Bank of New York Trust Co., N.A. v. Franklin Advisers, Inc.
726 F.3d 269
2d Cir.2013Background
- CLO II: a $600M collateralized loan obligation closed July 26, 2001; Franklin Advisers was collateral manager, BNY the trustee, Merrill Lynch underwriter; shareholders held CLO equity.
- Indenture/Agreement: Article 11 sets cascading "waterfalls" for distributions (interest and principal); Collateral Management Agreement incorporated Indenture provisions and provided for three fees to Franklin—two guaranteed (base and subordinated) and one contingent (payable only if shareholders received a 12% IRR "through" a Distribution Date).
- Optional redemption: Section 9.1 allowed shareholders holding a majority of preferred shares to call an optional redemption (liquidation before maturity).
- Dispute facts: Prior to the February 28, 2007 optional redemption, Franklin had not reached the 12% IRR on pre‑redemption cashflows, but including redemption proceeds the IRR exceeded 12% and Franklin claimed a Contingent Fee (~$7.2M -> $7.47M after later payments).
- Procedural posture: Trustee filed interpleader. District court granted Franklin partial summary judgment on (1) Contingent Fee may be paid on optional redemption, (2) redemption proceeds count in IRR, and (3) accrual timing was ambiguous (resolved in arbitration in Franklin’s favor). District court awarded attorneys’ fees and statutory prejudgment interest; judgment entered for ~$12.76M. Appeal followed.
Issues
| Issue | Plaintiff's Argument (Shareholders) | Defendant's Argument (Franklin) | Held |
|---|---|---|---|
| 1. Use of extrinsic evidence to interpret indenture | Sharon Steel and market practice bar extrinsic evidence for indentures; interpret text only. | Where contract is ambiguous, extrinsic evidence (custom, deal counsel testimony, models) may be considered. | Court: Applying New York law, extrinsic evidence is permissible when terms are ambiguous; no error in district court’s limited use. |
| 2. Whether Contingent Fee can be paid on an optional redemption | Article 9 (redemption provisions) creates a separate scheme that excludes Contingent Fee. | Article 9 supplements, not supplants, Article 11; waterfall and "through" language allow payment on redemption. | Held: Indenture allows payment of Contingent Fee on optional redemption. |
| 3. Whether redemption proceeds are included in IRR calculation | IRR should be calculated pre‑redemption; final distribution funds can’t "flow up" waterfall to fund Fee. | Definition of Contingent Fee and "through such Distribution Date" means include proceeds up to and including redemption date; calculations are made before distribution. | Held: Redemption proceeds are included in determining whether 12% IRR was met. |
| 4. When the Contingent Fee accrues (closing vs. IRR achievement) | Fee does not accrue until IRR hurdle is met (so no accrual from closing). | Fee accrues from closing even if payment is contingent on later distribution date. | Held: District court correctly found ambiguity and submitted accrual issue to arbitration; arbitration awarded accrual-from-closing and was confirmed—no reversible error. |
Key Cases Cited
- Sharon Steel Corp. v. Chase Manhattan Bank, N.A., 691 F.2d 1039 (2d Cir. 1982) (boilerplate indenture clauses get uniform interpretation; courts should avoid undermining market certainty)
- Jamie Sec. Co. v. The Ltd., Inc., 880 F.2d 1572 (2d Cir. 1989) (interpretation of indenture provisions governed by basic contract law)
- British Int’l Ins. Co. v. Seguros La Republica, S.A., 342 F.3d 78 (2d Cir. 2003) (under New York law, extrinsic evidence may be considered when contract is ambiguous)
- Oscar Gruss & Son, Inc. v. Hollander, 337 F.3d 186 (2d Cir. 2003) (attorneys’ fees indemnity clauses must be unmistakably clear to cover fee shifting between contracting parties)
- Manufacturer’s & Traders Trust Co. v. Reliance Ins. Co., 870 N.E.2d 124 (N.Y. 2007) (interpleader is equitable; statutory prejudgment interest under CPLR 5001(a) is not mandatory in equitable actions and CPLR 1006(f) caps interest against stakeholder)
- Rainbow v. Swisher, 527 N.E.2d 258 (N.Y. 1988) (plain contractual language controls; no extrinsic evidence needed where terms are clear)