Determining the Scope of an Indenture Trustee's Duties to BondholdersPublications - Client Alert | November 4, 2016
In the continuing saga of the Lower Bucks Hospital bonds, bankruptcy filings and appeals, the United States District Court for the Eastern District of Pennsylvania recently issued a potentially important decision addressing the scope of an indenture trustee’s duties to bondholders. Becker v. The Bank of New York Mellon Trust Co., N.A., 172 F. Supp. 3d 777 (E.D. Pa. 2016) (Becker). Based on this ruling, it is possible an indenture trustee could be liable for losses incurred by bondholders, notwithstanding fairly standard exculpatory language in a bond indenture, for failing to use reasonable care to preserve bondholders’ rights, including for failing to monitor and maintain the effectiveness of UCC financing statements.
Some background is necessary to place the bondholder’s district court case against the successor trustees in context.
It is important to note that a motion to reconsider the decision was recently denied and the decision may be appealed. In addition, while the language in the bond indenture may be somewhat similar to other bond indentures, it is also worth noting that the decision was based on Pennsylvania law and thus may be distinguishable from the law of New York or another state. The decision is notable at this point, however, because it involves fairly common indenture provisions and the case was not resolved, at least thus far, at the motion stage. Thus, the issues relating to the indentures may need to undergo further court proceedings or a trial.
The Bond Financing
The Becker case concerned $35,980,000 of revenue bonds (the Bonds) issued by The Borough of Langhorne Manor Higher Education and Health Authority (the Authority) in 1992 to finance capital improvements to The Lower Bucks Hospital (the Hospital).1 The Bonds were issued pursuant to a trust indenture (the Indenture) between the Authority and Continental Bank, as initial indenture trustee. The Authority loaned the Bond proceeds to the Hospital under a loan and security agreement (the Loan Agreement) between the Authority and the Hospital. The Hospital’s obligations under the Loan Agreement were secured by a pledge of gross revenues of the Hospital and amounts on deposit in reserve funds, which rights were assigned to the indenture trustee under the Indenture and related bond documents to secure the Bonds. Upon the closing of the bond financing, UCC financing statements were filed in the Hospital’s name, in favor of the Authority and the indenture trustee, to perfect the security interest granted by the Hospital in its gross revenues and other collateral. The initial UCC financing statements were properly continued in 1997 by the filing of continuation statements. All was right with the world.
The Hospital subsequently changed its name to Temple Lower Bucks Hospital, Inc. No UCC amendments were filed to reflect the change in the debtor’s name.2 In addition, the original UCC financing statements subsequently lapsed, rendering the trustee’s security interest in the Hospital’s gross revenues unperfected. Although the financing statements had lapsed, the Hospital subsequently informed J.P. Morgan Trust Company, National Association (JP Morgan), as successor indenture trustee, of the name change. JP Morgan filed a new financing statement in March 2003 correctly naming the Hospital as debtor and perfecting the security interest in the Hospital’s gross revenues. All was again right with the world.
However, matters became complicated when in 2006 the Hospital changed its name a second time, this time to Lower Bucks Hospital, while JP Morgan was still the indenture trustee. Again, no UCC amendments were filed to reflect the debtor’s name change. In addition, The Bank of New York Mellon Trust Company, N.A. (BNYM) later succeeded JP Morgan as indenture trustee. In due course, BNYM filed a UCC continuation statement in 2007 in an effort to continue the trustee’s perfected security interest, but the BNYM continuation statement continued the 2003 financing statement previously filed by JP Morgan under the debtor’s former (and now incorrect) name Temple Lower Bucks Hospital, Inc. On October 16, 2009, three years after BNYM became trustee and over six years after the 2003 financing statement was filed by JP Morgan under the debtor’s former name, Temple Lower Bucks Hospital, Inc., BNYM made two UCC filings: an amendment to the 2003 financing statement correcting the name of the debtor and a new financing statement in the correct name of the debtor. At a minimum, the new financing statement filed by BNYM should have been effective to again perfect the indenture trustee’s security interest in the Hospital’s gross revenues. But all was not right with the world.
