Commercial Division Blog

Posted: July 23, 2020 / Categories Commercial, Contracts

Indenture Did Not Permit Trustee to Sue to Protect Investor's Rights Until There was an Event of Default

On July 16, 2020, Justice Schecter of the New York County Commercial Division issued a decision in UMB Bank, N.A. v. Neiman Marcus Group, Inc., 2020 NY Slip Op. 20170, holding that an indenture did not permit a trustee to sue to protect investor's rights until there was an event of default, explaining:

Whether the Trustee has standing to assert pre-Event-of-Default fraudulent conveyance and tortious interference claims is a question of first impression in New York.

The words actually used in the Indentures are ultimately dispositive. In Cortlandt St. Recovery Corp., based on a provision almost identical to section 6.3, the New York State Court of Appeals held that an indenture trustee has standing to assert a post-event-of-default claim because an attempt to secure payment, and resolution is of interest to the entire class of security holders. Significantly, the Court concluded that the trustee's standing derived strictly from the indenture, not from any inherent authority to generally vindicate noteholders' rights. The analysis turned on the plain language of the indenture, because an indenture trustee is not a traditional common law fiduciary but rather a stakeholder whose duties and obligations are exclusively defined by the terms of the indenture. A trustee's power and authority is thus generally limited to that which is provided in the indenture.

The Court of Appeals was clear, moreover, that post-default, the indenture broadly authorized the trustee to pursue any available remedy, including fraudulent conveyance claims, to remedy an injury common to all noteholders arising from the failure to repay. After all, a payment default deprives noteholders of the money they are owed, and if repayment can only occur by pursuing a fraudulent conveyance claim, the trustee must be the one to bring it.

Here, by contrast, the Trustee could not bring the action pursuant to section 6.3. When this action was commenced, the Noteholders had not suffered a missed payment, the Notes had not matured, and there had been no default. Nor could it maintain this suit based on Section 6.5.

Section 6.5 is not an independent source of authority for the Trustee to act. It simply details how Noteholders may direct the Trustee to conduct any proceeding for any remedy that is already available to the Trustee or of exercising any trust or power already "conferred on the Trustee. The remedies that are available to and powers that are conferred on the Trustee are set forth in other provisions of the Indentures, such as section 6.3. In all of those provisions, an Event of Default is a threshold requirement. This is true of section 6.3's scope of authority and it is the first condition of the no-action clause set forth in section 6.6. Read as a whole, including sections 7.1(a) and 7.1(b) that address the Duties of the Trustee after an Event of Default, it is clear that the Indentures only permit Trustee actions after an Event of Default. Nowhere in the Indentures is any pre-Event-of-Default Trustee action contemplated. Section 6.5 only allows Noteholders to direct the Trustee with regard to any remedy that the Indentures make available to it, and the Indentures only make the remedy of asserting tort claims available if an Event of Default occurs and is continuing.

When the Trustee brought this suit, it lacked the ability to take action to secure payment. While there are certainly prophylactic benefits to unwinding pre-Event-of-Default fraudulent conveyances, had the parties wished to confer that right on the Trustee, they could have easily done so expressly in the Indentures.

Public policy compels this conclusion as well. These are sophisticated parties engaged in a sophisticated commercial transaction involving a Trustee with authority stemming solely from their own intricate agreements. Their contracts must be enforced in the most predicable manner consistent with their clear terms. In this complex commercial context, general notions of equity cannot be used to deviate from this mandate. Any negative market consequences can be easily remedied. Deal documents can provide trustees with broader pre-default rights, and the market can price deals accordingly. It is in the contracting parties' hands. The market is better suited to address these concerns at the outset rather than courts creating new rules that do not comport with settled law and expectations.

Because the Trustee lacks standing to commence a pre-Event-of-Default action, dismissal of all claims is mandated without prejudice to the proper commencement of a new action.

(Internal quotations and citations omitted).

Schlam Stone & Dolan represents investors in litigation relating to financial structures like the one at issue here. If you or a client questions regarding potential claims relating to such a structure, contact Schlam Stone & Dolan partner John Lundin at