No-Action Clause Must Be Strictly Construed

On June 10, 2014, the Court of Appeals issued a decision in Quadrant Structured Products Co., Ltd. v. Vertin, 2014 NY Slip Op. 04114, construing the scope of a no-action clause in a securities litigation.

The underlying action in Quadrant Structured Products is taking place in the Delaware Chancery Court. The plaintiff, a noteholder, sued the issuer for breach of fiduciary duty, fraudulent transfer, and other claims. The issuer argued that the action was barred by a no-action clause in an indenture signed by the noteholders providing:

No holder of any Security shall have any right by virtue or by availing of any provision of this Indenture to institute any action . . . upon or under or with respect to this Indenture . . . unless such holder previously shall have given to the Trustee written notice of default in respect of the series of Securities held by such Security holder . . . and unless also the holders of not less than 50% of the aggregate principal amount of the relevant series of Securities at the time outstanding shall have made written requests upon the Trustee to institute such action . . . .

The plaintiff argued that, by its language, the no-action clause applied only to actions on the indenture, and not to actions brought on the securities themselves. After a number of conflicting decisions in the Delaware courts, and because the indenture was governed by New York law, the Supreme Court of Delaware certified the question to the Court of Appeals.

The Court of Appeals agreed with the plaintiff. Distinguishing this indenture from others where the no-action clause “specifically mentioned claims arising under both the indenture and ‘the Securities,’” (emphasis in the original) the Court found that the no-action clause “only extended to actions or proceedings where a securityholder claims a right by virtue or by availing of any provision of the indenture.”

The Court of Appeals based this holding upon the fundamental rules of contract interpretation:

As the case law further establishes, we read a no-action clause to give effect to the precise words and language used, for the clause must be ‘strictly construed’ . . . . Even where there is ambiguity, if parties to a contract omit terms—particularly, terms that are readily found in other, similar contracts—the inescapable conclusion is that the parties intended the omission . . . . where [a] sophisticated drafter omits a term, expressio unius precludes the court from implying it from the general language of the agreement.”

The court further rejected the defendant’s argument that such an interpretation would defeat the purpose of the no-action clause and the intent of the parties—which was allegedly to prohibit individual suits by securityholders without the consent of the majority—by pointing out that the no-action clause only permitted the Trustee to take action with respect to “default in respect to the series of Securities,” and no default had yet occurred. “Logically then, the no-action clause applies when the Trustee is authorized to decide whether to act; it cannot serve as an outright prohibition on a suit filed by a securityholder in the case where the Trustee is without authorization to act.” (The Court also noted that the language was unambiguous, and that the intention of the parties could be determined from the four corners of the agreement.)

It appears therefore that this case turned on two drafting omissions in the no-action clause: (1) failing to restrict actions on the indenture and the securities; and (2) failing to explicitly bar all suits in the absence of a default. From the perspective of a commercial litigator in a dispute where “form language” is commonly used, the case also shows that courts can be persuaded to give substantial weight to any particular deviations from that “standard form.”