Court's 'No-Action' Clause Holding May Surprise Bond Issuers

In Quadrant Structured Products v. Vertin, the New York Court of Appeals recently made clear that no-action clauses in trust indentures will be “strictly construed” to give precise meaning to the words and language used in the agreements.¹ The court found that a no-action clause that specifically precludes minority bondholder enforcement of claims arising “by virtue or availing of” the indenture but does not expressly reference claims relating to “the Securities,” must be read narrowly to preclude only contractual indenture claims and not common law or statutory claims relating to the securities governed by the indenture.² This ruling may surprise some bond issuers who have assumed that this commonly-used form of no-action provision precluded all minority bondholder suits, which are often viewed as “strike suits” and can be unpopular with other bondholders.

Purpose of No-Action Clauses

The primary purpose of a no-action clause in a trust indenture is to deter minority securityholders from asserting duplicative, frivolous, or otherwise economically inefficient claims against the corporation at the expense of the majority’s interest.³ No-action clauses generally achieve these goals by channeling securityholder actions through a trustee, who is given the sole authority to initiate and prosecute lawsuits to enforce the rights of securityholders, but only when a specified majority of holders agree that such action makes sense.⁴ The trustee’s power to act for the bondholders is typically activated by majority vote and is meant to restrict such actions to situations where all bondholders anticipate a benefit. Delaware courts have generally construed no-action clauses broadly, as evidenced by Feldbaum and Lange, so as to limit bondholder suits where individual bondholders arguably seek an opportunistic advantage.⁵ In Feldbaum and Lange, the Chancery Court construed the no-action clauses, which barred securityholders from pursuing remedies under “this Indenture or the Securities,” to cover both contractual claims related to the indenture agreements and any claims that individuals may have as securityholders.⁶

Summary of ‘Quadrant’