In a recent case, RBC Capital Markets, LLC v. Education Loan Trust IV et al., 2011 WL 6152282 (Del. Ch. Dec. 6, 2011), a holder of notes issued under an indenture claimed that the issuer caused the trust to pay excess and unauthorized fees that allegedly reduced the amount of interest payments to the noteholder. The noteholder argued that because the breach ultimately affected the amount of interest it received, it was entitled to sue under an exception to the no-action clause mandated under the Trust Indenture Act, which clause allows noteholders to directly sue for principal and interest. In response, the issuer argued that the noteholder’s lawsuit was barred by the no-action clause that governs how a noteholder can bring suits against the issuer and a trust under the indenture. The Court of Chancery in Delaware dismissed the suit and held that the no-action clause was applicable and must be complied with because the noteholder’s claim was premised on proving a breach of the indenture that did not directly address the schedule or amount of interests due. Consequently, the noteholder could not sue under the exception to the no-action clause mandated by the Trust Indenture Act.

The plaintiff, RBC Capital Markets, LLC (“RBC”), the holder of notes issued under an Indenture of Trust (the “Indenture”) and certain supplemental indentures (collectively, the “Supplemental Indentures”) filed an action against the issuer of the notes, US Education Loan Trust IV, LLC (the “Issuer”) and the trust, Education Loan Trust IV (the “Trust” and together with the Issuer, the “Education Loan Trust”) claiming that the Issuer caused the Trust to pay millions of dollars in excessive fees to the Issuer in breach of limits on those fees set forth in the Supplemental Indentures. RBC claimed that those unauthorized and excessive payments negatively affected the input in the formula used to calculate the interest rate payments and therefore, ultimately reduced the interest payments received by RBC. Had the Trust paid the appropriate level of fees, the noteholders’ payments would not have been reduced. RBC asserted that because the affect of the breach was to reduce the interest paid to noteholders, RBC was entitled to sue under section 315(b) of the Trust Indenture Act, which provides that noteholders have a right to sue directly to collect interest and principal when due.

The Court of Chancery in Delaware rejected RBC’s argument. The Court found that the mandated section allowing a direct suit to collect interest and principal when due was a limited exception to the no-action clause. The Court explained that RBC had not alleged that the terms of the indenture requiring periodic payments were directly breached or that the interest rate formula was not applied correctly according to the Indentures. In fact, RBC admitted it received timely interest payments. Instead, the Court found that RBC’s action was a classic derivative action - RBC alleged that the breaches of the Indenture by the Issuer injured the Trust and the remedy was necessarily a monetary recovery against the Issuer to be paid into the Trust. Because RBC’s predicate for a recovery was proving a breach of legal obligations under Indenture other than those obligations directly addressing the payment of principal and interest, the Court held that the no-action clauses must be applied and satisfied.

Furthermore, the Court held that RBC’s reasoning for circumventing the no-action clause was contrary to the general purpose of no-action clauses. The Court, citing to the Commentaries on Model Debenture Provisions (the “Commentaries”) as well as relevant caselaw, stated that no-action clauses are standard provisions in indentures that serve a gate-keeping role in preventing individual holders of notes from bringing unworthy or unpopular actions against the issuer or trust and ensuring that all rights and remedies under the indenture are shared equally by noteholders. The essential purpose of the no-action provisions is to strike the right balance between enabling the effective enforcement of noteholder rights and the avoidance of capital-taxing suits that do not have the support of most noteholders. The no-action clause facilitates this by delegating the right to bring a suit enforcing rights of bondholders to the trustee. The Court held that under RBC’s reasoning, any breach whatsoever that has the effect of injuring a trust directly and thereby indirectly affecting the principal and interest would justify individual noteholder action under the exception to the no-action clause. The Court found that such reasoning allows the limited exception mandated under the Trust Indenture Act to render no-action clauses ineffective and is contrary to the very purpose underlying no-action clauses.

The decision is consistent with New York case law that has strictly interpreted indentures and in particular, boilerplate language such as no-action clauses. Moreover, the decision reinforces the notion that market-facilitating boilerplate provisions of indentures must be accorded a consistent and uniform construction and courts will often consider the underlying policy reasons described in the Commentaries in order to do so properly.