Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Fin. Corp., Docket No. 15–2124–cv(L), 15–2141–cv(CON)

• Decision Date: 17 January 2017
• Docket Number: August Term, 2015,Docket No. 15–2124–cv(L), 15–2141–cv(CON)
• Citation: 846 F.3d 1
• Parties: MARBLEGATE ASSET MANAGEMENT, LLC, Marblegate Special Opportunities Master Fund, L.P., Plaintiffs–Counter–Defendants–Appellees, v. EDUCATION MANAGEMENT FINANCE CORP., Education Management, LLC, Defendants–Appellants, Education Management Corporation, Defendant–Counter–Claimant–Appellant, Steering Committee for the Ad Hoc Committee of Term Loan Lenders of Education Management, LLC, Intervenor–Appellant.
• Court: U.S. Court of Appeals — Second Circuit

846 F.3d 1

MARBLEGATE ASSET MANAGEMENT, LLC, Marblegate Special Opportunities Master Fund, L.P., Plaintiffs–Counter–Defendants–Appellees,

v.EDUCATION MANAGEMENT FINANCE CORP., Education Management, LLC, Defendants–Appellants,Education Management Corporation, Defendant–Counter–Claimant–Appellant,Steering Committee for the Ad Hoc Committee of Term Loan Lenders of Education Management, LLC, Intervenor–Appellant.

Docket No. 15–2124–cv(L), 15–2141–cv(CON)

August Term, 2015

United States Court of Appeals, Second Circuit.

Argued: May 12, 2016

Decided: January 17, 2017

Sean E. O'Donnell (Christopher W. Carty, Lucy C. Malcolm, Stewart R. Gilson, Pratik A. Shah, Hyland Hunt, on the brief), Akin Gump Strauss Hauer & Feld LLP, New York, NY, for Plaintiffs–Counter–Defendants–Appellees.

Emil A. Kleinhaus (Alexander B. Lees, on the brief), Wachtell, Lipton, Rosen & Katz, New York, NY, for Defendants–Appellants and Defendant–Counter–Claimant–Appellant.

Antonia M. Apps (Aaron L. Renenger, on the brief), Milbank, Tweed, Hadley & McCloy LLP, New York, NY, for Intervenor–Appellant.

Before: CABRANES, STRAUB, and LOHIER, Circuit Judges.

LOHIER, Circuit Judge:

Defendant-appellant Education Management Corporation ("EDMC") and its subsidiaries appeal from a judgment following a bench trial before the United States District Court for the Southern District of New York (Failla, J.). The District Court held that a series of transactions meant to restructure EDMC's debt over the objections of certain noteholders violated Section 316(b) of the Trust Indenture Act of 1939, 15 U.S.C. § 77ppp(b). The transactions at issue, the District Court determined, stripped the non-consenting noteholders, plaintiffs-appellees Marblegate Asset Management, LLC and Marblegate Special Opportunity Master Fund, L.P. (together, "Marblegate"), of their practical ability to collect payment on notes purchased from EDMC's subsidiaries. As a result, the District Court ordered EDMC to continue to guarantee Marblegate's notes and pay them in full.

On appeal, EDMC argues that it complied with Section 316(b) because the transactions did not formally amend the payment terms of the indenture that governed the notes. We agree with EDMC and conclude that Section 316(b) prohibits only non-consensual amendments to an indenture's core payment terms. We therefore VACATE the judgment and REMAND to the District Court for further proceedings consistent with this opinion.

BACKGROUND

1. Facts

EDMC is a for-profit higher education company that relies heavily on federal funding through Title IV of the Higher Education Act of 1965, 20 U.S.C. §§ 1070 –1099. EDMC is the parent company of defendants-appellants Education Management, LLC and Education Management Finance Corporation (together, the "EDM Issuer").

In 2014 EDMC found itself in severe financial distress. Its enterprise value had fallen well below its $1.5 billion in outstanding debt. But restructuring its debt by resorting to bankruptcy court was not a realistic option for EDMC, which, the parties agree, would lose its eligibility for Title IV funds if it filed for bankruptcy and discontinued as an ongoing concern. See 20 U.S.C. § 1002(a)(4)(A).¹ EDMC therefore had to cooperate with its creditors outside of the bankruptcy process if it hoped to restructure its debt and persist as a viable entity.

EDMC's outstanding debt consisted of both secured debt (roughly $1.3 billion) and unsecured debt ($217 million). The secured debt was governed by a 2010 credit agreement between the EDM Issuer and secured creditors (the "2010 Credit Agreement"). The 2010 Credit Agreement gave EDMC's secured creditors the right, upon default, to deal with the collateral securing the loans "fully and completely" as the "absolute owner" for "all purposes." The collateral securing the debt consisted of virtually all of EDMC's assets.

