Go-To Guide:
  • Recent court decisions offer insights into how different courts interpret uptier transactions based on specific credit agreement terms.
     
  • Various credit agreement provisions, including buyback restrictions and sacred rights clauses, played key roles in these rulings.
     
  • Lender strategies, such as cooperation agreements, may emerge as potential responses to liability management transactions.

On Dec. 31, 2024, the U.S. Court of Appeals for the Fifth Circuit in Serta Simmons and the New York Appellate Division in Mitel each issued decisions concerning the validity of non-pro rata uptier transactions.1 The uptiers that the borrowers in Serta and Mitel undertook were prototypical; the borrowers negotiated with a subset of their existing lenders for new financing that would prime the existing debt, the participating lenders amended the existing credit documents to permit for such financing and/or lien stripping/subordination, and certain participating lenders exchanged their existing debt for some of the newly issued priming debt.

Despite the similarities, the two courts reached opposite conclusions on the uptiers’ validity, based on the terms of the underlying debt documents. In Serta, the Fifth Circuit held that the non-pro rata exchange did not constitute an “open market purchase” and, as a result, the exchange breached the existing credit agreement. Conversely, in Mitel, the New York court upheld the non-pro rata exchange, finding no similar restriction on affiliate buybacks existed in the underlying credit agreement.

These decisions round out a year that included another important decision, this one from the U.S. Bankruptcy Court for the Southern District of Texas in Incora, where in July 2024 the court ruled that the challenged uptier violated multiple indentures.2 

Takeaways from these decisions, and considerations for lenders, include
 

1. focusing on the credit agreement’s buyback and sacred rights provisions,
 
2. negotiating liability management transaction (LMT) blockers, including more broad-sweeping restrictions on uptiers, and
 
3. entering into cooperation agreements to thwart borrowers from pitting lenders against each other and the resulting race-to-the-bottom.
 

SertaMitel, and Incora Rulings

In Serta, the Fifth Circuit held that the debt exchange undertaken in a 2020 uptier did not qualify as an “open market purchase,” the exception to the pro rata sharing requirement that permitted borrowers to purchase loans from their lenders, and upon which Serta relied on for its exchange. In reaching its decision, the Fifth Circuit defined an open market purchase to mean one “that occurs on the specific market for the product that is being purchased”—e.g., a secondary market for syndicated loans—and not privately pursuant to a negotiated exchange.

Conversely, the New York Appellate Division in Mitel upheld the non pro rata exchange, finding that the underlying credit agreement expressly authorized the borrower to purchase loans from its lenders. The court rejected the non-participating lenders’ arguments that the exchange triggered the sacred rights provision concerning any change to loan terms that “directly adversely affected” lenders. The court found that the exchange did not waive, amend, or modify any loan term, and that the exchange’s effect on the non-participating lenders was indirect.

The Bankruptcy Court’s decision in Incora dealt with both sacred rights and buyback provisions. There, the court ruled that the uptier violated the existing indenture’s sacred rights provision because it released collateral without the required supermajority consent. In doing so, the court found the series of amendments that the debtors and the participating noteholders entered to obtain supermajority consent ineffective as they “had the effect of releasing all or substantially all of the collateral securing the debt.” As a result, the court held that the rights, liens, and interests that benefitted the noteholders under this indenture remained in full force and effect.

Additionally, the Incora court held that another indenture was breached when the issuer’s sponsor purchased notes from the participating noteholders in connection with the uptier. While that indenture permitted the issuer and its affiliates to purchase notes, it required any such purchase to be pro rata if the purchase was for less than all outstanding notes. The court therefore found that the sponsor’s purchase violated the pro rata treatment required under the indenture.

Considerations

In light of these rulings, lenders should consider:


1 In re Serta Simmons, No. 23-201481 (5th Cir. Dec. 31, 2024); Ocean Trails CLO VII v. MLN Topco Ltd., No. 24-00169 (N.Y. App. Div. 1st Dep’t Dec. 31, 2024).
2 Hearing Transcript, Wesco Aircraft Holdings, Inc. v. SSD Inv. Ltd., (In re Wesco Aircraft Holdings, Inc.), Case No. 23-90611, Adv. No. 23-03091 (Bankr. S.D. Tex. July 10, 2024).

Leave a Reply

Your email address will not be published. Required fields are marked *