Jennifer Selendy Speaks on Open Market Purchases

A common theme in the aftermath of debt uptiering transactions is the debate over whether privately negotiated transactions between a debtor and a group of creditors can qualify as an “open market purchase.†The reason for this recurring issue is that many debt agreements include carveouts for Dutch auctions and/or open market purchases from otherwise-applicable provisions restricting assignments to the debtor or other non-pro rata debt purchases. The term “open market purchase†is generally undefined in credit agreements, and courts have arrived at sharply different interpretations of the term.

Two New York courts addressing debt uptiering disputes have held that “open market purchase†is an ambiguous term and thus have allowed claims to proceed past motions to dismiss when minority creditors allege that an improper assignment was not an open market purchase. LCM XXII Ltd. v. Serta Simmons Bedding, LLC, 2022 WL 953109, at *7-8 (S.D.N.Y. Mar. 29, 2022) (“Serta Iâ€); ICG Global Loan Fund I DAC v. Boardriders, Inc., 2022 WL 10085886, at *8-9 (N.Y. Sup. Ct. Oct. 17, 2022). In Boardriders, a New York state court held that the term “open market purchase†was ambiguous as to whether it requires (1) that term loans must be retired and not exchanged, (2) that purchases be at market value or for cash, (3) that purchases be standalone transactions, and (4) that the transactions be offered to all lenders. 2022 WL 100085886, at *8. In Serta I, the debtor argued that “open market purchase†referred merely to an arm’s-length transaction at a price that a willing buyer and seller could agree upon. 2022 WL 953109, at *7. A federal court in the Southern District of New York rejected this argument, holding that the term could reasonably be read to mean a transaction open to any willing participants at a price set by market forces. Id. at *7-8.

The Serta I court was assisted by the expert report of Marti Murray, a veteran in the distressed debt market. Ms. Murray articulated that an open market purchase would generally be understood in the industry to mean a purchase of bank debt for cash in the secondary market conducted at arm’s length at or close to the prevailing market price. She identified 12 typical characteristics of open market purchases:

1. A documented internal decision to execute an open market purchase;
2. Identification of a dealer or dealers to assist in effectuating an open market purchase;
3. Engagement in secondary bank debt market price discovery;
4. Agreement to trade through a dealer;
5. Execution of a trade at or near the prevailing market price;
6. Execution of a trade for cash consideration;
7. No special conditions attached to the trade, other than usual and customary conditions for bank debt trades in the secondary market;
8. Internal documentation that a trade had occurred;
9. Execution of a trade confirmation;
10. Negotiation of a Purchase and Sale Agreement or similar agreement;
11. No detrimental effect on preexisting pari passu debt; and
12. To the extent the transaction was required to retire debt, declination in the borrower’s debt equal to the face amount of the debt purchased.

None of these characteristics was initially satisfied in the Serta uptiering transaction, and even at the time of the litigation, only a Purchase and Sale Agreement had been executed.

But a bankruptcy court in the Southern District of Texas subsequently reversed course in Serta’s Chapter 11 case. The court invoked its familiarity with the finance industry and determined that the uptiering was an open market purchase because it did not involve any coercion or manipulation. Serta Simmons Bedding, LLC v. AG Centre St. P’Ship (In re Serta Simmons Bedding, LLC), No. 23-0901 (Bankr. S.D. Tex. Mar. 28, 2023), transcript at 134 (“Serta IIâ€). This determination was made on a summary judgment motion, rather than a motion to dismiss, and thus the court had a broader record before it, but the court’s decision appeared to be based on the contract language and the judge’s experience in the industry. It is unlikely to be treated by New York courts as more persuasive than the above-referenced decisions, but the decision may be significant for future bankruptcy adversary proceedings, which frequently occur in the Southern District of Texas. For this reason, minority creditors seeking to challenge a debt uptiering should pursue their claims, whenever possible, prior to any bankruptcy filing by the borrower.

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