Serta Debt Ruling Lobs ‘Grenade’ Into Restructuring Strategies

An appeals court opinion striking down an “uptier” debt transaction between Serta Simmons Bedding LLC and a group of lenders is changing the calculus of some liability management exercises and sending ripples through the secondary debt markets.

The US Court of Appeals for the Fifth Circuit’s interpretation of the contract language that governed the uptier transaction—which became ubiquitous after the 2008 financial crisis—now threatens the popularity of liability management exercises that don’t treat all existing lenders equally.

The court’s New Year’s Eve opinion was the first time a federal appeals court weighed in on the controversial deal that shifted repayment priority among Serta’s lenders. Apollo Global Management Inc. and others that were excluded from the 2020 exchange prevailed in the Fifth Circuit after unsuccessfully challenging the deal during the bedding company’s 2023 bankruptcy.

A three-judge panel held that Serta should have gone to the secondary market for syndicated loans instead of privately tapping individual, existing lenders under an “open market purchase” provision of its debt contract.

“This is like a grenade dropping into almost everyone’s practice who does restructuring right now,” said University of Chicago Law School law professor Vincent Buccola.

‘Deathbed’

The Fifth Circuit’s Serta decision will “materially alter” the liability management exercise landscape, said David M. Hillman, co-head of Proskauer Rose LLP’s restructuring group.

The deal at issue, which provided Serta with a $200 million cash infusion and created a new tier of superpriority debt, benefited a slim majority of the company’s lenders.

“The Fifth Circuit materially limited the LME tool box by striking down the ability to selectively roll-up existing debt for some but not all lenders in the same facility,” Hillman said. The nonproportional debt exchange feature “is on its deathbed,” he said.

Hillman noted that other types of liability management exercises aren’t affected, such as issuing new priming debt or a “drop down” of assets to an unrestricted subsidiary.

In a statement, Serta said the ruling removed the company’s obligation to indemnify lenders and it tees up a contract dispute between certain creditors over the company’s 2020 debt refinancing.

“Serta Simmons Bedding’s business and its restructuring are unaffected by the Fifth Circuit’s decision and the Company continues business as usual,” it said.

Thinking Twice

Liability management deals with full or nearly full lender consent have sometimes been shaped by the threat of receiving inferior treatment, Buccola said. The Fifth Circuit’s opinion may eliminate that threat, he said.

“The whole kind of practice is being upended by this decision,” said Buccola, whose academic writing was cited in the Fifth Circuit’s opinion.

While the decision comes from a circuit court in an important jurisdiction where many large bankruptcies are filed, multiple attorneys noted that the opinion doesn’t bind other jurisdictions.

There is no clear trend emerging from other courts at this point, said Sean A. O’Neal, a partner at Cleary Gottlieb Steen & Hamilton LLP.

“The decisions on liability management transactions continue to be fact specific, with no uniform guidance,” O’Neal said. “That said, the decision shows that at least some courts are willing to scrutinize contractual language, in context, and push back on majority lender actions.”

By indicating that open market purchases must be available to all buyers and sellers, the court has challenged the intended use of the provision as a gateway to liability management transactions through private deals, said Linda W. Filardi, Flagstar Bank’s senior vice president and associate general counsel.

Those involved in such deals will have to think twice before taking part in liability management transactions that use the open market purchase structure and end up subordinating some lenders, she said.

“It certainly throws a wrench in the ability to make ‘open market purchases’ that are not transparent,” Filardi said.

‘Nail-in-the-Coffin’

Many credit agreements still include the “open market” exception, so borrowers will have to find other workarounds to avoid litigation risk, Duane Loft of Pallas Partners LLP said.

“This is a landmark decision in the world of liability management,” he said.

Loft also noted that the Fifth Circuit’s reversal of the part of Serta’s bankruptcy plan that provides indemnity for the participating lenders “is potentially very significant,” because those lenders now may bear the cost of litigation.

“That could make them think twice about sponsoring an aggressive LME,” Loft said.

The opinion “will have wide ranging and positive consequences for the vast majority of the syndicated loan market that contains these provisions,” according the nonprofit Creditor Rights Coalition, which filed an amicus brief asking the Fifth Circuit to reject the uptier deal.

“The 5th Circuit’s decision hopefully puts the ‘nail-in-the-coffin’ for liability management transactions that rely on distorted interpretations of contractual language to undermine the fundamental notion that lenders be treated equally,” the group said.

Mitel

Coincidentally, a second court on Dec. 31 also ruled on the use of liability management maneuvers.

Mitel Networks, a Canadian telecommunications company, won approval from a New York state appeals court of a controversial 2022 debt exchange challenged by lenders left out of the deal.

While the New York court reached a different conclusion than the Serta court, the contractual language in Mitel’s loan document doesn’t include the term “open market purchase” at issue in Serta, said Dan Kamensky, co-director of the Altman-Paulson Initiative on Credit & Distressed Opportunities at NYU Stern and founder of the Creditor Rights Coalition.

The language in that credit document gave Mitel the flexibility to buy back its debt by individual agreement with a selling lender at any time, Kamensky said.

Mitel’s loan document language is unusual and more closely resembles the type of language in the bond market where those types of transactions are less controversial, he said.