issue. Just because guaranties had in other prior restructurings been stripped before without bondholder consent does not mean that there's any misinterpretation of the statute. It could simply mean that previous bondholders weren't well counseled or had reasons not to litigate. There's never been a solid legal basis for assuming that the Trust Indenture Act allows majoritarian stripping of guaranties. 

As an initial matter, it's not at all clear to me that the courts in Caesar's or EDMC got it wrong in any meaningful way. If anything, the problem is that the courts took too indirect a route to the result they got. The Caesar's and EDMC courts both adopted a sort of "indirect effect" approach to guaranty stripping under section 316(b). I don't think that's right. Instead, I think the plain language of the statute indicates an absolute prohibition on guaranty stripping. The statute defines "obligor" to include "guarantor". What is a "right to payment" other than a "right to payment" by an obligor? Thus, the right to payment has to include the right to payment by a guarantor.  A plain language reading of the Trust Indenture Act would seem to indicate that the right to payment includes a guaranty, so a stripping of a guaranty is never allowed without the consent of an individual bondholder. (Where's the possible "judicial activism" or "out of control judiciary" in following the statutory language?)

This plain language reading also makes sense from a market perspective. Most guaranties make the guarantor co-liable, not secondarily liable. Indeed, as Bill Widen has taught us, corporate lending is almost always about lending to the corporate group, not to the specific "issuer" as the rest of the group typically guaranties the debt. Accordingly, what good does it do to protect the right to payment from an issuer, but not the right to payment from its co-obligors? 

By defining the right to payment as narrowly as the proposed rider does, it renders the Trust Indenture Act meaningless. A bondholder that extended funds based on there being co-liable guarantors could find itself being a creditor of only an asset-less issuer, while all of the issuer's assets are looted by the parents of the now-released guarantors. Think I'm making up that possibility? That's the fact pattern in Caesar's. Neutering the Trust Indenture Act is more than a "clarifying amendment". 

The proposed rider would also define the prohibition against "impairing or affecting" the right to institute suit as being actually "preventing" suit against only a "primary obligor (other than a guarantor)." Defining "impair or affect" to mean "prevent" isn't a mere clarification. It's a wholesale change. "Impair or affect" tolerates no material change in rights (in the bankruptcy context "impairment" is read very broadly, and the inclusion of the word "affect" suggests an even broader reading here). "Prevent" on the other hand is about actually stopping something, not just making it difficult or even extremely onerous.  Think of all the mischief that could be done through abusive exit consents: if you want to sue, you'll have to post a huge indemnity bond, agree to cover all of the obligor's legal expenses, sue in an inconvenient forum (perhaps before an arbitrator chosen by the obligor), and get the consent of 99% of the other bondholders before you sue. That sort of restriction of the right to institute suit would render whatever remains of the right to payment meaningless. This is certainly a substantive change, not a technical clarifying amendment.  

Furthermore, even if the courts did get it wrong, since when do we do retroactive legislation targeted at specific cases?  It might well be unconstitutional, but even if not, the previous example I can think of is the Terry Schiavo case. Not good company to keep, and it's notable that Ken Klee doesn't defend the retroactivity. Of course, absent the retroactivity, would we even see this rider? I doubt it. The whole point is to bail out Caesar's private equity sponsors. 



I have no dog in this fight. But I am concerned about the retroactive nature of the proposed change.

If Congress wants this to be the law going forward, so be it. Contracts will be adjusted accordingly. I am generally not very sympathetic to bondholders (just a personal bias), but I think they have the upper hand in this one on the retroactivity issue.

I would be very interested to see what expectation the parties had regarding the bondholders' rights and the TIA when they signed the contract.

"Of course, absent the retroactivity, would we even see this rider? I doubt it. The whole point is to bail out Caesar's private equity sponsors."

This is 100% correct.

Very clear, insightful analysis of this issue. Ken Klee ought to be ashamed of himself. I trust he is being well paid.

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