Issuer Fails to Recover from Indenture Trustee Funds Withheld from an Interest Payment to Fund Litigation Against the Company

May 29, 2007

Petrohawk Energy Corp. v. Law Debenture Trust Company of New York, 2007 W.L. 211096 (S.D.N.Y. 2/2/07). In this case, the Issuer failed to recover from the Indenture Trustee funds that the Indenture Trustee withheld from an interest payment to the Noteholders to fund litigation being pursued by the Indenture Trustee against the Issuer. Although the Issuer failed to take away the Indenture Trustee’s funding for the litigation, the Issuer had partial victory since the court’s decision was based on a determination that the Issuer discharged its liability to the Noteholders by the payment made to the Indenture Trustee. The proper parties to assert the claim for withholding the funds are the Noteholders, not the Issuer.

Facts. The Noteholders replaced U.S. Bank with Law Debenture as Trustee. Law Debenture then commenced an action in the Delaware Chancery Court asserting that a change of control had occurred triggering the right of Noteholders to have their Notes redeemed. The Issuer made its semi-annual interest payment to The Bank of New York as Paying Agent. Law Debenture obtained $1.2 of that payment though means not specified in the opinion which it proposed to hold to fund the Delaware litigation.

The Issuer promptly started an action in New York against Law Debenture seeking an order requiring Law Debenture to disgorge the funds on several theories including conversion and breach of trust. Law Debenture moved to dismiss for lack of standing and failure to state a claim. After reviewing the terms of the Indenture, the Paying Agency Agreement and the commentaries to the Model Indenture and the Revised Model Simplified Indenture, Judge Cote disposed of the complaint on the basis that the Issuer had no interest in the funds. The Indenture provides that the Issuer was considered to have paid the interest once it provided the funds to the Paying Agent. Judge Cote held that once the Issuer deposited the funds with the Paying, the Issuer had no further interest in the funds and the court did not need to address the Issuer’s arguments that the funds were trust funds. The case was not an unmixed blessing for the Indenture Trustee since the court observed that [i]f the Noteholders seek to recover the funds the action lies against the Indenture Trustee not [the Issuer].

Contributed by James Gadsden, Carter Ledyard & Milburn LLP in New York,

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