Moderating bondholder activism with no-action clauses: it's all a matter of interpretation 


September 2013

Bankruptcy and Insolvency Bulletin

The ability of individual bondholders to pursue legal remedies when they disagree with actions being taken by an issuer can be a powerful tool. In some instances bondholder activism has been tempered by a provision (a "no-action clause") embedded in most trust indentures that restricts individual bondholders from taking legal action in relation to claims that are considered to be common to other bondholders. Recently, in The Catalyst Capital Group Inc. v Data & Audio-Visual Enterprises Wireless Inc. et al ("Wireless"),1 the Ontario Superior Court of Justice held that a no-action clause did not bar a noteholder from pursuing an oppression application under Canadian corporate law.2 Fortunately for the litigating bondholder in Wireless, the Court dismissed a motion by the issuer to stay the noteholder's litigation based on the no-action clause.

The features of no-action clauses typically require bondholders to comply with stipulated preconditions, which include notice to the indenture trustee of an event of default under the indenture, a request by the holders of a prescribed percentage of bondholders for the indenture trustee to pursue an action, the offer of satisfactory security and/or or indemnity to the indenture trustee in relation to losses, liabilities or expenses for taking the requested action, a certain period of days for the indenture trustee to comply with the request and the indenture trustee not receiving, during such waiting period, instructions from a majority of bondholders that are inconsistent with the request.

Courts in the U.S. have explained the rationale for no-action clauses on the basis that by "purchasing bonds, plaintiffs waive their rights to bring claims that are common to all bondholders", including actions against issuers and non-issuer defendants.3 The proposition that a no-action clause should be broadly interpreted is supported by the policy consideration that suits which seek to enforce rights or interests shared ratably by all bondholders should be prosecuted by the indenture trustee on behalf of all noteholders.4 Such clauses also have been said to protect against the exercise of poor judgment by a single or minority group of bondholders who might wish to pursue actions that other bondholders might not consider in their best economic interests5 and to "prevent rash, precipitate, or harassing suits by bondholders who disrupt corporate affairs."6 U.S. courts also point out that no-action clauses often are drafted such that their scope depends on the nature of the claim sought rather than the identity of the defendant.7

Relatively few Canadian courts have been called on to determine the applicability of a no-action clause to legal actions independently pursued by bondholders. The Wireless decision provides some welcome guidance regarding the effectiveness of a no-action clause in relation to a claim that does not directly arise from a default in payment of principal or interest or other provision of the indenture, but rather involves an injury or claim arising from the plaintiff's status as a holder of notes or bonds.

Catalyst Capital Group Inc. ("Catalyst") was a significant creditor of Wireless that held over 25% of the principal amount of the notes issued pursuant to an indenture (the "Indenture"). Wireless required additional financing, which it arranged pursuant to secondary financing with subordinated notes issued to certain of the existing noteholders under the Indenture other than Catalyst (the "Unknown Purchasers").

When Wireless began to source additional secondary financing, Catalyst offered to provide a refinancing package that included consolidating existing debt with additional debt in favour of Catalyst. Instead, Wireless chose to proceed with the secondary financing through a second debenture in favour of the Unknown Purchasers. In response, Catalyst launched an oppression remedy application, alleging that the secondary financing had unusual and prejudicial features, including in relation to financial terms, maturity date, interest rate, fees and insufficient subordination of the notes. It formulated its claim as arising from the conduct of Wireless in entering into the new financing, and the oppressive result of such new financing.8 Catalyst further alleged that the trustee under the Indenture, who was also the collateral agent for security granted for Wireless' obligations under the Indenture (the "Trustee"), had placed itself in a position of conflict by acting as the collateral agent under the second financing.

