Serta’s Controversial Debt Deal Reversed By Appeals Court (2)

Apollo Global Management Inc. and other financial heavyweights that were excluded from an “uptier” debt transaction between Serta Simmons Bedding LLC and competing lenders won an appeals court battle to overturn the deal.

The opinion is a significant development in a controversial debt liability management deal that shifted repayment priority among Serta’s lenders and was a central issue in the bedding company’s 2023 bankruptcy. The decision provides key appellate court guidance over the viability of a type of liability management deal that’s spurred heated lender-on-lender disputes, and it may be significant for the secondary debt markets.

The 2020 uptier deal that gave Serta a $200 million cash infusion wasn’t an allowed open market purchase, a three-judge panel of the US Court of Appeals for the Fifth Circuit ruled on Tuesday, reversing a bankruptcy court opinion.

The appeal has been closely followed by distressed debt investors and advisers because courts seldom rule on the efficacy of uptier transactions and other liability management deals, which have become a more common fixture in corporate restructuring. Similar debt deals have been used by other companies attempting to avoid bankruptcy while fights with disgruntled lenders have occasionally spilled into court.

The Serta transaction was backed by lenders including Eaton Vance, Invesco Ltd., Barings LLC, and Credit Suisse Asset Management LLC.

While similar loan contracts since 2020 have included language to block such uptiers, there are likely many still out there with open market purchase exceptions that allow borrowers to not treat all similarly situated lenders equally, the court said.

“Though every contract should be taken on its own, today’s decision suggests that such exceptions will often not justify an uptier,” the opinion from Judge Andrew S. Oldham said.

Excluded Lenders

Serta’s lenders that were excluded from the debt restructuring deal urged the Fifth Circuit during July oral arguments to reverse the Houston bankruptcy court ruling that approved the transaction. Existing lenders that provided the $200 million cash infusion were then moved up in payout priority.

Excluded lenders, including Apollo, Gamut Capital SSB LLC, and Angelo Gordon & Co., argued that the bankruptcy court was wrong to find that the transaction qualified as an “open market purchase” and therefore was exempt from a 2016 contract provision that said all the lenders must share proportionally in recovery.

The appeals court on Tuesday agreed with the excluded lenders. Serta should have purchased its loans on the secondary market instead of privately tapping individual lenders outside of that market if it wanted an open market purchase, the court said.

The excluded lenders said they’re entitled to potentially “hundreds of millions of dollars,” equaling the delta that the included, favored lenders received in 2020.

Former Houston bankruptcy judge David R. Jones’ June 2023 ruling in Serta’s Chapter 11 was the first time a court weighed in on the merits on “debt liability management deals.”

Jones resigned in late 2023 and has been embroiled in scandal after revelations that he was in an undisclosed live-in relationship with a bankruptcy attorney whose firm often appeared before him in court.

The Fifth Circuit’s opinion comes as debt management deals that change repayment priority of existing loans have become increasingly common for businesses and lenders in the estimated $1.4 trillion market for syndicated commercial loans.

The appeals court vacated the US Bankruptcy Court for the Southern District of Texas’s decision rejecting the excluded lenders’ breach of contract counterclaims, sending it back to the lower court for reconsideration.

The appeals court also reversed an element of Serta’s bankruptcy plan that indemnified the participating lenders against claims related to the uptier transaction—a deal potentially worth more than $1 billion.

‘Financial Titans’

Serta, one of the largest US bedding makers and distributors in North America, filed for Chapter 11 in January 2023 with about $1.9 billion in debt. It emerged from bankruptcy in June 2023.

The lenders who were shut out of the cash infusion deal had, under their 2016 debt contracts governing $2.6 billion in loans, previously held the same level of priority as those who were offered the deal. But after the transaction, they wouldn’t be repaid until the included lenders finished collecting what they were owed first.

When the excluded lenders sued, Jones ruled an open markets purchase is “something obtained for value in competition among private parties.” Serta’s deal—in which the company purchased the loans back and the lenders reissued them—met that requirement, he found.

Jones cited internal emails from the excluded lenders that conceded they were “outmaneuvered” in the deal, and that the two lenders groups were played off against each other by Serta’s private equity sponsor at the time, Advent International Corp.

“Sophisticated financial titans engaged in a winner-take-all battle,” Jones said in his ruling.

The bankruptcy court opinion affirming the restructuring transaction was a win for Serta-style “uptier” exchange deals and allayed broader concerns that such transactions violated an implied covenant of good faith under New York contract law.

An attorney for the excluded lenders declined to comment.

Judges Catharina Haynes and Don R. Willett joined the opinion.

The excluded lenders were represented by Paul, Weiss, Rifkind, Wharton & Garrison LLP. The LCM lenders were represented by Holwell Shuster & Goldberg. Serta was represented by Weil, Gotshal & Manges LLP. The prevailing lenders were represented by Gibson, Dunn & Crutcher LLP.

The case is Excluded Lenders v. Serta Simmons Bedding LLC, 5th Cir., No. 23-20181, opinion 12/31/24.