The Lower Bucks Hospital Bankruptcy
Within 90 days of BNYM’s new UCC filings, on January 13, 2010 the Hospital filed bankruptcy. The Hospital followed its bankruptcy filing with a complaint to avoid the indenture trustee’s security interest in the gross revenues and reserve accounts. The Hospital asserted that the earlier 2003 financing statement filed in the Hospital’s former name became seriously misleading and ineffective under the UCC because it contained an incorrect debtor name, that such financing statement had lapsed, and that BNYM’s act in filing the new financing statement to perfect the trustee’s security interest in the 90-day period before the bankruptcy filing constituted an avoidable preferential transfer under Section 547 of the Bankruptcy Code. BNYM acted as the representative of the bondholders, as authorized by the indenture, in the Hospital’s bankruptcy, the Hospital’s case seeking to avoid the trustee’s security interest, and in court-ordered mediation to resolve the claims of the bondholders in the Hospital’s bankruptcy. In addition to acting as representative of the bondholders, BNYM also participated in the proceedings in its corporate capacity “to protect its own interests as an indemnitee-creditor of [the Hospital] under the transaction agreements and as a potential defendant in relation to foreseeable claims by bondholders that the security interests and lien had not been properly maintained.” Id. at 784.
After court-ordered mediation, the Hospital, BNYM (as representative of the bondholders and in its corporate capacity) and the unsecured creditors’ committee resolved their claims. Under a settlement stipulation, the trustee received an allowed secured claim in the Hospital’s bankruptcy, on behalf of bondholders, in the amount of $8,150,000, plus amounts on deposit in the reserve funds. In exchange, BNYM released all claims against the Hospital, including the obligation of the Hospital under the bond documents to indemnify BNYM as trustee. As discussed in the district court opinion, BNYM maintained that it had no liability to bondholders for failing to maintain perfection of the security interest. However, to resolve the trustee’s potential liability, and because BNYM would have no claim or other recourse in the bankruptcy case for indemnification, the stipulation required a “third party release” to be added to the Hospital’s plan of reorganization releasing BNYM from liability under any claim from bondholders. The terms of the stipulation were approved by the bankruptcy court and incorporated into the Hospital’s plan of reorganization. But all was still not right with the world.
Becker, a bondholder, requested the bankruptcy court to vacate its order approving the settlement stipulation and objected to confirmation of the Hospital’s plan. Becker asserted, among other things, that bondholders did not receive adequate notice of the settlement stipulation before it was approved, that bondholders were not adequately represented by BNYM as trustee in the settlement proceedings because there was a conflict of interest between BNYM and the bondholders, and that the Hospital’s plan should not be confirmed because it contained the third-party release between BNYM and bondholders. Becker also filed the complaint in the above-referenced case in district court against JP Morgan and BNYM, as successor indenture trustees. As described in the district court opinion, the bankruptcy court confirmed the Hospital’s plan, but without the third-party release.3
The amount of $8,150,000 as provided for in the stipulation and the confirmed plan was paid to BNYM as trustee. However, these funds have not been distributed to bondholders pending resolution of the issues in the Becker case.
The Becker CaseBecker’s complaint against JP Morgan and BNYM as successor indenture trustees, which was filed individually and on behalf of similarly situated holders of Bonds, asserted among other things that the successor trustees breached their fiduciary duties under common law and their contractual duties under the bond documents in failing to maintain the effectiveness of the UCC financing statements.4 The trustees filed motions for summary judgment disclaiming any common law or contractual duty to maintain the effectiveness of the security interest. BNYM also asserted that it held a superior right to a charging lien on the $8,150,000 settlement sum, under the Hospital’s plan and the terms of the Indenture, for the reimbursement of its legal fees.
In their summary judgment motions, the trustees asserted that they owed no duties to bondholders other than those specifically set forth in the Indenture. As noted in the district court opinion, the trustees’ standard of care set forth in the Indenture read: “The Trustee shall not be answerable for the exercise of any discretion or power under this Indenture nor for anything whatever in connection with the trust hereunder, except only its own wilful misconduct or negligence.” Becker 172 F. Supp. 3d at 791. The trustees also cited as further support a Loan Agreement provision providing for the Hospital to indemnify the trustee except for “liabilities caused by gross negligence, or wilful misconduct of the Trustee.” Id. at 790. The trustees asserted that they did not breach this standard of care.
