Decision Challenges Efficacy of Liability Management Strategies

The recent decision by the U.S. Court of Appeals for the Second Circuit in Chesapeake Energy v. Bank of New York Mellon Trust, No. 15-2366-CV, 2016 WL 4895581 (2d Cir. Sept. 15, 2016) reaffirms the prudence of requiring a final order and rewards the appellant for persevering despite its adversary’s determination to act upon a declaratory judgment subject to appeal. In an era of robust review of indenture provisions and the Trust Indenture Act, as well as accordion and similar basket provisions in credit agreements in the wake of Marblegate, Caesars, iHeartMedia and Arch Coal, the role of the courts in formulating strategies designed to provide optionality and additional time, even additional borrowed cash, to highly leveraged companies facing liquidity or other restrictions arising from the documents governing their funded indebtedness cannot be underestimated. Debtholders are sophisticated, comfortable in court, and often well funded. Companies are subject to complex capital structures, often including first and second lien debt, as well as publicly traded bond debt. Companies are often the beneficiaries of so-called “covenant lite” debt terms and baskets for investment and additional debt (including secured debt) which at times may be implemented with asset transfers or designation of “unrestricted” subsidiary affiliates. The amounts involved in any given liability management tactic can run into the hundreds of millions of dollars. Generally the debt documents are governed by New York law. Often, companies and their debtholders disagree on the extent of permitted activities. Hence, resort to the courts for a determination of the permissibility of a contemplated action may be a condition to executing on a disputed strategy. Chesapeake involved a dispute between bondholders and the issuing company regarding whether a “make whole” or pre-payment premium was required when the bond issue was refinanced. While the issue was discreet, the efficacy of a resort to the court for a speedy determination is now subject to question if there is an appeal pending—even one without a stay pending appeal.

Background

In February 2012, Chesapeake Energy, a publicly-traded Oklahoma corporation which produces oil and natural gas, issued $1.3 billion in senior notes due in 2019 (the Notes). One of the two indentures governing the Notes established two types of early redemption rights, exercisable at Chesapeake’s option—an early redemption at a lower “At-Par” price (equal to 100 percent of the principal amount plus accrued and unpaid interest), exercisable at “any time from and including Nov. 15, 2012 to and including March 15, 2013,” and redemption at a higher “Make-Whole” price (equal to the sum of the present value of the principal of the Notes and remaining interest payments) exercisable at any time after March 15, 2013. The early redemption option required that Chesapeake provide notice of the redemption at least 30 days, but not more than 60 days before the date of redemption.