Quick Takes on the Serta & Mitel Decisions
On New Year’s Eve, appellate courts released two important LME decisions on whether “uptiering” transactions violated the terms of credit agreement under New York law. In re Serta Simmons Bedding, L.L.C., No. 23-20181 (5th Cir. Dec. 31, 2024) (“Serta”); Ocean Trails CLO VII v. MLN Topco Ltd., No. 2024-00169 (1st Dep’t Dec. 31, 2024) (“Mitel”). Serta and Mitel each involved non-pro rata, off-market debt exchanges to a select group of majority lenders. In Serta, the Fifth Circuit struck down the uptiering transaction, while in Mitel, the New York Appellate Division, First Department, upheld it. At first blush, these decisions may appear contradictory, but there are key textual differences in the provision that set forth the requirements for a company to make non-pro rata purchases of debt from lenders in the same class.
As the Fifth Circuit explained, uptiering transactions emerged in recent years as a way for borrowers to attempt to amend their credit agreements to issue new super-priority debt to a majority of lenders in exchange for their existing debt. Typically, the majority lenders receive more senior loans, often at an above-market price; the company secures additional financing through the issuance of the new super-priority debt; and the minority lenders, who are excluded from the uptiering transaction, bear the cost, their now-subordinated debt is worth less than before. Uptiering transactions are controversial. They do not treat all lenders in the same class similarly by enabling the majority lenders to receive off-market senior debt in a non-pro rata exchange.
In Serta, the credit agreement required pro-rata sharing of payments among lenders of the same class, subject to exceptions, including in § 9.05(g) (emphasis added):
[A]ny Lender may, at any time, assign all or a portion of its rights and obligations under this Agreement in respect of its Term Loans to any Affiliated Lender on a non-pro rata basis (A) through Dutch Auctions open to all Lenders holding the relevant Term Loans on a pro rata basis or (B) through open market purchases ….
“Affiliated Lender” was defined to include the company. The majority lenders and company relied on the exception to pro-rata sharing that such lenders may exchange their existing debt with the company through an “open market purchase,” an undefined term. The Fifth Circuit disagreed. It interpreted “open market” to mean a “specific market that is generally open to participation by various buyers and sellers” and therefore an “open market purchase” must take “place on such a market as is relevant to the purchased product—here, the secondary market for syndicated loans.” The Court rejected the company’s and majority lenders’ definitions principally because they failed to give meaning to the word “market,” instead focusing simply on negotiations or competition among private parties without reference to a specific market. Because the uptiering transaction at issue was negotiated in private among the company and majority lenders—as opposed to the secondary market for syndicated loans—the court held that it was not a permissible “open market purchase.”
In Mitel, the applicable credit agreement generally prevented lenders from “receiving payment of a greater portion … than the proportion received by any other Lender entitled to receive the same proportion.” To effectuate the uptiering transaction, the majority lenders and company relied on an exception to pro rata sharing under section 9.04(i) of the credit agreement that provided the company may “purchase by way of assignment and become an Assignee with respect to Term Loans at any time.” (emphasis added).
New York’s Appellate Division, First Department, upheld the transaction, concluding that the term “purchase” is not “mutually exclusive” with a “‘refinancing’ or ‘exchange’ of the existing loans for new loans.” It interpreted the meaning of “purchase” to be not limited to a “cash payment” or contain a “prohibition on the use of debt” as payment. The uptiering transaction, which exchanged the majority lenders’ old debt for new senior debt, did not breach the credit agreement because it was a “purchase” by the company of its existing debt under section 9.04(i).
A way to reconcile Serta and Mitel is that non-pro rata, off-market debt exchanges are impermissible if the agreement has an “open market purchase” provision, but they are allowed if it has a plain “purchase” provision that enables the company to “purchase” debt. While the Fifth Circuit noted that the loan market has seen an increase in “uptier blockers” in recent years, many agreements pre-date the prevalence of uptier transactions. Serta and Mitel suggest that courts will look closely at the text of the relevant agreement in determining whether the transaction is permissible.
In addition, one other holding of Serta may have implications on future transactions where the company ultimately files for bankruptcy. At the time of the uptiering transaction, the company agreed to indemnify the majority lenders for their participation in the transaction. In an effort to have this indemnification obligation survive when the company emerged from bankruptcy, the majority lenders argued it was a “settlement indemnity” between the company and its creditors to gain approval for bankruptcy plan confirmation. The Fifth Circuit disagreed, holding that this settlement indemnity was “an impermissible end-run around the Bankruptcy code” and specifically 11 U.S.C. § 502(e)(1)(B), which disallows any contingent claim for reimbursement where the claiming entity is co-liable with the debtor. Given that uptiering transactions typically focus on distressed companies at risk of bankruptcy and carry a high risk of litigation, the unavailability of indemnity for majority lenders may impact their willingness to participate in such transactions going forward.
*The views expressed in this article do not necessarily reflect the views of Elsberg Baker & Maruri (“EBM”) or any of its clients. EBM associate Garrett Gerber contributed this article.