New York’s highest court has concluded that a “no-action” clause in a New York law-governed indenture does not bar the commencement of an action or proceeding on a securityholder’s common law or statutory claims relating to the securities when the no-action clause at issue omitted a reference to claims relating to “the Securities” themselves despite the no-action clause’s specific preclusion of contractual claims arising under the applicable indenture.1 The decision is of particular importance to investors in bonds and other securities with provisions that limit actions by individual holders.

No-Action Clauses

In order to deter minority securityholders from pursuing frivolous, duplicative or otherwise uneconomical claims at the expense of the majority of securityholders, a trust indenture, pursuant to which bonds or other securities are issued, generally includes a no-action clause to channel securityholders’ claims through the indenture trustee. A no-action clause typically delegates the right to commence and prosecute such claims and causes of action in the first instance to the indenture trustee and conditions the commencement of such litigation upon the request of the majority or some other significant threshold of securityholders. Because the purpose of a no-action clause is not to suppress the legitimate rights of securityholders, but rather to promote the economic prosecution of any such claims, no-action clauses generally are drafted quite broadly. The Court of Appeals of New York, the state’s highest court, has provided helpful guidance construing “no action” provisions in Quadrant Structured Products Co. v. Vertin (“Quadrant”).

Quadrant Structured Products Co. v. Vertin

In Quadrant, a minority securityholder asserted various claims, directly and derivatively, against the issuer, the issuer’s officers and directors, the issuer’s parent corporation, and an affiliated entity for alleged breaches of fiduciary duty and fraudulent transfers, among other things. The claims arose from the issuer’s exposure to credit default swap obligations incurred during the financial crisis of 2008 and other alleged misconduct. The defendants moved to dismiss, arguing that the minority securityholder’s claims were barred by the no-action clause of the indenture. The no-action clause at issue provided:

Limitations on Suits by Securityholder. No holder of any Security shall have any right by virtue or by availing of any provision of this Indenture to institute any action or proceeding at law or in equity or in bankruptcy or otherwise upon or under or with respect to this Indenture, or for the appointment of a trustee, receiver, liquidator, custodian or other similar official or for any other remedy hereunder, unless such holder previously shall have given to the Trustee written notice of default in respect of the series of Securities held by such Security holder and of the continuance thereof, as herein before provided, and unless also the holders of not less than 50% of the aggregate principal amount of the relevant series of Securities at the time outstanding shall have made written request upon the Trustee to institute such action or proceedings in its own name as trustee hereunder and shall have offered to the Trustee such reasonable indemnity as it may require against the costs, expenses and liabilities to be incurred therein or thereby and the Trustee for 60 days after its receipt of such notice, request and offer of indemnity shall have failed to institute any such action or proceedings …. (emphasis added)2

Following a round of appeals in the Delaware courts, where the minority securityholder commenced its action, Delaware’s highest 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.

The Court of Appeals, in no uncertain terms, concluded that the no-action clause at issue only precluded the enforcement of securityholders’ contract claims arising under the indenture and did not preclude securityholders from bringing common law and statutory claims relating to the securities.

In reaching its conclusion, the Court of Appeals applied well-established principles of New York contract law. The Court of Appeals found that the indenture was clear and unambiguous and interpreted the indenture in accordance with its plain meaning. It further observed that a no-action clause must be “construed strictly” and “read narrowly.”

With these principles in mind, the Court of Appeals found that the no-action clause’s specific reference to the indenture and the omission of an express reference to the securities barred the individual prosecution of indenture-related contract claims only, not common law and statutory claims relating to the securities. The Court of Appeals supported its opinion by comparing and reconciling its construction with the construction of similar indentures under New York law by various state and federal courts.

The defendants argued that references to the indenture in the no-action clause should be interpreted to include the securities because it would frustrate the intention of the parties to read the no-action clause otherwise. The addition of “the securities” to the clause would have been superfluous and without meaning, the defendants argued, because the purpose of the no-action clause was to prohibit these very types of “lone ranger” suits and because the Trust Indenture Act of 1939 would have rendered the no-action clause unenforceable to an extent, at least as to claims against the indenture trustee or claims for past-due interest or principal on the securities.

The Court of Appeals disagreed, again reasoning that a plain reading of the indenture demonstrated no intention to channel the plaintiff’s common law or statutory claims relating to the securities through the trustee. To the contrary, the Court of Appeals concluded that the indenture demonstrated the parties’ intent not to limit the prosecution of minority securityholders’ common law and statutory claims relating to the securities because the no-action clause conditioned securityholder action upon the delivery of a notice of a continuing event of default, in which event the trustee would be authorized to take remedial action. The no-action clause, the Court of Appeals reasoned, did not preclude claims over which the trustee was without authorization to act, such as the claims at issue.

In a concluding note, the Court of Appeals cited a model no-action clause drafted by the Ad Hoc Committee for Revision of the 1983 Modified Simplified Indenture, in which the Committee includes “the Securities” but explains in the commentary that “[t]he clause applies, however, only to suits brought to enforce contract rights under the Indenture or the Securities, not to suits asserting rights arising under other laws.” The Ad Hoc Committee thus interprets the scope of the model no-action clause narrowly in comparison to similar no-action clauses that other courts have interpreted under New York law. The Court of Appeals, however, cited the Ad Hoc Committee’s commentary not to express an opinion on whether no-action clauses should be construed in the manner suggested by the Ad Hoc Committee commentary but rather to emphasize that its interpretation of the no-action clause could not have upset the parties’ expectations.

Concluding Thoughts

The reasonable expectations of the parties may very well have been that securityholders’ common law and statutory claims relating to the securities would have been limited by the no-action clause. Quadrant, however, emphasizes the care that must be taken when drafting such clauses. The absence of one word, “securities,” in an otherwise unambiguous document drafted by sophisticated parties, may disrupt the reasonable expectations of an orderly prosecution of common claims among similarly situated securityholders. Although the limited scope of a no-action clause does not confer merit to a minority securityholder’s underlying claims, Quadrant and its progeny could influence how investors and issuers alike delegate authority with respect to the multitude of potential claims arising from the issuance of securities.

1 Quadrant Structured Prods. Co. v. Vertin, ___ N.E.3d ___ (2014), 2014 N.Y. Slip Op. 04114, 2014 WL 2573378 (N.Y. June 10, 2014).
2 Quadrant, 2014 N.Y. Slip Op. 04114, at 8–9.