Research on Law Relating to Interpretation of Bond Indentures II – New York

Author: LegalEase Solutions

Introduction

How courts would interpret law relating to bond indenture. The Indenture has a definition of Senior Debt, which explicitly excludes: “any accounts payable or other liability to trade creditors arising in the ordinary course of business.” Because of the lack of commas, there is an ambiguity as to what the phrase means.  The issue is when there are two phrases joined by the disjunctive “or” with a modifier after the second phrase and no commas to make the sentence clear, how courts would interpret the same.

Further, the indenture also has the phrase: “…short-term Indebtedness (including without limitation Indebtedness under Swap Contracts) that is incurred in the ordinary course of business…”  There is a rule of construction that says “an accounting term not otherwise defined has the meaning assigned to it in accordance with GAAP.”  Under GAAP, short-term debt is 1 year or less. But “short-term,” may not be an accounting term in this context. The issue is whether short-term should be considered an accounting term defined by GAAP when not otherwise defined or whether the short-term must be looked at in the context of the particular business.

Questions Presented

  1. How would courts in New York interpret the indenture clause “any accounts payable or other liability to trade creditors arising in the ordinary course of business” in the absence of commas to make the clause more clear?
  2. Would courts in New York interpret short term debt as an accounting term defined by GAAP when not otherwise defined or whether the short-term must be looked at in the context of the particular business?

Short Answers

  1. New York courts consider grammar and punctuations as unreliable interpretive tools to which resort should be had only when other means of interpretation fail. The general purpose of a contract is a more important aid to the meaning.  Therefore, an interpretation that limits accounts payable to those incurred in the ordinary course of business would possibly be upheld as it is more consistent with the underlying intent of protecting bondholders’ rights.
  2. The definition of Short-term debt will most likely be considered debt of less than one year, unless it can be shown that the particular business is such that a different standard should be used. GAAP is not a set of rigid rules and Courts have interpreted financial terms to be independent of GAAP in the context of a particular business.

Discussion

  1. THE INTERPRETATION THAT LIMITS ACCOUNTS PAYABLE TO THOSE INCURRED IN THE ORDINARY COURSE OF BUSINESS WOULD POSSIBLY BE UPHELD AS IT ACCORDS BETTER WITH THE UNDERLYING INTENT.

How courts would interpret the clause “any accounts payable or other liability to trade creditors arising in the ordinary course of business.”  Whether the qualifying phrases “to trade creditors” and “arising in the ordinary course of businesses” are to be applied to both the antecedent subject-matters or only to the first preceding one is the issue for research.

Bond indentures will be construed in accordance with the general principles of interpretation applicable to contracts as under New York law interpretation of indenture provisions is a matter of basic contract law.U.S. Bank N.A. v. U.S. Timberlands Klamath Falls, L.L.C., 864 A.2d 930 (Del. Ch. 2004) at 939, 940 (applying New York law).

The Indenture, in issue, has a definition of Senior Debt, which explicitly excludes: “any accounts payable or other liability to trade creditors arising in the ordinary course of business.” The lack of commas leads to an ambiguity as to the meaning of the phrase.  Three possible interpretations of the clause are possible: (A) (i) Accounts payable, or (ii) other liability to trade creditors arising in the ordinary course of business; (the phrase at the end modifies only the second noun);  (B) (i) Accounts payable arising in the ordinary course of business, or (ii) other liability to trade creditors arising in the ordinary course of business; (the phrase at the end modifies both nouns in the or statement); or (C) (i) Accounts payable to trade creditors arising in the ordinary course of business, or (ii) Other liability to trade creditors arising in the ordinary course of business (the infinitive “to trade creditors,” and the phrase thereafter modify both nouns in the or statement).

Cases with regard to interpretation of contracts where grammar and punctuation are ambiguous have come up before New York courts in a line of decisions.  Courts have consistently held that provisions that are ambiguous as far as the usage of grammar and punctuations are concerned will be interpreted in the light of the general intent of the parties as found in the rest of the indenture agreement.  In Kent v. Common Council of Binghamton, 40 Misc. 1 (N.Y. Misc. 1903), the defendant company opposed the plaintiff’s action to restrain the enforcement of a tax levied by defendant city on the ground that the company was exempt from paving between its tracks and two feet each side thereof as per the terms of the charter, franchise agreement and the contract between the company and the city.  On interpreting the charter and franchise to determine the force of the distinction sought to be made between the words “consolidated with” and “consolidated into” the defendant company, the Supreme Court of New York, Special Term, Broome County held:

…contracts are to be given an interpretation which will best carry into operation and effectuate the objects to be attained, without reference to accurate grammatical construction of a word, phrase or sentence. In other words, grammar must yield to the fact, for the purpose of carrying out the intention and object sought to be attained, instead of defeating both the intention of the legislators and the object of the parties.