The court disagreed with the trustees’ view that their standard of care was defined solely by the bond documents. The court held that, following the default under the Indenture caused by the Hospital’s bankruptcy filing, the trustees “were fiduciaries of the bondholders’ interests in property-that is, [the Hospital’s] unrestricted gross revenues as well as the security interests, liens, and reserve funds created by the transaction agreements.” Id. at 788. While the nature and extent of a trustee’s powers are to be primarily ascertained from the applicable trust instrument, the court held that a trust instrument “does not exempt a corporate or an indenture trustee from all common-law fiduciary duties.” Id. at 789. The court further reasoned that, notwithstanding the language in the bond documents quoted above, the trustees “can be held liable for negligent conduct-that is, the failure to use reasonable care to assure that the bondholders’ rights and interests were protected and preserved.” Id. at 791. The court also stated that the trustees’ common law duties included a duty to act “with undivided loyalty” toward the bondholders’ interests. Id. The court then determined that triable issues existed, in part based on conflicting expert reports, concerning the scope of the trustees’ standard of care under common law and the related custom and practice in the corporate trust industry.
The trustees also argued that they were not in breach of any contractual duties under the bond documents because they held no contractual duty to maintain the effectiveness of UCC filings. Instead, the trustees stated that the bond documents tasked the Authority and the Hospital with the requirement to maintain the perfection of security interests. In support of their argument, the trustees cited a provision in the Indenture stating that “the Authority shall obtain” a legal opinion on UCC matters no less often than once every five years “as reasonably requested by the Trustee.” Id. at 793. This provision reads in its entirety:
Concurrently with the execution and delivery hereof and thereafter from time to time, as reasonably requested by the Trustee, not less often than once every five (5) years, the Authority shall obtain an opinion of Counsel and furnished a signed copy thereof to the Trustee, setting forth what, if any, actions by the Authority or Trustee should be taken to preserve such security.
Id. The trustees contended that the foregoing language permitted them to obtain an opinion on the status of UCC filings, but did not require them to obtain such an opinion.
The court again declined to rule in favor of the trustees. The court concluded that this provision could be read as either requiring an investigation by the trustees or, alternatively, as granting them discretion to request an investigation. However, even if the provision provided the trustees with discretion to obtain an opinion rather than require them to obtain the opinion, the court reasoned that the trustees were still “plainly required to exercise that discretion ‘not less often than once every five (5) years’” and thus could be liable for failing to exercise that discretion and obtain an opinion. Id. The court also cited a further assurances provision in the Indenture which contained similar language (to the effect that “[t]he Authority shall perform” actions to preserve bondholder rights “as shall reasonably be requested by the Trustee”) and concluded that the further assurances provision could also be read as requiring the trustees to take affirmative action to ensure the bondholders’ rights were preserved. Id. at 793-4. The court concluded, however, that because these provisions could be read as being either permissive or as providing the trustees with affirmative duties to monitor and preserve the applicable UCC filings, the provisions were ambiguous. Accordingly, the court concluded that summary judgment could not be granted on the trustees’ contractual duties because triable issues existed concerning the intent and meaning of these provisions of the bond documents.
BNYM also asserted reimbursement rights and a charging lien on the $8,150,000 settlement sum for the payment of its legal fees. In sum, the court distinguished between the fees incurred by BNYM before confirmation of the Hospital’s plan (when claim resolution and negotiations were taking place) and the fees incurred after the plan was confirmed (when the bond documents were cancelled upon the payment of the settlement sum and the proceedings focused only on BNYM’s requested third-party release from bondholder liability). The court held that BNYM’s right to charge the settlement sum for legal fees incurred before plan confirmation should be resolved at trial, but struck down each of BNYM’s arguments to recover legal fees incurred post-confirmation. The court stated that: “After the effective date of the Plan, BNYM asserted the third party release before the bankruptcy court and appellate tribunals to protect only its personal interests. BNYM should bear the risks and the costs of its chosen strategy.” Id. at 802.
As set forth above, the decision is not a final adjudication of the issues presented herein. The decision is nevertheless notable at this point because it was not resolved, at least thus far, at the motion stage despite the fairly common indenture provisions at issue and may need to undergo further court proceedings.
