More Restructuring Is Coming for Credit Lenders and Investors

The 2023 credit market will be challenging for lenders and investors, and the next six to nine months are likely to see many liability management transactions as both private equity sponsors and public companies turn to their existing investors for liquidity and maturity extensions.

Lessons for the coming year can can be drawn from the past year’s trends in litigation. These transactions take many shapes, including uptiering, but all use a similar approach.

Companies offer benefits such as new senior priority debt or enhanced economics to investors who are willing to provide maturity extensions and/or new capital. Businesses are also making the existing debt facility less attractive through exit consents that limit covenants and subordinate or release liens.

The transaction may be offered to all holders to maximize the potential for a comprehensive maturity extension. Or they may be structured with—and available to—only a select group of investors.

This type of non-pro rata transaction can be used to raise liquidity and create additional debt pricing discounts that can then be used for the benefit of the borrower. However, these transactions have risks, as dissenting investors may seek to challenge them through litigation.

Serta Simmons Bedding, TriMark USA, and Boardriders Inc. all completed uptiering transactions in 2020 in the wake of the Covid-19 pandemic and were challenged by nonparticipating lenders.

Challenges to Claims

While the litigation claims arising from these transactions differ from case to case, two common categories of claims tend to be brought.

First, complaints usually assert that the express terms of the contract were breached. The plaintiffs in Serta and Boardriders claimed that the transactions had been negotiated in private among a select group of holders in breach of provisions prohibiting non-pro rata payments to lenders. Some claimants have also alleged that the transactions involved actions that required the vote of each lender, or sacred rights provisions.

The second type of challenges assert a claim for breach of the implied covenant of good faith and fair dealing on the theory that the transaction, even if not expressly prohibited by the agreements, deprived dissenting lenders of their bargained-for first-priority collateral rights.

First Litigation Wave

Some courts have said that as long as the transaction technically complied with the contractual language at each step, neither a contractual breach nor a breach of the covenant of good faith and fair dealing could be successful.

For example, when faced with a request to enjoin the Serta transaction, the New York State Supreme Court determined that there was not a high likelihood of success on the merits because the transaction appeared to comply with the literal terms of the agreements. Not long after this ruling, the objecting lenders withdrew their lawsuit. New York’s Supreme Court hears cases outside the authority of the state’s lower courts.

In TriMark, the New York State Supreme Court declined to dismiss a claim that the enabling amendment was invalid because the transaction had implicated sacred rights provisions. But the court rejected the objecting lenders’ separate good faith and fair dealing claim.

If the dissenting lenders succeed on their contractual breach claim, the court reasoned, the implied duty claim was duplicative. The court also held that if the dissenting lenders’ contract claim failed, the implied duty claim would also fail because it could not be used as a basis to prevent the participating lenders from taking actions permitted by the agreement.

Second Litigation Wave

The next wave has resulted in different decisions.

Certain nonparticipating lenders in the Serta case filed a complaint in the US District Court for the Southern District of New York, asserting substantively the same claims alleged in the original state action.

In contrast to the reasoning in Trimark, the federal court held that even if the uptier transaction was authorized as an “open market purchase,” the claim for breach of the implied covenant of good faith and fair dealing could also survive at this stage of the case.

The court found that the plaintiffs had adequately alleged that they expressly bargained for first lien, priority, pro rata rights, and that the amendment to the agreement was undertaken in bad faith because it deprived the plaintiffs of the benefit of that bargain.

And just two months ago, the New York State Supreme Court in the Boardriders case ruled that claims similar to those brought in Serta and Trimark were adequately pleaded to survive a motion to dismiss.

Unlike in prior cases, the court looked to the holistic effect of the transaction—rather than the step-by-step analysis conducted by other courts—in determining whether certain provisions of the agreement had potentially been breached. The court also permitted the implied covenant of good faith and fair dealing claim to proceed. In the wake of these decisions, some of the objecting lenders in Serta refiled their previously withdrawn lawsuit in the New York Supreme Court.

None of these cases have been litigated to conclusion, nor have appellate courts weighed in on the issues. If these litigations ultimately proceed to decisions on the merits, the results should provide further guidance on the permissibility of certain structures and may warrant potential adjustments to these transactions. We expect to see substantial activity and a continued evolution in the form of these liability management transactions in the coming year.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

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Author Information

Marshall Huebner is co-head of Davis Polk’s restructuring group. He has played a key role in many of the largest and most complex restructurings of the last 30 years.

Angela Libby is a partner in Davis Polk’s restructuring group. She advises debtors, creditors, banks, hedge funds, lenders, asset purchasers and other strategic parties in a wide range of corporate restructuring matters.

Damian Schaible is co-head of Davis Polk’s restructuring group. He has extensive experience in a wide range of corporate restructurings and bankruptcies.

Davis Polk’s Paavani Garg contributed to this article.