Locke Lord QuickStudy: The Covenant Loophole That Wasn’t: SDNY Derides Windstream’s Structuring Efforts as “Too Cute by Half”

On February 15, 2019, following a full bench trial, the Honorable Jesse M. Furman ‎‎(S.D.N.Y.) entered judgment in favor of Aurelius Capital Master, Ltd. (“Aurelius”) and against ‎Windstream Services, LLC (“Windstream”) in the amount of $310,459,959.10.  Judge Furman ‎further declared that Windstream had precipitated the acceleration of the amounts owing to ‎Aurelius by violating the terms of the Indenture dated January 23, 2013 (the “Indenture") ‎governing its 6.375% senior unsecured notes due 2023 (the “Notes”).  In so ruling, Judge Furman ‎rejected both Windstream’s efforts to structure around the restrictions contained in the ‎Indenture, as well as the company’s after the fact efforts to rally other stakeholders to support a ‎waiver of the resulting default.  Ten days later, Windstream had filed for Chapter 11 relief in the ‎United States Bankruptcy Court for the Southern District of New York.  ‎

Judge Furman’s ruling offers an interesting point of contrast to the J. Crew/Eaton Vance ‎dispute, wherein a borrower successfully utilized the terms of its credit agreement to transfer ‎substantial asset value away from the borrower and to its unrestricted subsidiaries.  Here, Judge ‎Furman firmly rejected a hyper technical reading of the Indenture, and found the issuer to have ‎triggered a default by engaging in a prohibited sale leaseback transaction that substantially ‎increased the company’s Consolidated Leverage Ratio, even where the issuer had arguably ‎structured around that prohibition.  Judge Furman noted that Windstream’s “financial maneuvers ‎‎– and many of its arguments here – are too cute by half”.  In doing so, the court looked past the ‎form of the transaction in question and instead focused on its substance.  If the J. Crew dispute ‎demonstrated that an issuer would not hesitate to unlock liquidity through the most aggressive ‎reading of the “permitted investments” section of its credit agreement, the Windstream decision ‎reminds us that judges still retain the power to police the borders of such agreement – particularly ‎where the issuer’s financial statements, operations and regulatory filings are inconsistent with the ‎issuer’s position.‎

The Transactions at Issue

In August 2013, the Windstream board of directors approved the formation of a new ‎parent holding company, Windstream Holdings, Inc. (“Holdings”).‎

In 2015, Windstream and Holdings engaged in a series of transactions as follows (the ‎‎“2015 Transactions”):‎

• In March 2015, certain restricted subsidiaries of Windstream (the “Transferor ‎Subsidiaries”) transferred material assets (the “Transferred Assets”) to Windstream, ‎which in turn transferred those assets to a newly-formed wholly-owned REIT subsidiary, ‎Uniti Group, Inc. (at such time known as Communications Sales & Leasing, Inc.) ‎‎(“Uniti”) and certain of Uniti’s subsidiaries.  In exchange for the transfer of the ‎Transferred Assets, Windstream received, among other things, all of the common stock of ‎Uniti.‎
• In March 2015, following the transfer of the Transferred Assets, Windstream transferred ‎the majority of the Uniti common stock to Holdings and Holdings transferred all such ‎Uniti common stock to its shareholders, at which point the Uniti common stock became ‎publicly traded.‎
• In April 2015, Holdings entered into a master lease agreement with Uniti (the “Master ‎Lease”) pursuant to which Holdings was granted the exclusive right to use the ‎Transferred Assets.‎

The Ruling

If the Master Lease had been entered into by the Transferor Subsidiaries (instead of ‎Holdings), the transactions described above would have violated the prohibition against Sale and ‎Leaseback Transactions set forth in the Indenture.  Windstream took care to keep the Transferor ‎Subsidiaries off the Master Lease, so as to avoid this prohibition.  Judge Furman was wholly ‎unpersuaded by these structuring efforts, pointing instead to the economic reality of the 2015 ‎Transactions, and Windstream’s conduct following the consummation thereof, noting that “the ‎Transferor Subsidiaries have entered into more than 120 agreements subleasing or otherwise ‎granting rights in the Transferred Assets to third parties” and “in any number of these ‎agreements, the Transferor Subsidiaries have explicitly represented that they are lessees under the ‎Master Lease.”  The court further noted that the Transferor Subsidiaries have paid every monthly ‎rent payment (over $50 million per month) owed to Uniti under the Master Lease, pointing out ‎that “[t]he fact that they make those payments indirectly through Holdings is of no moment. ‎Holdings is a holding company with no operations and, thus, incapable of making the payments ‎on its own.”  In short, as Judge Furman concisely noted, “. . . the Transferor Subsidiaries’ use and ‎enjoyment of the Transferred Assets walks like a lease and talks like a lease. That’s because it is a ‎lease.”  ‎

In addition to the economic reality of the transactions, the court also based its opinion on ‎the concept of judicial estoppel, which provides that a party cannot take a position in a legal ‎proceeding that is contrary to a position such party took in an earlier proceeding.  Over the course ‎of 2014, Windstream sought approval from various state regulators to consummate the 2015 ‎Transactions.  As noted in the opinion by Judge Furman, Windstream “made explicit ‎representations to nine state regulatory bodies that the Transferor Subsidiaries would transfer ‎ownership of the Transferred Assets and then ‘lease them back on an exclusive, long-term ‎basis.’”  Accordingly, the court noted that Windstream is judicially estopped from representing ‎to state regulators that the Transferor Subsidiaries will lease the Transferred Assets, on the one ‎hand, and then taking the position in this litigation that the Transferor Subsidiaries do not in fact ‎lease the Transferred Assets, on the other hand. ‎

Given Judge Furman’s emphasis upon the underlying economic reality of the 2015 ‎Transactions (and the resulting increase in leverage), as well as his reliance upon the doctrine of ‎judicial estoppel, it seems fair to infer that Windstream’s position had some foundation in the ‎plain language of the Indenture.  That Windstream lost so completely at the trial court level – ‎notwithstanding a plain language justification for its position – demonstrates that extrinsic ‎evidence and the supporting factual record can be equally important to defending (or attacking) ‎the position taken by an issuer.  Windstream took the position that the Master Lease was entered ‎into by Holdings and thus not prohibited by the Indenture – but then took actions inconsistent ‎with this position, particularly in its regulatory filings, financial statements and its dealings with ‎third parties.  These inconsistencies doomed what could otherwise be a plausible reading of the ‎Indenture.‎