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Court of Chancery Finds That, Under New York Law, Notes May Be Voluntarily Cancelled Absent Provision in the Indenture to the Contrary

By Francis G.X. Pileggi

In Concord Real Estate CDO 2006-1, Ltd. v. Bank of America N.A., C.A. No. 5219-VCL (Del. Ch. May 14, 2010), read opinion here, the Court of Chancery addressed the issue of whether notes issued as part of a collateralized debt obligation were discharged when the holder surrendered them voluntarily to the obligors with the intent that the notes be canceled. On cross motions for summary judgment by the issuers and the trustee of the indenture, the Court of Chancery construed the plain language of an indenture under applicable New York contract law and held that notes issued pursuant to the indenture could be voluntarily cancelled.

This summary was provided by Kevin F. Brady and Ryan P. Newell of Connolly Bove Lodge & Hutz LLP.

In 2006, the Plaintiffs issued notes (the 'Notes') as part of Concord Real Estate CDO 2006-1 (the 'Concord CDO'), a collateralized debt obligation. Plaintiff Concord Real Estate CDO 2006-1, Ltd. ('Issuer') was the Issuer of the Notes and Plaintiff Concord Real Estate CDO 2006-1, LLC ('Co-Issuer') was the Co-Issuer. The Issuer and Co-Issuer were formed by Concord Debt Holdings LLC ('Concord Sponsor'). The Notes were issued subject to an Indenture Agreement (the 'Indenture'). Defendant Bank of America N.A. (the 'Trustee') was the Trustee of the Indenture.

In December 2009, Concord Sponsor was concerned that Concord CDO might fail a par value test. If, as of a measurement date, the par value test was not met, 'then funds that otherwise would be used to pay interest on the class of Notes at the level where the test failed and on any junior securities [would be] instead used to redeem the most senior class of Notes then outstanding.' This process continued until the test was satisfied or the senior Notes are redeemed. To avoid failing the par value test scheduled for February 2009, Concord Sponsor sought to cancel the Notes in January 2009. However, the Trustee would not cancel the Notes, believing instead that Notes could not be cancelled voluntarily under the terms of the Indenture.

To the extent the Notes were outstanding as of the February 2009 Measurement Date, then the par value test was not met. If the Notes were outstanding, Class A shareholders would receive $922,135.82 in redemptions and Class F Notes and Preferred Shares would not receive any interest payments. However, if they were not outstanding as of that date, then the test was met and the Class A shareholders would not receive those significant redemptions, but instead the Class F Notes would receive $38,226.32 and the Preferred Shares receive $548,110.93.

As the Indenture did not directly touch upon the issue of the surrender of Notes with an intent to cancel, the Court turned to New York common law and the Delivery Rule, under which 'the delivery of a promissory note to the obligor with the intent to cancel the note discharges the obligation and cancels the debt.' Since there was no provision in the Indenture precluding the right to surrender the Notes, the Court held that Concord Sponsor had the right to surrender the Notes. Accordingly, the Notes were discharged when surrendered.

Finally, contrary to the Trustee's argument that permitting cancellation would be contrary to the expectations of the Noteholders, the Court held that:

'[a]s long as the Coverage Tests are met on each respective Measurement Date and timely payments of principal and interest are made, then the Noteholders' contractual expectations are being met. Provided that they do not run afoul of any other provision of the Indenture, the Issuer and Co-Issuer do not breach their contractual obligations by taking actions to remain in compliance with the Coverage Tests and avoid the mandatory redemption obligation. Permitting the cancellation of the . . . Notes in accordance with the Delivery Rule is thus consistent with and does not defeat the contractual expectations of the senior Noteholders.'

The Court found that the Issuer and Co-Issuer properly delivered the discharged notes for cancellation to the Trustee in its capacity as Notes Registrar and, therefore, the notes were discharged when the Issuer and Co-Issuer redeemed them voluntarily to the obligors with the intent that the notes be canceled. As a result, under the plain language of the Indenture, the notes at issue were not outstanding as of January 5, 2010, the date on which they were delivered for cancellation so the Court granted the plaintiffs' motion for summary judgment.

 

Full post as published by Delaware Corporate and Commercial Litigation Blog on May 25, 2010 (boomark / email).