Bank of New York Mellon v. Realogy Corp.
979 A.2d 1113, 2008 WL 5259732, 2008 Del. Ch. LEXIS 186 (2008)
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Rule of Law:
Under New York law, a contractual provision prohibiting the addition of security to refinancing indebtedness will not be negated by a proviso allowing security 'to the extent then permitted' elsewhere in the agreement. Such a proviso will be interpreted narrowly to avoid rendering the primary prohibition meaningless, a concept known as avoiding the 'exception that swallows the rule'.
Facts:
- In 2007, Realogy Corporation was taken private in a leveraged buyout, financed by significant debt, including a senior secured Credit Agreement and several classes of unsecured notes.
- Among the unsecured debt were Senior Toggle Notes, which ranked equally with the Credit Agreement debt but were unsecured, and allowed Realogy to pay interest in-kind rather than in cash.
- Following a downturn in the real estate market, all of Realogy's unsecured notes began trading at a deep discount to their face value.
- In November 2008, Realogy announced a debt refinancing transaction, offering holders of its unsecured notes the opportunity to exchange them for a participation in a new, smaller term loan facility.
- This new term loan facility would be secured by a second lien on substantially all of Realogy's assets, granting participants a higher priority in bankruptcy than the existing unsecured noteholders.
- The terms of the exchange offer prioritized holders of other unsecured notes over the Senior Toggle Noteholders, making it unlikely that the latter would be able to participate and benefit from the new security.
Procedural Posture:
- The Bank of New York Mellon, as Trustee for the Senior Toggle Notes, and High River Limited Partnership sued Realogy Corporation in the Delaware Court of Chancery (trial court).
- The Trustee's complaint sought a declaratory judgment that Realogy's proposed debt exchange transaction would constitute a breach of the governing Indenture.
- The fraudulent transfer counts brought by High River were stayed by agreement of the parties.
- The case was put on an expedited schedule, and both the Trustee and Realogy filed cross-motions for summary judgment on the contract interpretation issue.
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Issue:
Does a proposed debt exchange, which refinances existing unsecured notes with new term loans secured by a second lien on corporate assets, violate the unsecured notes' Indenture by creating a lien that fails to qualify as a 'Permitted Lien' because the underlying transaction is not 'Permitted Refinancing Indebtedness' under a related Credit Agreement?
Opinions:
Majority - Lamb, Vice Chancellor
Yes. The proposed transaction violates the Senior Toggle Notes' Indenture because the lien securing the new term loans is not a 'Permitted Lien'. A lien is only 'Permitted' if it secures indebtedness incurred 'under the Credit Agreement,' which requires the new debt to comply with all of the Credit Agreement’s covenants. The transaction violates the Credit Agreement’s negative covenant against refinancing unsecured debt with secured debt because the new loans do not qualify as 'Permitted Refinancing Indebtedness.' The court rejected Realogy's argument that a proviso in the definition of 'Permitted Refinancing Indebtedness' created a loophole allowing the addition of security. Adopting Realogy's interpretation would create an 'exception that swallows the rule,' rendering the main prohibition against adding security meaningless. The court adopted the Trustee's narrower interpretation, which gives effect to all parts of the definition. Therefore, the refinancing is prohibited by the Credit Agreement, the lien is not a 'Permitted Lien' under the Indenture, and the transaction constitutes a breach of the Indenture.
Analysis:
This case serves as a key precedent for interpreting complex financial instruments under New York law, emphasizing the cannon of construction that disfavors interpretations rendering contractual provisions meaningless surplusage. It reinforces creditor protections by strictly construing negative covenants that prevent borrowers from subordinating existing unsecured debt through creative refinancing schemes. The decision demonstrates that courts will meticulously analyze interconnected agreements (here, an indenture and a credit agreement) to block transactions that violate the spirit, if not the hyper-technical reading, of the covenants. For future cases, it signals that attempts to use ambiguous provisos to nullify clear, restrictive covenants are likely to fail.
