Uptier Transactions and Other Lender-on-Lender Violence: The Potential for More Litigation and Disputes on the Horizon

Introduction to Lender-on-Lender Violence

“Lender-on-lender violence” refers to various types of transactions through which a company, often in critical need of additional funding, gives an advantage to a subset of existing lenders at the expense of other existing lenders. Lender-on-lender violence has been noted more in recent news, with priming and uptier measures being attacked by the non-participating lenders that had been left out of such transactions, in cases such as Serta Simmons, Boardriders, Trimark, and TPC Group. Lender-on-lender violence transactions, which used to happen mostly in in-court restructuring processes, have been increasingly used in out-of-court restructurings in recent years including during the COVID-19 pandemic.

During prior periods when capital for businesses was cheaper and there was more competition for deal opportunities, some debtors and lenders/investors entered into credit agreements, indentures, and/or other transactions with looser covenants, which, among other things, might permit substantial debt modifications in some participating lenders’/investors’ favor. As many corporate borrowers hit harder times during the pandemic, some lenders and investors required borrowers to undertake, or took part in, “priming” or “uptier” measures (“lender-on-lender violence”), to attempt to elevate their priority and improve their collateral position vis-à-vis the other, non-participating lenders and investors.

Structures of a “Lender-on-Lender Violence” Transaction

Commonly used structures of a “lender-on-lender violence” transaction include priming, uptiering, and financing through an unrestricted subsidiary or affiliate.

• Priming Transaction: A “priming” transaction usually involves a borrower issuing a new debt that is secured by the same collateral as but is (newly) more senior to an existing debt.
• Uptiering Transaction: An “uptiering” transaction usually involves an incremental financing by the majority of lenders in the most senior class on a super-priority basis and an exchange of an existing debt held by those lenders with a new debt more senior to the existing debt.
• Unrestricted Subsidiary Transaction: An unrestricted subsidiary transaction usually involves a borrower, with the consent of the majority of lenders, transferring valuable assets in the collateral pool for existing debts to a subsidiary (existing or newly created) that is exempt from the covenants of those existing debts and arranging that subsidiary to issue a debt secured by those assets.

While the specific mechanics of the lender-on-lender violence transaction may differ, the common thread is that, after the transaction, a group of lenders that believed to have first priority position over certain collateral is subordinated to other lenders with respect to that collateral. Importantly, in a distressed situation, the lack of clarity in a credit document may incentivize lenders to form a majority and strike a deal with the borrower to protect themselves at the expense of other lenders.

The Serta Simmons Case and Other Developments

Some recent, favorable case law treatment of uptier measures (favorable to the lenders using the uptier measure) may incentivize some lenders and investors:

1. to use such mechanisms to preserve or enhance their interests and more aggressively negotiate or litigate the matter, and/or
2. to more specifically address the issues in more specific agreement documentation (or perhaps more broadly or generally)

One the one hand, many lenders/investors would prefer more specific, clearer documentation to minimize transactional and litigation costs and uncertainties. On the other hand, conceivably some lenders/investors may prefer more generalized language to potentially allow for more flexibility to deal with the circumstances as they develop.

An important recent case is Serta Simmons Bedding, LLC, et al. v. AG Centre Street Partnership L.P., et al., Adv. Proc. No 23-09001 (Bankr. S.D. Tex. April 6, 2023). In 2020, Serta Simmons Bedding implemented transactions resulting in some of Serta’s existing lenders (the “uptier lenders”) (including Invesco Ltd. and Eaton Vance Corp.) providing new priming loans and exchanging some of their existing loans for new priority debt (the “uptier transaction”). When the excluded lenders who were not invited to participate found themselves being subordinated by the uptier transaction (below $1.1 billion in new debt), litigation ensued in the U.S. District Court for the Southern District of New York and New York state court for several years before Serta and its affiliates filed for bankruptcy in the U.S. Bankruptcy Court for the Southern District of Texas. In an April 2023 ruling, Bankruptcy Judge David Jones, overseeing the chapter 11 cases, found that the debtor had complied with its existing credit agreement when the debtor had taken out a rescue loan in 2020 from a majority of its senior lenders while excluding others from participating. Judge Jones ruled that the credit agreement unambiguously allowed the 2020 deal as an open-market repurchase of the senior debt held by Invesco, Eaton Vance, and the other participants.

