Much has been written concerning the liability of an issuer to
pay a make-whole premium for debt that has been accelerated in
bankruptcy. See Debt Dialogue, August 2016 (" No Turnover of the Make-Whole Amount in the EFH
Bankruptcy") A recent case, Wilmington Savings Fund
Society v. Cash America International, (S.D.N.Y. September 19,
2016), addressed a slightly different but related issue. Where an
event of default is continuing under an indenture, may the trustee
compel the issuer to redeem the debt and pay a make-whole premium,
rather than accelerate and receive par? The court's answer in
the circumstances of the case was yes, so long as the default may
be deemed voluntary.
In May 2013, Cash America International issued $300 million worth
of notes in a private placement. The indenture trustee was
Wilmington Savings Fund Society (WSFS). Among the covenants of the
indenture was a prohibition against Cash America's disposing of
its properties. That prohibition had a number of exceptions, one of
which allowed Cash America to engage in disposition transactions if
"the aggregate book value of the properties disposed of does
not exceed" 10% of the company's "consolidated total
assets."
In 2014, Cash America announced that its board of directors
approved a spin-off of its subsidiary Enova International. Cash
America was in the business of providing secured non-recourse
lending, and Enova conducted the online aspect of the business. In
October 2014, a noteholder sent a letter to Cash America warning
that the spin-off would violate the provisions of the indenture
prohibiting dispositions, and suggesting that Cash America should
redeem the notes together with a make-whole premium rather than
violate indenture. Cash America responded by saying that the
spin-off would not breach the indenture, and that if there were a
breach, the noteholders' sole remedy would be acceleration.
Shortly thereafter, Cash America effectuated the spin-off by
conveying 80% of the interest in Enova to its shareholders.
The court first addressed the question of whether the Enova
spin-off constituted a breach of the indenture, which turned on
whether the spin-off qualified for the exception where the
aggregate book value of the transferred properties did not exceed
10% of consolidated total assets. Cash America maintained that the
aggregate book value of the Enova shares should be calculated by
taking assets minus liabilities, i.e., shareholder equity, in which
case the transaction would not have constituted a breach. The court
sided with WSFS in that for the purposes of determining book value,
what mattered was the aggregate book value of the assets of Enova.
The court's conclusion was compelled by the plain language of
the indenture, which read, "[f]or purposes of determining the
book value of property constituting capital stock or similar equity
interests of the subsidiaries disposed of provided in [the relevant
covenant], such book value shall be deemed to be the aggregate
book value of all assets of the subsidiary that shall have issued
such capital stock or similar equity interest." Cash
America argued from the generally accepted meaning of "book
value" in the case law, which the court understandably found
unpersuasive.
The court next turned to the question of remedy and specifically
whether the noteholders were entitled to recoup not only the
principal amount of their notes, but also the make-whole premium
prescribed in the indenture. The Cash America indenture required
the issuer to pay upon redemption an amount equal to the sum of the
present values of the remaining principal and interest on the notes
being redeemed, discounted at the Treasury Rate (as defined), plus
50 basis points, effectively providing for a make-whole premium.
Cash America, as noted, maintained that the prepayment premium was
irrelevant to a circumstance of breach, because in that case the
only remedy of the trustee and the noteholders was to accelerate
the notes and receive payment at par. The court disagreed, placing
reliance upon the well-known decision of the Second Circuit in
Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d
1039 (2d Cir. 1982). In that case, the issuer, UV Industries, Inc.,
disposed of its assets in piecemeal fashion to a variety of buyers
under a predetermined plan of liquidation. The last such
disposition was to Sharon Steel, which assumed UV Industries'
obligations under a series of indentures, in accordance with the
successor obligor provisions of those debt documents. The
noteholders challenged the characterization of Sharon Steel as the
successor issuer, maintaining that UV Industries had breached the
successor obligor provisions of the indentures with this maneuver.
Both the district court and the Second Circuit ruled in favor of
the noteholders. On the issue of remedies, the Second Circuit held
the "acceleration of the provisions of the indentures are
explicitly permissive and not exclusive of other remedies,"
and that there was "no bar ... to [the lender] seeking
specific performance of the redemption provisions where the debtor
causes the debentures to become due and payable by its voluntary
actions."
As in Sharon Steel, the Cash America indenture had both a
redemption clause requiring payment of the make-whole premium and a
customary provision for acceleration upon the occurrence of an
event of default. Also as in Sharon Steel, the
acceleration provisions in the Cash America indenture were
permissive and not exclusive of other remedies, and the default was
due to the voluntary action of the issuer. Finding Sharon Steel
controlling, the court held that the trustee was entitled to seek
specific performance and compel Cash America to redeem the notes
together with the prepayment make-whole.
In rebutting a variety of arguments advanced by Cash America, the
court rejected the contention that Sharon Steel required a showing
of bad faith, as where the issuer triggers an acceleration in order
to avoid paying the redemption premium. The court found no such
requirement in Sharon Steel and held that the only
criteria of relevance was whether the issuer by its voluntary
action occasioned the event of default.
Finally, the court rejected Cash America's argument that
requiring payment of the premium was inequitable, would effectively
destroy the use of acceleration clauses and would "upend the
nation's debt markets." The court found that Cash America
had prior notice that Enova spin-off could constitute a breach of
the indenture. Also, the court observed, Cash America could have
foreclosed the application of Sharon Steel due to
voluntary breaches of the indenture by drafting provisions to the
contrary.
Observations
In a nutshell, Cash America stands for the proposition
that one of the remedies available to noteholders and trustees for
an issuer's conscious breach of an indenture is redemption, and
that such a redemption may be deemed voluntary for purposes of
payment of a make-whole or other redemption premium. If the holding
stands up on the appeal that is sure to follow, trustees and
noteholders would be afforded another weapon in their arsenal of
enforcement against actual or prospective breaches of indentures.
Also, if the movement toward redrafting of acceleration clauses in
the post-Momentive Performance Materials era is any guide
(see Debt Dialogue, above), we might well see
similar developments codifying the Cash America decision
in the express language of indentures of the future.
For the moment, issuers, noteholders and trustees are advised to
take heed of the additional remedial optionality being offered by
Cash America. Not only might the Cash America
alternative entitle holders to a make-whole premium where none
would be available on straight acceleration, but the deemed
redemption might not trigger cross-acceleration of other series of
debt, which would ordinarily force the issuer into bankruptcy.
Finally, the decision showcases the utility and efficacy of
noteholder communications to an issuer warning of potential or
threatened breaches. By sending such a notice in this case, the
noteholder assured a balance of equities that tilted in its favor.
Left open for another day and decision are the precise contours of
those indenture breaches that are considered "voluntary"
and therefore may give rise to a deemed redemption under the
jurisprudence of Sharon Steel and Cash
America.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.