Id. at 5. (emphasis added)

Accordingly, it is an elementary rule of contractual interpretation that the purpose of the contract and the object it seeks to achieve should be of primary concern in the course of interpretation of the various provisions contained therein.  The bond indenture, in this case, should be interpreted to give effect to the purpose behind the entire bond agreement by reading the rest of the indenture, notwithstanding the punctuations and grammatical errors in it.  As Justice Holmes said in United States v. Whitridge (197 U.S.  135, 143), “the general purpose [of a contract] is a more important aid to the meaning than any rule which grammar or formal logic may lay down.  See also Rohring v. City of Niagara Falls, 212 A.D.2d 320, 326 (N.Y. App. Div. 1995);  Braschi v. Stahl Associates Co., 74 N.Y.2d 201 (N.Y. 1989).

Richied v. D.H. Blair & Co., 272 A.D.2d 170 (N.Y. App. Div. 2000), was an action based on an employment agreement in which respondent bank agreed to compensate appellant, in addition to his annual salary, in the amount of 50 percent of its fees for any financing services provided to clients.  The appellant based his argument on the absence of a comma between the words “securities” and “for” in the phrase “public offerings of securities for which compensation may be outlined in (d) below”.  According to the appellant, this evinced intent to limit the exclusion of public offerings from the 50% compensation rate only to those public offerings for which an alternative compensation scheme is provided.  Holding that this is clearly an unexpected and unreasonable result, the court stated that “punctuation is an unreliable interpretive tool to which resort should be had only when other means of interpretation fail.” Id. at 171.

In Reliance Grant Elevator Equipment Corp. v. Reliance Ball Bearing Door Hanger Co., 205 A.D. 320 (N.Y. App. Div. 1923), the trial court’s order holding that the provision for the termination of the contract in the event that yearly sales did not amount to $ 150,000 applied only to the renewal periods and not to the first five-year term was under challenge.  The plaintiff’s version was that the sentence containing the proviso is a complete sentence, the proviso clause being separated by a comma and commencing with a small “p,” and that, therefore, the proviso must be held to apply only to the antecedent clause. In rejecting the contention as absurd, the court held:

Punctuation is a most fallible standard by which to interpret a writing; it may be resorted to when all other means fail; but the court will first take the instrument by its four corners, in order to ascertain its true meaning; if that is apparent on judicially inspecting the whole, the punctuation will not be suffered to change it.” In a contract the words, and not punctuation, are the controlling guide in its construction. Punctuation is no part of the English language * * *. It is always subordinate to the text, and is never allowed to control its meaning. The court will take the contract by its four corners, and determine its meaning from its language, and, having ascertained from the arrangement of its words what its meaning is, will construe it accordingly, without regard to the punctuation marks, or the want of them. * * * But the words control the punctuation marks and not the punctuation marks the words.

Id. at 323. (emphazis added) (internal citation omitted)

Hicks v. Haight, 171 Misc. 151 (N.Y. Misc. 1939) was a case where the employee field an action for breach of a contract of employment alleging that he was hired to act as chief executive officer of the corporation, that the corporation willfully and fraudulently deprived the employee of the bonus provided for in the agreement, and that directors conspired to maliciously induce the corporation to breach the employee’s contract of employment.  The contract of employment provided for employment “as president and/or general manager * * * subject to the general control” of the corporation.  Interpreting the words and/or as used in the agreement, the court held:

The interpretation to be afforded may depend in each instance upon the circumstances under which it [the expression ‘and/or’] is used, and it must be so construed as to express the true intention of the parties to the transaction. The practical construction placed on the expression by the parties, and the circumstances surrounding execution of the agreement, may be of some aid in determining which interpretation will best accord with the equities of the situation.  Such determination, however, must be left to the trier of the facts.

