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First Department Holds Compliance with No-Action Clause in Indenture Was Excused on Futility Grounds

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  • Posted on: Nov 7 2018

Practitioners and their clients involved in bond offerings or other credit instruments are no strangers to trust indentures. These agreements typically contain a no-action clause, the primary purpose of which is to deter minority securityholders from filing duplicative, economically inefficient, or otherwise meritless lawsuits against the issuer, servicer, or other third party at the expense of the majority’s interest.

No-action clauses generally achieve these purposes by funneling 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 number of holders agree that such action is appropriate. The trustee’s power to act for bondholders is typically triggered by a majority vote and situations in which all bondholders will benefit from such action.

Delaware courts have generally construed no-action clauses broadly.  E.g., Feldbaum v. McCrory Corp., 1992 WL 119095 (Del. Ch. June 1, 1992); Lange v. Citibank, N.A., 2002 WL 2005728, *1 (Del. Ch. Aug. 13, 2002). In Feldbaum and Lange, the Court of Chancery 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 might possess as securityholders.

In Quadrant Structured Products v. Vertin, 23 N.Y.3d 549 (2014), the New York Court of Appeals, answering a certified question from the Delaware Supreme Court, held that a no-action clause that bars claims brought “upon or under or with respect to” an indenture will not bar all claims by investors against other parties to the indenture.

In Quadrant, a minority holder of notes asserted various claims, directly and derivatively, against the issuer of the notes, the issuer’s officers and directors, the issuer’s parent corporation, and an affiliated entity for, inter alia, alleged breaches of fiduciary duty and fraudulent transfers. The claims arose from, among other things, the issuer’s exposure to credit default swap obligations incurred during the 2008 financial crisis. The defendants moved to dismiss the complaint, arguing that the plaintiff’s claims were barred by a no-action clause in the governing indenture, which “permitted only Trustee-initiated suits upon request of a majority of securityholders, and prohibited individual securityholder actions.” 23 N.Y.3d at 557. The Delaware Court of Chancery dismissed the complaint.

Following a number of appeals concerning the application of New York law, which governed under the indenture, the Delaware Supreme Court certified the following question to the New York Court of Appeals:

A trust indenture no-action clause expressly precludes a security holder who fails to comply with that clause’s preconditions, from initiating any action or proceeding upon or under or with respect to “this Indenture” but makes no reference to actions or proceedings pertaining to “the Securities.”

The question is whether, under New York law, the absence of any reference in the no-action clause to “the Securities” precludes enforcement only of contractual claims arising under the Indenture, or whether the clause also precludes enforcement of all common law and statutory claims that security holders as a group may have.

In answering the question, the Court of Appeals held that under New York law, a no-action clause that covers any action alleging claims “upon or under or with respect to” the indenture will bar contract claims based on the indenture only but will not bar investors’ other common law or statutory claims.

As these cases illustrate, a no-action clause, like the Athilon clause, that refers only to actions under the indenture, is limited by its language to indenture-based contract claims. However, a no-action clause similar to the clauses in Feldbaum and Lange, that refers specifically to claims and remedies arising under the indenture and the securities, applies to all claims, except those excluded from coverage as a matter of law. Here, the Athilon no-action clause when strictly construed and afforded its plain meaning, makes no reference to the securities, and therefore does not apply to claims arising outside the scope of the indenture. Accordingly, we agree with the Delaware Chancery Court’s Report on Remand that Feldbaum and Lange are distinguishable, and the Athilon no-action clause applies only to contract claims under the indenture, not to Quadrant’s common-law and statutory claims.

Quadrant, 23 N.Y.3d at 564.

