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A federal appeals court has invalidated a controversial corporate debt restructuring manoeuvre, ruling a lower bankruptcy court erred in its handling of the 2023 Chapter 11 restructuring of the mattress retailer, Serta Simmons Bedding.
However, a New York appeals state court issued a contradictory ruling on the same issue on Tuesday afternoon, creating confusion about the state of the law and leaving lawyers and investors scrambling to understand the conflicting decisions.
Minority lenders of Serta, which included funds such as Angelo Gordon and Apollo Global Management, had their loan interests pushed aside for repayment in a 2020 refinancing transaction known as an “uptier exchange”. The move allowed a slim majority of Serta lenders to leapfrog the minority group, which recovered little on its loans in the subsequent restructuring.
A three-judge panel of the US Fifth Circuit Court of Appeals wrote in a decision released on Tuesday that Serta “must respect the sacred right of pro-rata sharing and engage with its lenders on equal footing”.
Tuesday’s decision was eagerly anticipated by corporate debt markets, which have been racked in recent years by “creditor-on-creditor violence” transactions where a slim majority of lenders or bondholders offer a troubled company fresh capital in exchange for higher priority on existing debt positions.
The Serta ruling may force investors and lawyers to curtail their most aggressive deal structures that critics say have upset the predictability and fairness of debt markets. The court noted that the consequences of its Serta ruling could be far reaching.
Serta’s 2020 uptier “was the first major uptier. But it was far from the last,” the opinion said. “Though every contract should be taken on its own, today’s decision suggests that such exceptions will often not justify an uptier.”
Uptiers have been particularly controversial as many corporate lawyers believed standard debt contracts prohibited large creditors from disadvantaging smaller creditors in the same class, a reading the appeals court appeared to confirm.
Serta and the majority lenders who prevailed in the uptier exchange argued to the court that the company had merely chosen the financing option, $200mn of fresh capital in 2020 amid the turmoil of the pandemic, that best allowed it to survive. The company said the excluded minority lenders had offered their own similarly punitive package that it rejected.
After Serta filed for Chapter 11 in January 2023, the bankruptcy court agreed the retailer’s loan contract allowed enough flexibility for the majority group to swap only their existing loan for a new senior loan and leave others behind. The majority group took control of Serta in the bankruptcy while the excluded lenders were left with poor recoveries.
Southern District of Texas bankruptcy court judge David Jones said in a March 2023 oral ruling that, “For the nature of what was being transacted, this fits within [the definition] of an open market purchase, . . . this is very easy for me,” noting all the creditors were sophisticated funds.
The appeals court, however, ruled the “open market” language that allowed for the majority debt exchange was not correctly interpreted since the minority group was excluded from the chance to participate.
“An open market is a designated market, not merely the background concept of free competition that characterises much of modern American commerce,” wrote the appeals court, which is based in New Orleans.
But in the separate ruling on Tuesday, the New York appeals court rejected minority creditor efforts to challenge a 2022 uptier exchange transaction conducted by telco Mitel Networks. That court wrote that the existing loan contract did not expressly prevent debt exchange transactions that excluded some creditors.
“There is no indication in the agreements that a refinancing or exchange cannot include a purchase, nor is there any indication that a purchase requires payment in full, upfront, in cash, or that debt cannot constitute payment,” the appeals court wrote.
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