The unsecured debt, to which we will refer as the "Notes," was also issued by the EDM Issuer and governed by an indenture executed in March 2013 and qualified under the Trust Indenture Act of 1939 (the "Indenture"). The Notes were guaranteed by EDMC as the parent company of the EDM Issuer (we refer to this guarantee as the "Notes Parent Guarantee") and carried a high effective interest rate—nearly 20 percent per year—to compensate for the riskier nature of the unsecured debt. Both the Indenture and the offering circular relating to the Notes informed lenders who had purchased them (the "Noteholders") about their rights and obligations as junior, unsecured creditors. For example, the offering circular explained that the Notes Parent Guarantee was issued solely to satisfy EDMC's reporting obligations, that it could be released solely by operation of the release of any later guarantee EDMC issued to secured creditors, and that Noteholders should therefore not assign any value to the Notes Parent Guarantee. Marblegate holds Notes with a face value of $14 million but never held any secured debt.

As EDMC's financial position deteriorated, its debt burden became unsustainable. After negotiating with EDMC, a majority of secured creditors agreed in September 2014 to relieve the EDM Issuer of certain imminent payment obligations and covenants under the 2010 Credit Agreement. The resulting agreement was a new amended credit agreement entered in the fall of 2014 (the "2014 Credit Agreement"). As consideration for these changes, EDMC agreed to guarantee the secured loans (the "Secured Parent Guarantee").

Around the same time, a group of creditors formed an Ad Hoc Committee of Term Loan Lenders (the "Ad Hoc Committee") and established a Steering Committee, which is an intervenor-appellant in this appeal, to negotiate with EDMC.² The Steering Committee and EDMC eventually devised two potential avenues to relieve EDMC of its debt obligations.

The first option, which obtained only if creditors unanimously consented, was designed to result in (1) most of EDMC's outstanding secured debt being exchanged for $400 million in new secured term loans and new stock convertible into roughly 77 percent of EDMC's common stock, and (2) the Notes being exchanged for equity worth roughly 19 percent of EDMC's common stock. EDMC estimated that this first option would amount to roughly a 45 percent reduction in value for secured lenders and a 67 percent reduction in value for Noteholders.

The second option would arise only if one or more creditors refused to consent. Under that circumstance, a number of events would occur that together constituted the "Intercompany Sale." Secured creditors consenting to the Intercompany Sale would first exercise their preexisting rights under the 2014 Credit Agreement and Article 9 of the Uniform Commercial Code (UCC) to foreclose on EDMC's assets. In addition, the secured creditors would release EDMC from the Secured Parent Guarantee. That release in turn would effect a release of the Notes Parent Guarantee under the Indenture. With the consent of the secured creditors (but without needing the consent of the unsecured creditors), the collateral agent would then sell the foreclosed assets to a subsidiary of EDMC newly constituted for purposes of the Intercompany Sale. Finally, the new EDMC subsidiary would distribute debt and equity only to consenting creditors and continue the business.

The Intercompany Sale was structured to incentivize creditors to consent. While non-consenting secured creditors would still receive debt in the new EDMC subsidiary, that debt would be junior to the debt of consenting secured creditors. Non-consenting Noteholders would not receive anything from the new company: though not a single term of the Indenture was altered and Noteholders therefore retained a contractual right to collect payments due under the Notes, the foreclosure would transform the EDM Issuer into an empty shell. In offering to exchange the Notes for equity in the new EDMC subsidiary, therefore, EDMC and the Ad Hoc Committee explicitly warned Noteholders that they would not receive payment if they did not consent to the Intercompany Sale.

Except for Marblegate, all of EDMC's creditors (representing 98 percent of its debt) eventually consented to the Intercompany Sale.

2. Procedural History

Marblegate, the sole holdout, sued to enjoin the Intercompany Sale on the ground that it violated Section 316(b) of the Trust Indenture Act of 1939 (the "TIA"), 15 U.S.C. § 77ppp(b). Marblegate Asset Mgmt. v. Educ. Mgmt. Corp., 75 F.Supp.3d 592 (S.D.N.Y. 2014) ("Marblegate I"). Section 316(b) of the TIA, entitled "Prohibition of impairment of holder's right to payment," provides as follows:

Notwithstanding any other provision of the indenture to be qualified, the right of any holder of any indenture security to receive payment of the principal of and interest on such indenture security, on or after the respective due dates expressed in such indenture security, or to institute suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of such holder, except as to a postponement of an interest payment consented to as provided in paragraph (2) of subsection (a) of this section, and except that such indenture may contain provisions limiting or denying the right of any such holder to institute any such suit, if and to the extent that the institution or prosecution thereof or the entry of judgment therein would, under applicable law, result in the surrender, impairment, waiver, or loss of the lien of such indenture upon any property subject to such lien.

15 U.S.C. § 77ppp(b) (emphasis added).

Before the District Court, EDMC argued that "the right ... to receive payment" is necessarily defined by the payment terms in the Indenture itself, such that Section 316(b) prohibits only non-consensual amendments to an indenture's core payment terms. Therefore, EDMC asserted, the Intercompany Sale complied with Section 316(b) because it did not amend any Indenture term and because Marblegate's right to initiate...