Article courtesy of Ariel Emmanuel (King & Spalding)
In re Serta Simmons Bedding, L.L.C., No. 23-20181, No. 23-20450, No. 23-20363, No. 23-20451, 2024 WL 5250365 (5th Cir. Dec. 31, 2024)
In 2016, Serta entered into a $1.95 billion first lien term credit facility and a $450 million second lien term loan credit facility. The credit agreements governing these credit facilities, for ratable treatment among the lenders.
As Serta’s financial condition deteriorated, in 2020 it agreed with certain lenders holding a majority of loans under its credit facilities (the “Participating Lenders”) to consummate an uptier transaction. Serta and the Participating Lenders entered into a super priority term loan credit agreement in which the Participating Lenders provided Serta with a $200 million first-out super priority term loan, and exchanged $1.2 billion of their existing first lien term loans for approximately $875 million of second-out super priority term loans. This uptier transaction had the effect of subordinating the remaining minority lenders that were not invited to participate in the uptier transaction (the “Excluded Lenders”).
The Excluded Lenders filed a lawsuit against Serta and the Participating Lenders alleging that the uptier transaction violated the terms of the existing credit facilities. In 2023, Serta filed for chapter 11 bankruptcy. The Bankruptcy Court determined that the purchase that effectuated the exchange of first and second lien loans for second out super priority loans was valid under the open market purchase exception in the existing credit agreement. The Bankruptcy Court defined an open market purchase as “something obtained for value in competition among private parties”. Additionally, the confirmed bankruptcy plan contained an indemnity provision in favor of the Participating Lenders against any liability to the Excluded Lenders. The Excluded Lenders appealed the decision.
On appeal, the Fifth Circuit Court of Appeals rejected the Bankruptcy Court’s conclusions, saying that Serta did not repurchase its loans on a transparent and competitive secondary loan market, instead choosing to engage privately with individual lenders. The Court of Appeals held that the exchange of new super priority loans for existing loans in the uptier transaction was not a permissible “open market purchase” of the existing loans under the terms of the first lien credit agreement. The court stated that an “open market purchase” is limited to the purchase of corporate debt that occurs on the secondary market for syndicated loans. By transacting with the Participating Lenders on a private basis in a way that was not open to all sellers of the existing loans, Serta avoided the secondary market altogether and violated the Excluded Lenders’ right to ratable repayment.
The Court of Appeals also held that the related indemnity granted to the Participating Lenders in Serta’s bankruptcy plan violated the Bankruptcy Code and should be removed from the bankruptcy plan. The Court of Appeals found that the indemnity violated Section 502(e)(1)(B) of the Bankruptcy Code, which disallows contingent claims for reimbursement where the claimant is co-liable with the debtor. Because the Participating Lenders and Serta were both liable to the Excluded Lenders for breach of the first lien credit agreement, the Participating Lenders were not entitled to any protection through the bankruptcy case of their contingent reimbursement claims against Serta.
