On December 31, 2024, the Fifth Circuit Court of Appeals (the “Court”) struck down the controversial 2020 “uptier transaction” executed by Serta Simmons Bedding (“Serta”). The Serta case and several other state court and bankruptcy cases over the last few years have sparked increasing focus on so-called “liability management exercises” involving distressed borrowers and their lenders.
The Serta transaction was structured under Serta’s 2016 credit agreement, which included pro rata sharing provisions and allowed the company to repurchase debt through “open market purchases” without unanimous lender consent. In 2020, facing financial distress, Serta raised $200 million in new super-priority financing by amending the agreement with a majority of its lenders, rather than with all affected lender consent, by utilizing the exception for “open market purchases”. Participating lenders received newly issued first-lien debt, effectively moving them “up” in repayment priority ahead of non-participating lenders— even though all had originally held the same class of debt. The excluded lenders challenged the deal, and the Court ultimately agreed, finding that the transaction breached the pro rata sharing provisions and did not qualify as a valid “open market purchase.”
Defining the “Open Market Purchase” Exception
The Court’s decision hinged on its interpretation of what constitutes an “open market purchase” and emphasized that an “open market” purchase must take place in the relevant market for the debt— in this case, the secondary market for broadly syndicated loans— and must be accessible to multiple potential buyers and sellers.
The Court concluded that Serta’s highly selective and privately negotiated transaction did not resemble the kind of arm’s-length trading that the credit agreement intended to permit. Because Serta’s transaction lacked these characteristics, it could not be shielded by the open market exception.
Implications Beyond Syndicated Loans: Club Deals and Private Credit
Much of the initial analysis on the Serta decision has focused on the broadly syndicated loan market, but the decision and subsequent market reactions have also had a significant impact on club deals and direct lending transactions. These types of deals typically involve a small number of relationship-based lenders and do not trade in an active or liquid secondary market.
While there is typically no “open market purchase exception” (since there is no “open market") in direct lending deals, privately negotiated amendments, restructurings and repurchases are not just common— they are often the only practical method for managing liabilities. Accordingly, the growing practice of including “Serta blocker” language in direct lending and club Credit Agreements, as well as similar attempts to prevent or limit other liability management structures, may restrict direct lenders’ workout options without the benefit of the open market “out” available in more widely syndicated loans.
Key Takeaways for Private Client Players
The increased focus on liability management transactions, including up-tiering as in the Serta case, creates a shifting landscape and evolving set of leverage points for borrowers, lenders and sponsors operating in private credit markets. This is true with respect to existing deals, as well as new financings. Many existing credit agreements in this space were not drafted with liability management transactions in mind, and provisions regarding voting requirements and exercise of various rights and obligations of the lenders may be imprecise or insufficient (or may be a great opportunity, depending on a party’s perspective) in light of market developments.
Given these developments, borrowers and lenders are required to scrutinize their documentation closely to assess whether liability management transactions— particularly those that could alter payment priority— are permissible under the existing terms as well as in new deals. In some cases, parties may need to proactively amend existing agreements (in particular, the pro rata treatment, security, assignment and amendment & waiver provisions) to clarify provisions regarding negotiated exchanges or require unanimous lender consent for various liability management arrangements.
A Call for Contractual Precision
In the wake of the Serta ruling, one message is clear: precision in drafting is essential. In a legal environment where parties are willing to ask courts to scrutinize even commonly used deal structures, flexibility must be clearly and explicitly built into loan documents. Otherwise, parties may find that even well-intentioned restructurings expose them to significant litigation risk. As liability management techniques continue to evolve, so too must the contracts that govern them.
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