New York Court’s Ruling Could Have Broader Implications for No-Action Clauses
August 26, 2021
Priming transactions have grown in frequency during the pandemic, and with them, new ways to test the limits of credit agreement provisions. In a recent example, lenders to struggling restaurant-supplier TriMark entered into a transaction whereby they provided new money to TriMark, primed non-participating existing lenders, and then amended the existing credit agreement to broaden the contract’s “no-action clause” to make it difficult for non-participating lenders to bring suit under the credit agreement. It didn’t work. On August 16, 2021, the New York Supreme Court in Audax Credit Opp. v. TMK Hawk Parent, Corp. permitted the non-participating lenders’ lawsuit to go forward. The ruling could have broad implications for leveraged finance transactions and inter-lender liability because the Court rejected defendants’ reliance on the no-action clause to argue that the non-participating lenders lacked standing to bring the suit.
Background on No-Action Clauses
No-action clauses are a common feature in indentures and credit agreements. They typically limit the right of individual lenders or bondholders to bring an action unless: (i) the lender has given written notice to the trustee of a “continuing Event of Default,” (ii) the holders of at least 25% of the principal amount have made a written request to the trustee to institute a suit, (iii) the holders have offered to indemnify the trustee, (iv) the trustee has failed to bring the suit within 60 days of notice, and (v) no direction inconsistent with the request for a suit has been given to the trustee by a majority of the holders. There are two purposes for these clauses. First, they deter individual lenders from bringing their own claims for unjustifiable or frivolous reasons, causing expense to the company and diminishing its assets, and second, they ensure that remedies pursued under the loan will benefit all of its holders.1 While no-action clauses are customary in credit agreements and generally enforceable under New York law absent certain circumstances, they are also construed strictly and read narrowly.2
The TriMark Litigation
In response to significant financial distress caused in part by the pandemic’s effect on the restaurant industry, in September 2020, TriMark issued $120 million of new super senior debt to the lender defendants, secured by the same collateral that secured TriMark’s existing first-lien debt. The transaction had the effect of injecting substantial liquidity into TriMark at a very uncertain time. The transaction included an agreement between TriMark and the lenders who participated in the liquidity transaction to amend the terms of the original credit agreement to eliminate the restrictions on TriMark’s issuance of incremental senior debt. TriMark also issued $307.5 million of new super senior debt to these same lenders through a dollar-for-dollar exchange for the lender defendants’ existing $307.5 million face amount of first-lien debt. The effect of this transaction was to push down non-participating lenders in the capital structure, effectively transforming their first-lien debt to third-lien debt, and causing the market value of their loans to plummet.
To protect the transaction from challenge by the non-participating lenders, the lender defendants broadened the no-action clause in the original credit agreement, precluding lenders from “tak[ing] or institute[ing] any actions or proceedings, judicial or otherwise, for any... right or remedy or assert[ing] any other Cause of Action,” not only against TriMark, but also against the lender defendants. Instead, the amendment required the lenders to direct the administrative agent to sue, and post a cash indemnity of all fees and costs that the administrative agent determined could be incurred in connection with the suit.
Denouncing the transaction as a “cannibalistic assault,” in November 2020, the non-participating lenders brought suit (1) against the lender defendants and TriMark for a declaratory judgment that the amended credit agreement was void, breaches of the original credit agreement, breaches of the implied covenant of good faith and fair dealing, and violations of the New York Uniform Voidable Transactions Act, and (2) against TriMark’s private equity sponsors for tortious interference with the credit agreement. The Court dismissed all of the claims except for the declaratory relief and breach of contract claims, focusing principally on whether the amendments to the credit agreement were invalid because they impacted lenders “sacred rights” granted under the credit agreement, thereby requiring plaintiffs’ consent.
The No-Action Clause Ruling
In response to the lawsuit, the lender defendants argued that plaintiffs lacked standing because they did not comply with the amended no-action clause or provide a cash indemnity and request that the administrative agent initiate the litigation. The Court rejected this argument, reasoning that no-action clauses are generally enforceable because they reflect an “ex ante agreement to sacrifice certain individual rights for the ‘salutary purpose’ of benefitting the venture as a whole,” and here, there was no ex ante agreement or salutary benefit. Plaintiffs never consented to the broadening of the no-action provision, and the provision could not reflect an arms’ length agreement since the lender defendants crafted it with the sole intention of immediately exiting the contract. Moreover, there was no “salutary purpose” to benefit the venture because the amendment was done as an act of self-interest to prohibit plaintiffs from suing the lender defendants.
Potential Implications
While the Court emphasized that “[t]his holding is confined to the allegations made in the Complaint and does not reflect hostility to no-action provisions in general,” the Court’s ruling could potentially have broader implications for future transactions and litigations. On one hand, this is clearly not a typical case, and the Court was particularly troubled by the lender defendants’ amendment of the no-action provision, which is out of step with industry norms. As the Court noted, “[t]he parties have not cited, and the Court has not found, any case in which a no-action provision was strategically deployed in a manner alleged here... as part of a larger scheme to breach and then exit the agreement.” It goes without saying that amending a contract prospectively to kill a lawsuit is going to raise any judge’s eyebrow.
But the Court’s commentary on no-action clauses potentially suggests a broader ruling. The Court refused to enforce the amended no-action clause because doing so would not effectuate a principle purpose of such clauses, to protect an issuer from multiple claims from different lenders, in order to protect the venture as a whole. While there is a logic to this ruling, that limitation is not found in the plain language of no-action clauses and could create difficulty for lenders seeking to enforce bargained-for no-action clauses in future inter-lender disputes if such enforcement is held to that standard. It will have to be seen if courts read such a broad rule into the TriMark court’s holding, or if they continue to enforce the plain language of no-action clauses.
1See Quadrant Structured Prods. Co., Ltd. v. Vertin, 23 N.Y. 3d 549, 560 (2014); see also Feldbaum v. McCrory Corp., Civ. A. No. 11866, 18 Del. J. Corp. L. 630, 1992 WL 119095, at *6 (Del. Ch. June 2, 1992) (“The primary purpose of a no-action clause is thus to protect issuers from the expense involved in defending lawsuits that are either frivolous or otherwise not in the economic interest of the corporation or its creditors.”).
2See Quadrant Structured Prods., 23 N.Y. 3d at 565; Anato Opportunity Fund I, LP v. Wells Fargo Bank, N.A., 153 A.D. 3d 1161, 1162 (1st Dep’t 2017).
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