Wireless took the position that Catalyst's application was barred because Catalyst had not complied with the notice to the Trustee and other provisions of the no-action clause under the Indenture. Section 6.06 of the Indenture stipulated that (except to enforce the right to receive specified payments under the Indenture), no noteholder could pursue a remedy "with respect to the Indenture or the Notes unless" it satisfied five contractual steps.9 Wireless encouraged the Court to give a broad application to the phrase "with respect to" used in section 6.06, relying on the reasoning of other Ontario decisions that had broadly construed the application of similar no-action clauses.10

Catalyst maintained it was entitled to proceed with its application on the basis that (a) the no-action clause did not apply to oppression claims, (b) there had not been an "Event of Default", as defined under the Indenture, and therefore the claim was not one the Trustee could bring; and (c) even if the clause were held to apply, there existed exceptions that would allow its action to proceed. As Catalyst was not complaining about any default under the Indenture, it maintained that its application for relief from oppression was outside the scope of the no-action clause and that the clause did not apply. In support of its position, Catalyst relied on the narrow construction of a no-action clause by the Court in Millgate Financial Corp. v BF Realty Holdings Ltd. ("Millgate").11 In Millgate, the Court held that the no-action clause in the trust indenture did not prevent holders of debentures from bringing legal proceedings for claims other than a default of contractual obligations by reason of the payment of principal and interest on the debentures being in default.

After reviewing the no-action clause and other terms of the Indenture, the Court in Wireless refused to stay Catalyst's application. In coming to its decision, the Court referred to the few Canadian authorities that had considered no-action clauses under trust indentures, observing that "what emerges from these cases is that the result in any case will depend entirely on the actual wording of the indenture in question."12

In this context, the Court reviewed the indenture as a whole and determined:

(a)    reading the Indenture, the Trustee's powers, duties and obligations were limited to enforcing payment defaults;

(b)    the no-action clause in Wireless was not nearly as broad as the clauses in Casurina or Amaranth; and

(c)    the Trustee was not authorized to initiate a suit for oppression under the Indenture.

The Court reviewed the parties' positions in the context of the overarching rationale set out in Feldbaum, and stated that it must consider not only whether the application sought a remedy common to all bondholders, but also whether the Indenture gave the Trustee the power to pursue the suit in question.13 Examining provisions dealing with the duties of the Trustee under the Indenture, the Court determined that the Trustee's powers were limited to acting against Events of Default as defined in the Indenture, being payment defaults which had not occurred. In analyzing whether the no-action clause applied, the Court stressed the need to look beyond the broad preamble of a no-action clause (which, if read in isolation, might appear to apply), to other language within the Indenture.14 Specifically, the Court next considered whether the Indenture gave the Trustee the power to pursue the kind of suit that Catalyst had initiated. It concluded that the wording of the no-action clause in the Indenture was not broad enough to encompass Catalyst's claim.

The Court emphasized that a no-action clause must be interpreted in conjunction with the wording of the indenture, when read as a whole. In Wireless, the Indenture limited the powers of the Trustee to acting in relation to specific "Events of Default", which were narrow in scope. Moreover, because the powers of the Trustee under the Indenture to take action were limited, the Court did not consider the Trustee as being authorized under the Indenture to initiate a suit for oppression. These factors persuaded the Court to conclude that Catalyst was not prohibited from pursuing its application for relief. This reasoning is not inconsistent with earlier decisions that restricted a bondholder's rights to bring suit where such actions were within the powers of the indenture trustee.

In coming to its decision, the Court explicitly recognized that other cases had determined that "default is not necessary to invoke the no action clause, and that no action clauses can be broad enough to encompass oppression applications."15 Nonetheless, the no-action clause was found to be sufficiently restrictive, when read in conjunction with the rest of the Indenture, and, in particular, the powers given to the Trustee, to lead the Court to conclude that it did not prohibit Catalyst from proceeding with its action.

Key to the analysis in Wireless is the holding of the Court that contractual waivers of rights under a no-action clause in an indenture should be considered in the context of the wording of a trust indenture when read as a whole. This decision does not undermine the enforceability of no-action clauses, conceptually, but rather underscores the need to review the applicability of such a provision in conjunction with the entire indenture, including the powers it gives to the indenture trustee to take the type of legal action that a noteholder may seek to pursue. Significantly for the noteholder in Wireless, the finding that the no-action clause did not apply was made against a backdrop of other cases that have broadly interpreted no-action clauses to confine noteholder litigation. 

by Sheryl E. Seigel

1 2013 ONSC 2710, 228 ACWS (3d) 442 [Wireless].