Based on the district court’s ruling, it is possible that an indenture trustee could be found liable for losses incurred by bondholders, based on fiduciary and common law duties, despite the type of exculpatory language at issue in the Becker bond documents. The document provisions in this instance were, at least at the initial motion stage, insufficient to obtain a summary judgment ruling avoiding such liability. Instead, absent an appeal, settlement or other resolution, the liability issues in this case may need to proceed to trial. Moreover, absent such an appeal, settlement or other resolution of the issues in this case, it does not appear that the legal fees incurred by BNYM in connection with such trial would be reimbursed from the settlement sum.
In addition, many of the document provisions quoted above are similar to provisions in other bond financings. Thus, the reasoning of the Becker decision, and any further rulings from a trial or appeal of the issues set forth herein, could have broader application to the scope and nature of an indenture trustee’s duties in many other bond transactions. Further proceedings in the Becker case may determine in more detail the nature and scope of an indenture trustee’s common law and contractual duties, including, in particular, whether a trustee’s failure to monitor and maintain the effectiveness of UCC filings could constitute a breach which gives rise to a trustee’s liability to bondholders. It is also worth noting that, while the language in the bond indenture may be similar to other bond indentures, the Becker decision was based on Pennsylvania law and thus could be distinguishable from the law of New York or another state.
The Becker case also focused only on the language in the bond documents at issue. Thus, bond documents with different provisions, such as those that more specifically or expressly define the nature and scope of an indenture trustee’s duties or that expressly exclude matters from a trustee’s duties (such as monitoring and maintaining the effectiveness of UCC filings or other matters), could possibly lead to a different result.
Last, the court in another recent case declined to rule in favor of a trustee on whether the trustee’s duties required it to file a proof of claim in a bankruptcy case at issue and on the scope of the trustee’s indemnification rights. See FMS Bonds, Inc. v. Bank of New York Mellon, No. 15 Civ. 9375 (ER), 2016 WL 4059155 (S.D.N.Y. July 28, 2016). The court in such case determined that issues of material fact existed which precluded a ruling in favor of the trustee at the motion stage. In addition, prior to the Becker ruling, other courts have held that indenture trustees subject to the Trust Indenture Act of 1939 may be required by such law to obtain the consent of bondholders in out-of-court restructurings that impair bondholders’ ability to receive payments on their bonds. See generally Marblegate Asset Mgmt. v. Education Mgmt. Corp., 75 F. Supp. 3d 592 (S.D.N.Y. 2014); Marblegate Asset Mgmt., LLC v. Educ. Mgmt. Corp., 111 F. Supp. 3d 542 (S.D.N.Y. 2015); MeehanCombs Glob. Credit Opportunities Funds, LP v. Caesars Entm't Corp., 80 F. Supp. 3d 507 (S.D.N.Y. 2015); BOKF, N.A., v. Caesars Entm't Corp., 144 F. Supp. 3d 459 (S.D.N.Y. 2015). These cases were in separate contexts from the Becker case, and certain of them focused on the terms of the Trust Indenture Act of 1939. However, these cases, like the Becker ruling, may show that greater scrutiny could be imposed on a trustee’s actions in cases where payments to bondholders are at stake or are being compromised. The purpose of this alert is to provide general information about industry developments, but does not attempt to assess the merits of the case or of any argument.
For additional information, please contact your Kutak Rock attorney, a member of our Bankruptcy group, or the author of this client alert.
1 The discussion herein is intended to be a general overview, and not a detailed examination of all proceedings and motions.
2 Generally speaking, an amendment of the UCC financing statements to reflect the correct name of the debtor would have been necessary to continue the trustee’s perfected security interest in future revenues generated by the Hospital.
3 The bankruptcy court had concluded, in In re Lower Bucks Hosp., 471 B.R. 419 (Bankr. E.D. Pa. 2012), that the addition of the indenture trustee among the other parties released from liability under the Hospital’s plan was not adequately disclosed, and the court declined to enforce the third-party release in favor of the trustee.
4 A separate complaint was filed against each successor trustee, but the complaints were later consolidated. Also, Becker’s motion for class certification, to include all bondholders, was granted on October 5, 2016.