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Serta Simmons Bedding LLC (“Serta”), a mattress manufacturer, had engaged in a controversial “uptier” restructuring transaction in 2020 which resulted in an uneven repayment of its existing debts and an arguably inequitable treatment of certain of its existing lenders.
In the existing credit agreements (governed by New York law) signed between Serta and its existing lenders, all of the existing lenders were entitled to debt repayment pro rata to each other unless this right was amended or waived with unanimous consent. Unanimous consent was absent. However, an exception to pro rata repayment was provided in the context of an “open market” purchase of debts under the credit agreements by an “affiliated lender” of the existing lenders, which term included Serta. This meant that the borrower could effectively buy back its own debt under the credit agreements in an “open market” setting and that the borrower was not obliged to ensure that it does not buy back more from a lender than is warranted by that lender’s proportionate holding of existing debts under the credit agreements.
Seizing on this exception, Serta implemented a debt for debt exchange whereby certain of its existing lenders (who had consented to providing Serta with additional loans) had their existing loans bought by Serta in exchange for newly issued debt of Serta (for a lower principal amount than the original loans held by such lenders but which had attached to it a higher priority (super priority) in terms of right to repayment and entitlement to enforcement proceeds relative to the existing loans held by such lenders). Those among the existing lenders who had not provided Serta with additional loans were excluded from the debt for debt exchange and thereby subordinated to the participating lenders and they were unable to have their debt claims satisfied out of the assets of Serta due to their subordinate position in the waterfall.
Non-participating lenders commenced legal action against Serta asserting that the debt for debt exchange was not valid because it did not constitute an “open market purchase”. In June 2023, the bankruptcy court in the Southern District of Texas gave a declaratory judgment stating that the debt for debt exchange indeed constituted an open market purchase because there was a purchase of debt and the price paid was the result of competition between private actors. In the present case, the participating lenders and the non-participating lenders had put forward their own versions of a debt for debt exchange and ultimately Serta decided to accept the proposal put forward by the participating lenders. Subsequently in December 2024, however, the US Court of Appeals for the Fifth Circuit ruled otherwise. According to the Fifth Circuit, having referred to a number of sources including legal dictionaries and New York State judicial precedents, an “open market” is a reference to the secondary market for syndicated loans in general and in the present case there was no purchase of debt by Serta from such secondary market meaning the open market purchase exception failed to apply to the debt for debt exchange in the present case. The debt for debt exchange was the result of private negotiations between the borrower and a subset of its existing lenders rather than between the borrower and the sellers on the market for syndicated loans (which would have included non-participating lenders). Further appeal on this point is to be expected.
In the face of financial difficulties, there undoubtedly are temptations to impose a strained interpretation on the words of a loan agreement in order to arrive at a particular outcome. Where there is room for ambiguity, honest disagreements can and most likely will arise. While the informality of the phrasing “open market” may have also been a concession granted to the borrower in order to offer a competitive and tailored financing, it was a departure from best practice and it could not guarantee to the borrower its desired outcome in this instance.