2 In Canada, federal and most provincial legislation include a corporate oppression remedy to address conduct construed to be oppressive to or unfairly prejudicial to or that unfairly disregards the interests of a complainant. Oppression claims can be asserted by practically any "stakeholder", including a shareholder and even a creditor, for corporate actions that infringe on the stakeholder's legitimate expectations. The legislation allows the court discretion regarding the remedies it may impose in relation to the conduct complained of, permitting expansive orders to be made as the court sees fit in relation to the oppressive conduct against or in relation to the corporation and others. A finding of oppression is dependent on the facts of an individual case and a court will consider, among other things, the reasonable expectations of the complainant. In Wireless, Catalyst made broad allegations of oppression against Wireless, alleging that its reasonable expectations were violated by the secondary financing that Wireless had arranged which preferred the interests of the "Unknown Purchasers" and thwarted its reasonable expectations. Wireless maintained that Catalyst's application for oppression fell within the scope of actions contemplated by the no-action clause in the trust indenture, as a result of which it was barred until such time as Catalyst complied with the notice and other provisions of such clause.

3 Feldbaum v McCrory Corp, 1992 WL 119095 (Del Ch) at 7 [Feldbaum]; see also Akanthos Capital Mgmt, LLC et al v CompuCredit Holdings Corp et al, 677 F 3d 1286 (11th Cir 2012) at 1293 [Akanthos].

4 Feldbaum, supra note 3 at 6.

5 Ibid at 5-6.

6 Athankos, supra note 3 at 1296, citing Watts v Missouri-Kansas-Texas R Co, 383 F2d 571 (5th Cir 1967) at 574.

7 Akanthos, supra note 3 at 1294; see also Feldbaum, supra note 3 at 7.

8 In support of its oppression claim, Catalyst argued that its reasonable expectations were violated by the secondary financing, giving rise to its oppression claim; see Wireless, supra note 1 at para 15.

9 In Wireless, section 6.06 of the Indenture provided as follows (see para 8):

Except to enforce the right to receive payment of principal, premium, if any, or interest when due, no Holder of a Note may pursue any remedy with respect to the Indenture or the Notes unless:

1)    Such Holder gives to the Trustee prior written notice than [sic] an Event of Default is continuing;

2)    Holders of at least 25% in aggregate principal amount of the then outstanding Notes make a written request to the Trustee to pursue the remedy;

3)    Such Holders have offered to the Trustee security or indemnity reasonably satisfactory to the Trustee against any loss, liability or expense;

4)    The Trustee has not complied with the request within 60 days after receipt of the request and the offer of security or indemnity; and

5)    During such 60-day period, Holders of a majority in aggregate principal amount of the then outstanding Notes have not given the Trustee a direction inconsistent with such request.

A Holder of a Note may not use this Indenture to prejudice the rights of another Holder of a Note or to obtain a preference or priority over another Holder of a Note.

10 Casurina Limited Partnership v Rio Algom Ltd, [2004] OJ No 177, 181 OAC 19, aff'g [2002] OJ No 3229 (SCJ), leave to appeal to SCC refused, 335 NR 199 (September 30, 2004) [Casurina]. See also Amaranth LLC v Counsel Corp, [2003] OJ No 4674, 40 BLR (3d) 212 (SCJ) [Amaranth].

11 [1994] OJ No 1968, 15 BLR (2d) 212 (Gen Div).

12 Wireless, supra note 1 at para 22.

13 Ibid at para 25.

14 Ibid at para 33.

15 Ibid at para 42.

a cautionary note

The foregoing provides only an overview and does not constitute legal advice. Readers are cautioned against making any decisions based on this material alone. Rather, specific legal advice should be obtained.

© McMillan LLP 2013