Enter Sandman: Serta sends high-ranking lenders to Never-Never-Land | Locke Lord LLP

Serta Simmons Bedding, LLC (“Serta”) provides one of the latest examples of a creative borrower taking advantage of the flexibility of their loan terms to access new liquidity at the expense of their existing senior lenders. Serta is one of the largest manufacturers and distributors of mattresses in North America. With the approval of a subset of its senior lenders, Serta conducted a debt swap that included the repayment of part of its existing senior debt at a discount and the issuance of new senior debt for the lenders to participate – thereby preparing the non-participating lenders. Realizing that this recapitalization would significantly undermine their overriding rights, the nonparticipating lenders attempted to require the transaction to close. The New York State Supreme Court denied the restraining order and the transaction closed.

Serta is the latest in a series of high profile lender / borrower disputes that have included J. Crew, Petsmart, and Travelport, among others. In these disputes, borrowers generally used flexible terms in their loan agreements to transfer valuable collateral beyond the reach of their secured creditors. The Serta situation is unique in that it was not a matter of transferring the lender’s collateral, but of subordinating the lender’s repayment claim (without the consent of all lenders whose liabilities were subordinated).

background

In November 2016, Serta entered into certain credit facilities, including the issue of 1.95 billion. As part of the contested recapitalization transaction, Serta carried out a debt swap in which certain lenders under the 2016 loan agreement replaced their 2016 debts (at a discount) against new ones Debt that is documented under a separate credit facility exchanged. In return for exchanging their debts at a discount, the converting lenders were given priority payment over 2016 lenders who did not participate in the exchange.¹

The barter lenders, who held just over 50% of the principal outstanding balance of the Serta loans, performed this recapitalization without the consent of the non-barter lenders. Rather than seeking such consent, the converting lenders (who were the “required lenders” under the Loan Agreement) approved an amendment to the 2016 Loan Agreement, authorizing the new debt to be taken in exchange for the 2016 debt. The Loan Agreement empowered the Administrator to enter into a subordinate or inter-credit agreement with respect to any claim that may be subordinate under such credit agreement. With the approval of the amendment to the loan agreement and the issuance of the new claim, the authorized representative was automatically authorized to subordinate the 2016 loan liabilities to the obligations from the new loan agreement.² Indeed, the converting lenders approved the priming of the existing 2016 Notes in favor of the new Notes issued to them as part of the exchange. In practical terms, this structure resulted in the non-barter lenders being prepared.

In the litigation, plaintiffs argued that the recapitalization transaction violated the “sacred rights” of non-barter lenders, that is, rights that cannot be waived or changed without the consent of 100% of the lender group. The sacred rights in question fall into two categories: the proportionally Sharing regulations and the prohibition on releasing all collateral from lenders.

Proportional distribution

Loan agreements typically have a “waterfall” provision that specifies how proceeds from the realization of collateral are to be distributed and used. In the Serta 2016 loan agreement, the waterfall required that the proceeds from the liquidation of collateral be shared proportionally among the first lenders (after paying certain senior expenses). Plaintiffs argued that the recapitalization transaction would become a de facto Change to this waterfall regulation, as the lenders who swap would be given preferential payment over the lenders who did not swap.

The court disagreed and found that the recapitalization of Serta did not require changes to this section of the loan agreement. According to its terms, the 2016 waterfall regulation only regulates the use of proceeds between lenders under such a loan agreement from 2016. This provision does not apply to a new class of secured lenders who require payment regardless of the terms of the 2016 Loan Agreement. After the new class of debt is issued, the use of the proceeds between the 2016 commitments and 2020 commitments would be governed by the creditors agreement approved in connection with the recapitalization. The 2016 loan agreement expressly provides that the waterfall provisions are subject to any inter-credit agreement in all respects. Accordingly, the court found that the recapitalization transaction did not conflict with the waterfall.

the proportionally The apportionment rules also stipulate that if a lender receives a voluntary advance payment for its loans, which is a larger proportion than the other lenders, this excess amount must be divided proportionally among all lenders. This provision would appear to prohibit the debt-for-debt swap, as such a transaction would be a non-proportionally Exchange of credits.

However, the court reached a different conclusion and found that the debt swap was executed under Section 9.05 (g) of the 2016 Loan Agreement, which provides: “Any lender may at any time submit all or part of their rights and obligations under this contract in relation to their fixed-term loan [Serta] on a non-pro-rata basis … by buying in the open market … without the consent of the AdministratorOften referred to as the open market buy regime, this is often found on upper middle class credit facilities and large market caps. the proportionally The sharing rule explicitly excludes payments that lenders receive in connection with open market purchases by the borrower. Since the recapitalization was done through this open market buying mechanism, the court found that the transaction was not against the proportionally Share requirement.

Release of collateral

The release of all or substantially all of the lender’s collateral is another sacred right that cannot normally be changed or revoked without the consent of all lenders. Plaintiffs argued that the subordination envisaged by the recapitalization represented a “release” of the 2016 lenders’ collateral. This argument did not convince the court either. In that ruling, the court found that the recapitalization actually did not release any collateral (the 2016 lenders retained their liens, albeit subordinated) and the plaintext of the 2016 loan agreement did not contain any non-subordinate language of sacred rights.

diploma

The Serta situation shows that borrowers seeking liquidity are scouring their balance sheets and loan agreements to find ways in which additional availability can be identified and leveraged. In this context, secured lenders are well advised to carefully examine their loan agreements, to consider the interaction of restrictions, covenants and holy rights and to ensure that their liens are not through strategic negotiations with a subset of the lender group or with a new lender group.

While a ban on releasing all or substantially all of the lender’s collateral is a well-established sacred right, the Serta case suggests that lenders would do well to insist on subordination protection as an additional sacred right. Such sacred right against subordination provisions are not common in medium-sized or large-cap credit transactions (although such provisions exist in a minority of businesses). Likewise during proportionally Splitting provisions in loan agreements have long been sacred fundamental rights, and the Serta situation can lead secured lenders to expressly provide that such provisions may not be indirectly changed or changed (even if such a change is made in accordance with a separately documented credit facility).

We note that the court’s decision in the Serta case was made in connection with the decision and rejection of an application to order the termination of the recapitalization. The judicial standard applicable to such an order is different from that which would apply to a full litigation of the present disputes. The plaintiffs have not complied with the injunction including the requirement to prove a prospect of success in the matter. This failure does not determine the final case, and it remains to be seen whether plaintiffs will ultimately fail with their objection to the recapitalization. However, the Serta transaction underscores the need for secured lenders to carefully review the sacred rights protections contained in their loan agreements and to roll back those parts of the agreements that could reverse or terminate those protections. The Serta case provides a dramatic example of the devastating economic consequences of such a final. If Serta had filed for Chapter 11 bankruptcy protection and attempted to issue the new senior debt through an debtor facility, Serta would have been required to demonstrate that the non-barter lenders received adequate protection. In contrast, and under the recapitalization carried out by Serta, the non-barter lenders were prepared with no substitute liens or adequate protection of any kind.

With the unprecedented impact of the global pandemic, secured lenders are increasingly able to cope with the complexities of the out-of-court debt swap and run the risk that that swap will rearrange rights and priorities under the Facility in a highly detrimental manner should heed Metallica’s admonition Enter Sandman: “Sleep with one eye open and hold your pillow tight.” As the Serta recapitalization shows, a borrower can use the flexibility under the loan agreement to find new sources of liquidity and, with the approval of the slim majority of the required lenders, some parts of the lender group preferable to others in unexpected ways. Those lenders outside the group of required lenders may be sent “never land” without remedy or recourse.