Jilted Investors Find Hope Challenging Lien-Altering Debt Deals

Secured lenders whose liens are diminished through a creative but controversial way of raising money for distressed corporate borrowers may glean hope from a string of court rulings that have come down on the side of spurned investors.

At issue is a form of debt management in which a distressed company, seeking new funds to avoid bankruptcy, enters into a transaction with a bare majority of its lenders that places their debt above that held by a minority of institutions left out of the negotiations without their consent.

Such “uptier” or “priming” transactions have generated hostility among some financial creditors towards deal participants, including the private equity firms who largely own the distressed companies engaging in the technique. This form of “lender on lender violence” is relatively new, tracing its roots to pandemic-related financial fallout in 2020.

The uproar over such debt exchanges has led to high-profile lawsuits involving some of Wall Street’s biggest names.

But in a ruling last week, New York State Supreme Court Justice Andrea Masley allowed a minority group of first lien lenders to Boardriders Inc. to continue pressing claims for breach of contract and breach of “the implied covenant of good faith and fair dealing” against the Oaktree Capital Management-backed sports apparel company.

It’s the latest instance of a judge letting investors pursue claims against a company and its chosen subset of superpriority lenders. That offers hope to investors who’ve been left out of deals at a time when such disputes are likely to multiply as more companies find themselves in need of fresh capital.

“It’s another brick in the wall so to speak,” said University of Pennsylvania Wharton School professor Vincent Buccola. “Plaintiffs may have a very good claim here.”

Cat’s Out of Bag

Clever balance sheet and asset transfer maneuvers have been gaining some attention for the last few years. J. Crew is one of the most notable examples, making waves in 2016 when it moved intellectual property to a Cayman Islands subsidiary out of the reach of existing creditors, though it still filed for bankruptcy in 2020.

Since the onset of the Covid-19 pandemic, a few companies have facilitated uptier exchanges.

Boardriders, the owner of surfwear brands Quiksilver and Billabong, was one of three companies in 2020 to execute a priming transaction to the detriment of a few lenders. Food services company Trimark USA LLC and mattress manufacturer Serta Simmons Bedding LLC—both owned by private equity firms—also completed uptiering deals involving hundreds of millions of dollars to stave off potential bankruptcies.

Historically, lenders didn’t engage in these types of deals that stealthily put them in front of other similarly situated creditors for repayment.

But now, “lender on lender violence” situations “seem to be increasing in frequency,” with more likely to follow, as distressed borrowers struggle to make interest payments, said debt finance attorney Jason Ulezalka of Locke Lord LLP.

The trend may result in underlying loan agreements coming under greater legal scrutiny, he said.

“The cat’s out of the bag in terms of these folks doing these types of transactions,” Ulezalka said.

Civil Court Challenges

Aggrieved lenders have been quick to bring lawsuits challenging uptiering deals that they say unfairly amended their loan agreements and pushed them down in the pecking order for repayment.

The results, so far, are encouraging for plaintiffs like Apollo Global Management Inc. and Angelo Gordon, who sued Serta Simmons Bedding LLC and owner Advent International over the company’s 2020 debt transaction. In that suit, and others brought against Trimark USA and Boardriders, courts have denied motions to dismiss core claims of unfair treatment.

“You can’t do one of these types of transactions without opening the door to litigation,” said corporate finance and restructuring attorney Jennifer Taylor of O’Melveny & Myers LLP.

In the Oct. 17 decision from the Boardriders case, Masley said the claims brought by an array of hedge funds adequately alleged that the defendants breached a “sacred rights” provision in the credit agreement.

Although no civil court has reached a final judgment on the merits of these suits, the results to date “give the plaintiffs a good roadmap of the kind of claims that you’ll bring and that might be successful,” Taylor said.

While the suits against Serta Simmons and Boardriders remain on the path to trial, Trimark USA settled earlier this year by allowing plaintiff creditors to exchange their debt on a dollar-for-dollar basis in a tranche of “super senior” loans.

Bankruptcy Court Outlier

Despite failures to dismiss legal challenges over priming transactions, it seems unlikely that companies and their lenders are going to be dissuaded from attempting similar deals in the future, said Taylor.

There are still existing corporate loans with “loose language” that could be utilized by distressed companies, and creative usage of that language “is going to continue to evolve,” she said.

And while some companies have run into legal setbacks after an uptiering transaction, chemical manufacturer TPC Group Inc. recently scored a crucial victory in bankruptcy court over a similar dispute.

In a July 6 decision, Judge Craig Goldblatt of the US Bankruptcy Court for the District of Delaware ruled that pre-bankruptcy debt maneuvers that subordinated $930 million in senior notes to $204 million in new notes issued to a two-thirds majority of TPC’s lenders was permissible under the terms of the loan documents.

The ruling “is a bit of an outlier” that creates the possibility of companies looking to Delaware bankruptcy court when these types of controversial debt deals are put to the test, said Taylor.

“That may be some sort of indication of where these things might be heading,” she said.