Financial fraud is complex. The schemes cooked up by fraudsters are intricate, and the financial maneuvers used are often difficult to follow. The fraud alleged in Cortlandt Street Recovery Corp. v Bonderman (No. 14) is no different.
Breaking it down to the extent I can, a number of private equity investors were interested in acquiring a profitable and debt-free telecom company in Greece, and set up a group of shell companies in Luxembourg to make the buy. The group, called Hellas Group, borrowed heavily (about €1.6 billion) to buy the Greek company, and had very little equity to repay the loans. In another round of borrowing in 2006, Hellas Finance (a subsidiary of Hellas Group) borrowed €200 million in exchange for payment-in-kind notes, which were governed by the indenture that is the focus of this case.
What’s an indenture? An indenture is a legal agreement that vests title of securities, like the payment-in-kind notes here, in a single trustee who is given certain specified powers to act on behalf of all of the noteholders. It’s usually tough to get all noteholders who may have different interests to act collectively, so the appointment of the indenture trustee to act on their collective behalf helps to solve that problem. Generally included in the bundle of rights given to the indenture trustee, which are limited to what’s in the agreement, is the right to bring suit to recover the principal, interest, costs, and fees in the event that the investment tanks and the debtor defaults.
In Cortlandt Street Recovery Corp., at the same time that Hellas Finance issued the payment-in-kind notes, Hellas the parent redeemed €973.7 million in convertible preferred equity certificates, and paid the cash to the private equity investors. For a more in depth look at the Hellas investments, read this Economist piece. When the global financial crisis hit, Hellas Finance defaulted on the payment-in-kind notes, as did another Hellas subsidiary that had guaranteed the notes.
The indenture trustee, on behalf of all of the noteholders, brought an action to recover the €200 million and interest from Hellas, a number of the Hellas subsidiaries, and the private equity investors, alleging that the convertible preferred equity certificate redemptions were fraudulently intended to render Hellas Finance, the primary debtor, insolvent. Even though the private equity investors weren’t parties to the payment-in-kind notes, the indenture trustee alleged claims against them for breach of contract, fraudulent conveyances, unlawful corporate distribution, and unjust enrichment, and sought to pierce the corporate veil on an alter ego theory.
The private equity investors moved to dismiss, and Supreme Court granted the motion. The Court held that the indenture that specified the indenture trustee’s powers and rights did not allow it to sue for recovery for the alleged fraud. The Court also dismissed the alter ego claims.
The Appellate Division, First Department modified the order on appeal, and reinstated the indenture trustee’s claims against the private equity investors. The Court held, the indenture governing recovery for default under the payment-in-kind notes “confers standing on the trustee to pursue . . . the fraudulent conveyance and other . . . claims, which seek recovery solely of the amounts due under the notes, for the benefit of all noteholders on a pro rata basis, as a remedy for an alleged injury suffered ratably by all noteholders by reason of their status as note holders” (Cortlandt St. Recovery Corp. v Hellas Telecommunications, S.à.r.l., 142 AD3d 833, 833-834 [1st Dept 2016]). The Appellate Division also reinstated the alter ego theory claims, and then granted leave to the Court of Appeals.
Because the right of the indenture trustee to bring suit is defined by the indenture agreement, the Court of Appeals began its analysis with normal principles of contract law. A contract means what its unambiguous words say. The contract’s language has to be read in context of the obligations. And a court can’t read any language of an agreement to be meaningless. In this case, the indenture agreement provided:
If an Event of Default occurs and is continuing, the Trustee may pursue any available remedy to collect the payment of principal, premium, if any, and interest on the Notes or to enforce the performance of any provision of the Notes or this Indenture.
That’s pretty clear, the Court held. “[A]ny available remedy” means any remedy at law or in equity. “The plain meaning of section 6.03, then, is to authorize a trustee to pursue any lawful means of enforcing the noteholders’ rights, against any individual or entity, based on any viable theory of recovery in order to secure repayment upon the event of a default on the debt to noteholders” (Opn, at 10).
In the context of this case, that means that the indenture trustee isn’t just limited to asserting claims against Hellas Finance, as the debtor, or the Hellas subsidiary, as the guarantor. It can go after the private equity investors too, as long as the recovery it is seeking is for the principal, interest, and related costs of the payment-in-kind notes on behalf of all of the noteholders.
The Court, in dicta, also noted that its plain meaning interpretation of the indenture was consistent with the interpretation of the virtually identical language of the Revised Model Simplified Indenture, and the related commentary by the American Bar Association. The model indenture, the Court noted, appears to have been the form for the indenture in this case, and so the parties surely would have expected the two to have been given the same construction.
The Court was careful to caution, however, that this interpretation of the indenture only holds for post-agreement fraud, like the one alleged here. For fraudulent inducement claims based on pre-indenture misrepresentations, the interpretation is different. In that kind of case, the “any available remedy” language does not give the indenture trustee any right to bring claims for violations of the federal or state securities laws, primarily because the individual noteholders likely will be in different positions, which could create conflicts for the trustee, and can bring their own claims.
Like the Appellate Division, the Court of Appeals too agreed that the indenture trustee had validly stated alter ego theories against the private equity investors. Whether the trustee can make out that case, however, is a different question for a different day.
The case will now proceed back in the trial court, with the indenture trustee trying to show that this all was just a massive fraud to line the private equity investors’ pockets, and the investors arguing that these were legitimate recapitalization efforts that just didn’t end up working out. I’ll leave it to the financial investment experts to guess how that’s going to come out.
The Court of Appeals’ opinion can be found here.
New York Appeals 