In reaching its decision, the Court found that the indenture was clear and unambiguous and interpreted the indenture in accordance with its plain meaning. Id. at 564 (“As we have discussed, the no-action clause is clear on its face and applies to indenture contract claims only.”). It further observed that a no-action clause must be “construed strictly” and “read narrowly.” Id. at 560 (“we read a no-action clause to give effect to the precise words and language used, for the clause must be ‘strictly construed’” and “[a]pplying these well[-] established principles of contract interpretation, and with the understanding that no-action clauses are to be construed strictly and thus read narrowly….”).

With these principles of contract interpretation in mind, the Court found that the specific reference in the no-action clause to the indenture and the omission of an express reference to the securities barred the initiation of indenture-related contract claims only, not common law and statutory claims relating to the underlying securities.

Last month, the Appellate Division, First Department, addressed the question whether the plaintiffs’ claimed failure to comply with a no-action clause in an indenture precluded them from asserting their breach of contract claims. In Blackrock Balanced Capital Portfolio (FI) v. U.S. Bank N.A., 2018 N.Y. Slip Op. 06990 (1st Dept. Oct. 18, 2018) (here), the Court, applying Quadrant, held that the plaintiffs’ failure to comply with the no-action clauses was excused because it would have been futile to demand the trustee commence an action against itself for breaches of the governing Pooling and Service Agreements (“PSA”).

Blackrock involved breach of contract allegations by holders of certificates issued by residential mortgage-backed securities trusts of which U.S. Bank is the trustee. The complaint alleged that the trustee breached its obligations under the PSAs by failing to provide notices to cure to servicers once it gained knowledge of certain servicing breaches and by failing to make prudent decisions concerning the events of default.

The Court rejected the defendant’s argument that all of the plaintiffs’ breach of contract claims had to be dismissed because the plaintiffs failed to allege compliance with the requirements of the no-action clauses in each of the PSAs. The Court found that “[c]ompliance with the clauses was excused because it would be futile to demand that the trustee commence an action against itself for breaches of the PSA.” Quadrant, 23 N.Y.3d at 566; see also Cruden v. Bank of New York, 957 F.2d 961, 968 (2d Cir. 1992) (no-action clause will not bar security holder suit against Trustee because “it would be absurd to require the debenture holders to ask the Trustee to sue itself”). “Once performance of the demand requirement in the no-action clause is excused,” noted the Court, “performance of the entire provision is excused, including the requirement that demand be made by 25% of the certificate holders. Thus, under well-established rules for contract interpretation (Quadrant, 23 N.Y.3d at 560), the Court concluded that there was “no basis for requiring that the suit be supported by 25% of certificate holders.” BlackRock Core Bond Portfolio v. US Bank Natl. Assn., 165 F. Supp. 3d 80, 97-99 (S.D.N.Y. 2016).


A no-action clause typically channels the right to initiate lawsuits to the indenture trustee and conditions the commencement of any litigation upon the demand of the majority or some other threshold of securityholders. In New York, such clauses are “construed strictly” and applied “narrowly.” For this reason, the language used in a no-action clause to define the scope of the limitation is critical. In Quadrant, the language used made the difference between allowing or barring securityholders the right to commence their own lawsuit. As the Quadrant court noted, trust indentures and no-action clauses contained therein, like all contracts, will be interpreted using the traditional rules of contract interpretation. Thus, a no-action clause that refers specifically to claims and remedies arising under the indenture and the securities issued pursuant thereto, applies to all claims and bars the securityholders from initiating their own litigation. However, where the no-action clause makes no reference to the securities being issued, it does not bar claims that arise outside the scope of the indenture.

As Quadrant makes clear, the importance of contract interpretation in the no-action clause/trust indenture context cannot be emphasized enough. Quadrant, 23 N.Y.3d at 560, 564 (courts interpreting no-action clauses should “give effect to the precise words and language used”). Indeed, it was the underpinning of the Blackrock court’s decision. Under the no-action provision of the PSAs, the trustee was the demand party for claims against the issuer or third parties. Compliance with the demand requirement was, therefore, excused because the securityholders were asking the trustee to sue itself, not the issuer or other third parties.

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