Id. at 154. (emphasis added)

In Smith v. Robson, 148 N.Y. 252 (N.Y. 1896), the Court of Appeals of New York was confronted with an ambiguous contract between a theatrical manager and an actor, that contained the provision: “The said J. R. Smith (the actor) further agrees that if, at any time, Stuart Robson (the manager) shall feel satisfied that he is incompetent to perform the duties which he has contracted to perform in good faith, or is inattentive to business * * * then he (Robson) may annul this contract by  giving two weeks’ notice to said J. R. Smith.”  Andrews, Ch. J, in interpreting the application of the qualifying words, ‘in good faith,’ thought it sufficiently plain to intend to apply to the conduct of the defendant, as if the contract had read, ‘if in good faith the employer shall be satisfied and said that “…the force of the argument of counsel, based on the absence of a comma after “sheet pavement” in the 6th clause of the agreement, is badly shaken.”  The court was relying on Judge Barrett’s opinion in Grinnell v. Kiralfy, 8 N.Y.S. 623 (N.Y. Misc. 1890) where that interpretation which was “fair and reasonable construction of the contract” was upheld.

Specifically on the issue of usage of  commas, the Attorney General of New York in 2004 N.Y. Op. (Inf.) Att’y Gen. 5 (N.Y. AG 2004), opined that where a descriptive or qualifying phrase follows a list of possible antecedents, the qualifying phrase generally refers to and modifies all of the preceding clauses and not merely the last preceding antecedent.  In the instant context of interpretation of bond indentures, this would lead to the meaning that the qualifying phrases “to trade creditors” and “arising in the ordinary course of businesses” are to be applied to both the antecedent subject-matters-(i) accounts payable and (ii) other liability.

Courts in New York have been consistent in subordinating punctuations to the intention of the contractual provision.  Punctuation and grammatical construction may be weighed to clarify, but not to defeat, the parties’ intent. Wirth & Hamid Fair Booking v. Wirth, 265 N. Y. 214, 219.  The court is permitted in the interpretation of contracts to reject grammatical constructions, and adopt those which will give effect to the intent of the parties. Brandt v. Godwin, 3 N.Y.S. 807, 810 (N.Y. Misc. 1889).

The above discussion shows that courts lay emphasis on the general purpose of the bond indenture while interpreting the various provisions contained.  Bond indentures are framed with the primary intention of securing the rights of bondholders to receive interest and payment.  In view of this purpose, the disputed (exclusion) clause “any accounts payable or other liability to trade creditors arising in the ordinary course of business” would possibly include only those debts incurred in the ordinary course of business.  This means that a “senior debt” would exclude those debts incurred in the ordinary course of business.  However, it would not exclude extraordinary debts because the entirety of the agreement attempts to protect the interests of bondholders.  An interpretation that limits accounts payable to those incurred in the ordinary course of business appears to be more consistent with the underlying intent of protection of bondholders’ rights.  If the term “senior debt” was to exclude “any accounts payable” without the restrictive clause ”arising in the ordinary course of business”, it would lead to an unfair and unreasonable construction of the stipulation.

  1. THE DEFINITION OF SHORT-TERM DEBT WILL MOST LIKELY BE CONSIDERED DEBT OF LESS THAN ONE YEAR, UNLESS IT CAN BE SHOWN THAT THE PARTICULAR BUSINESS IS SUCH THAT A DIFFERENT STANDARD SHOULD BE USED. GAAP IS NOT A SET OF RIGID RULES AND COURTS HAVE INTERPRETED FINANCIAL TERMS TO BE INDEPENDENT OF GAAP IN THE CONTEXT OF A PARTICULAR BUSINESS.

Although an extensive search was conducted, no cases were found which deals with the definition of a short term debt.  No precise definition of a short term debt has been dictated by the New York Courts.  But Courts have in passing in some cases considered short term debts to be of less than a year.  Wein v. State, 39 N.Y.2d 136, 148 (N.Y. 1976), (in the context of state contracting a short term debt).  Schulz v. State, 84 N.Y.2d 231, 243 (N.Y. 1994), (stating that the State may validly contract short-term debt if repaid within one year).  Estate of Anglin v. Estate of Kelley, 270 A.D.2d 853, 854 (N.Y. App. Div. 2000) (one clause in the agreement contained a provision for accounting as per generally accepted accounting principles (GAPP) another section provided that  “[i]n conjunction therewith, the General Partners may, in their sole discretion, adopt certain accounting methods”. The Court held that the section does not permit the adoption of accounting methods deviating from generally accepted accounting principles and also held that that the doctrine of practical construction has no application in the absence of any ambiguity).