Various arguments and counterarguments were raised in Serta, including, for instance:

1. the lien subordination was effectively the same as lien releases, and so all lenders were required to have consented to the amendment versus lien subordination and lien releases are clearly different and distinct concepts, and lien subordination amendments only require majority consent given such amendments are not included in the list of amendments requiring all lenders to consent;
2. the debt-for-debt exchange for the uptier lenders was not a valid open market purchase because there was no cash consideration, there were no open market purchases open to all lenders, and the price at which the term loans were exchanged was not the prevailing market price versus the acquisition of term loans in the form of debt-for-debt exchanges are as valid as cash purchases of term loans, absent explicit restrictions to the contrary; and
3. all lenders were required to consent to any amendment that resulted in a reduction in outstanding term loans versus only the lenders whose term loans were reduced must consent.

There are other recent cases like Serta Simmons that are generally favorable for approving and enforcing priming and uptier transactions:

• See, e.g., Bayside Capital Inc. and Cerberus Capital Management, L.P. v. TPC Group Inc. (In re TPC Group Inc.), Adv. Case No. 22-50372 (CTG) (Bankr. D. Del. July 6, 2022). Prepetition debt maneuvers that subordinated $930 million in senior notes to $204 million in new notes issued to a 2/3 majority of TPC’s lenders was permissible under terms of the loan documents; subordination was not one of the “sacred rights” in indenture requiring consent of all holders of the original notes; “There is nothing in the law that requires holders of syndicated debt to behave as Musketeers. To the extent such holders want to be protected against self-interested actions by borrowers and other holders, they must include such protections in the terms of their agreements.”
• But see, e.g., ICG Global Loan Fund 1 DAC v. Boardriders, Inc., No. 655175/2020 (N.Y. Sup. Ct. filed Oct. 9, 2020). The debtor was owner of surfwear brands Quiksilver and Billabong; allowing excluded group of lenders to continue pressing claims for breach of contract and breach of “the implied covenant of good faith and fair dealing” against Oaktree Capital Management.
• See also TriMark Press Release: TriMark USA Announces Resolution of  Litigation With Its Lenders. Settlement between food services company TriMark and certain excluded lenders resolving dispute arising from a September 2020 transaction in which the Company raised $120 million in new liquidity by issuing two tranches of new loans that ranked senior to earlier first lien term debt.[/efn_note]

Takeaways for Lenders and Investors

As more lender-on-lender violence transactions are negotiated and implemented and more such transactions are contested by aggrieved lenders in and out of court, various interesting issues come to the forefront including the following:

• Until the case law is further developed, there may be substantial risks on both sides for material disputes and litigation, with the attendant increase in costs, delays and uncertainties.
• In the short term, in many cases, contracting parties may require clearer, more explicit provisions regarding lender-on-lender violence transactions.
• Alternatively, some contracting parties may desire and negotiate for more general or flexible provisions. Further, it yet unclear whether any formulation of the relevant provisions may be a complete safeguard against lender-on-lender violence risk.

It will be interesting to see how such issues develop in the courts and in out-of-court matters, and how the negotiation, documentation and enforcement of transactions is affected.

We think you’ll also like:

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[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars (which you can watch at your leisure, and each includes a comprehensive customer PowerPoint about the topic):

1. Representing Asset Purchasers in Bankruptcy
2. Bankruptcy Transactions 301: Advice For The Advanced Practitioner
3. Opportunity Amidst Crisis- Buying Distressed Assets, Claims, and Securities for Fun & Profit]

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