Indenture 'No-Action' Clauses Bar Independent Claims By Securityholders

Two recent cases, from the Eleventh Circuit1 and New York,2 illustrate the limitations that "no-action" clauses in indentures place on the ability of Security holders3 to enforce claims against third parties. Indentures governing debt securities almost universally contain two clauses that address the rights of Security holders to enforce claims. The first is the "no-action" clause and the second is the "non-impairment" clause.

The Clauses

A typical formulation of a "no-action clause" is: Limitation on Suits. A Security holder may pursue a remedy with respect to this Indenture or the Securities only if:

(1) the Holder gives to the Trustee notice of a continuing Event of Default;

(2) the Holders of at least 25% in principal amount of the Securities make a request to the Trustee to pursue the remedy;

(3) such Holder or Holders offer to the Trustee indemnity satisfactory to the Trustee against any loss, liability or expense;

(4) the Trustee does not comply with the request within 60 days after receipt of the request and the offer of indemnity; and

(5) during such 60-day period the Holders of a majority in principal amount of the Securities do not give the Trustee a direction inconsistent with the request.

A Security holder may not use this Indenture to prejudice the rights of another Security holder or to obtain a preference or priority over another Security holder.4

The "no-action" clause is balanced by the "non-impairment" clause, often appearing as the next section of the indenture. A typical "non-impairment" clause reads:

Rights of Holders to Receive Payment. Notwithstanding any other provision of this Indenture, the right of any Holder of a Security to receive payment of principal and interest on the Security, on or after the respective due dates expressed in the Security, or to bring suit for the enforcement of any such payment on or after such respective dates, shall not be impaired or affected without the consent of the Holder.5

The Competing Interests

The competing interests embodied in these two sections of an indenture are, on the one hand, the right of each individual holder to receive payment on its security when due and, on the other hand, the collective enforcement of rights created under the indenture for the common benefit of all Security holders. The extremes are easy to illustrate. For a secured indenture, it is impractical for each Security holder to have the right to separately foreclose on the collateral shared by all to recover the sums due to that Security holder. Conversely, every Security holder has the right to file suit to recover the principal6 or interest that was not paid when due on its security. The rationale for "no-action" clauses is expressed in the Commentaries on Model Indenture Provisions:

The major purpose of this Section is to deter individual debentureholders from bringing independent law suits for unworthy or unjustifiable reasons, causing expense to the Company and diminishing its assets. The theory is that if the suit is worthwhile, 25% of the debentureholders would be willing to join in sponsoring it. The 25% figure is standard. An additional purpose is the expression of the principle of law that would otherwise be implied that all rights and remedies of the indenture are for the equal and ratable benefit of all the holders.

Note that this limitation is only on suits under the indenture€"the right of a debentureholder to sue on his debenture for payment when due is absolute and unconditional.7

As expressed in a Fifth Circuit decision in 1967, such clauses "are justified where they prevent rash, precipitate, or harassing suits by bondholders who disrupt corporate affairs by seeking to reach and deal with the security underlying the bond obligations."8

Objections to "No-Action" Clauses

Security holders prefer not to have to comply with...