In construing financial terms in a contract, NY courts generally rely on GAAP.  However, courts have consistently held that GAAP is not a set of rigid rules ensuring identical treatment of identical transactions, but rather characterizes the range of reasonable alternatives that management can use. In re Burlington Coat Factory Sec. Litig., 114 F.3d 1410, 1421 (3d Cir. 1997). In this case, while reversing the dismissal of the federal securities law claims of plaintiff investor class against the defendant corporation and its officers, the court held that GAAP lays down only general guidelines and its applicability varies from transaction to transaction.  Further, In re Worldcom, Inc. Secs. Litig., 352 F. Supp. 2d 472 (D.N.Y. 2005) the plaintiff moved against the defendant accounting firm under Securities Act of 1933 and the Securities Exchange Act of 1934. The court while determining the issue in dispute, interpreted the audits made by the firm.  The firm was the long-term outside auditor for the Defendant Company.   The court considered Generally Accepted Accounting Principles individually and in the context of their impact on the company’s financial statements and observed:

GAAP is not the lucid or encyclopedic set of preexisting rules.   Far from a single-source accounting rulebook, GAAP encompasses the conventions, rules, and procedures that define accepted accounting practice at a particular point in time. GAAP changes and, even at any one point, is often indeterminate. The determination that a particular accounting principle is generally accepted may be difficult because no single source exists for all principles.

Id. at 478.

Thus, even though GAAP is relied on by the courts, it is not the sole authority in resolving ambiguous financial terms.  The New York courts will also look in to the particular business transactions at issue.

In Pittsburgh Coke & Chemical Co. v. Bollo, 560 F.2d 1089 (2d Cir. 1977)the Appellant Company brought suit against Appellee stockholder for fraud under Rule 10b-5 of the Securities and Exchange Act of 1934 and for breach of the warranties contained in the agreement between the parties and certificate provided on the condition of the stock. The defendant breached his warranty by failing to write off sufficient amounts of Standard’s inventory. The agreement provided that all financial statements [of Standard] have been prepared in accordance with GAAP applied on a consistent basis throughout the periods involved. The court observed that the particular financial term in a contract should be construed in relation to the particular type of business involved.

The term “generally accepted accounting principles”, as used in the sale of Standard to PCC, should not be interpreted in vacuo but only in relation to the particular type of business involved. “Generally accepted accounting principles” are not synonymous with any specific inventory write-off policy. The unique nature of Standard’s business should make it self-evident that its retention of parts and equipment for substantial periods of time and its ability to supply some old part when needed were one of the foundation stones on which its business had been built.

Id. at 1092.

As dictated by the court in Pittsburgh Coke, a financial term in a contract should be construed in relation to the particular type of business involved.  In Delta Holdings v. National Distillers & Chem. Corp., 945 F.2d 1226 (2d Cir. 1991), while dealing with the dispute over the disclosure of documents, representations, and warranties in the reinsurance matter, the court discussed the relevance of GAAP. The court observed that though under GAAP a reinsurer is obligated to make a reasonable estimate of IBNR liabilities GAAP does not specify a precise actuarial method and there are certain alternatives for dealing with the subject matter in question. Id. at 1229.  Phrases in the contract should not be divorced from the commercial context in which it is used. Id. at 1248. 

Thus, in the light of the above cases, while interpreting the phrase short-term Indebtedness in bond indenture, it may be construed in the context of the particular business or the commercial context in which it is used.

Conclusion

In New York, the general purpose of the bond indenture, which is to protect rights of bondholders’ rights, is a more important aid in interpretation of ambiguous clauses.  The disputed (exclusion) clause “any accounts payable or other liability to trade creditors arising in the ordinary course of business” would possibly include only those debts incurred in the ordinary course of business.  An interpretation that limits accounts payable to those incurred in the ordinary course of business appears to be more consistent with the underlying intent of protection of bondholders’ rights.

The definition of Short-term debt will most likely be considered debt of less than one year, unless it can be shown that the particular business is such that a different standard should be used.  GAAP is not a set of rigid rules and Courts have interpreted financial terms to be independent of GAAP in the context of a particular business.  While interpreting the phrase short-term Indebtedness in bond indenture, it may be construed in the context of the particular business or the commercial context in which it is used.