Regarding the validity of so-called uptier transactions, Bankruptcy Judge Craig T. Goldblatt of Delaware said that “snippets” of language in the loan agreement read “in isolation” would make “plausible arguments” both ways.
Viewing the legal issues as a commercial matter, Judge Goldblatt validated the uptier transaction in the case before him. Otherwise, he said that an indenture provision ensuring ratable distribution among holders would become “an anti-subordination provision in disguise.”
Judge Goldblatt explained how loan indentures could be written to prohibit an uptier transaction.
‘Uptier’ Loan Transactions
In its “most aggressive form,” Judge Goldblatt described an uptier transaction as
one in which the debtor and a majority (but not all) holders of a syndicated debt issuance agree to enter into a new loan that is supported by a superior lien in the same collateral that secured the original debt. Thereafter, the debtor repurchases the participating lenders’ share in the prior (now junior) loan — effectively leaving behind the minority holders in a tranche of debt that is now junior to that held by the majority lenders. While such a transaction would typically require an amendment to the original credit agreement or indenture, those documents are typically drafted to permit a majority (or, in some cases, a supermajority) of the holders to amend the agreement without the consent of the minority.
In the case before him, Judge Goldblatt said that the transaction was “somewhat less aggressive.” He summarized the transaction as follows:
While the transaction at issue did involve the issuance of new debt that would be senior to the old, unlike the more aggressive “uptier” transactions, the majority holders here retained their positions in the old (now junior) loan, rather than selling those loans back to the debtors and thus exiting the junior tranche.
The dispute arose in the context of litigation to approve so-called DIP financing in a newly filed chapter 11 case. Holders of 10% of about $1.1 billion in bonds issued in 2019 were objecting to the DIP financing. While holders of more than two-thirds of the bonds had approved the uptier financing in 2021, the objectors had not been invited to participate in the uptier financing.
The DIP financing offered the debtor a fresh $85 million but would “roll up” the 2021 uptier financing into the DIP loan. If approved, the DIP financing would put participants in the 2021 financing at the top of the debt stack, much higher than holders of the 2019 bonds who weren’t invited to be in the 2021 uptier lending.
The objectors were contending in substance that the 2019 indenture rendered the 2021 uptier financing unenforceable. If Judge Goldblatt were to uphold the objection, the loan made in 2021 would be junior to the 2019 financing, not senior. In that case, the proposed DIP financing might not be tenable.
Judge Goldblatt resolved the dispute on summary judgment.
The 2021 and 2019 Indentures
Judge Goldblatt waded through all of the conceivably applicable provisions, especially those in the 2019 indenture and the accompanying intercreditor agreement with the banks providing inventory and receivables financing. The 2019 bonds had a first-priority lien on assets not subject to the working capital lender’s first lien.
Four provisions in the 2019 loan were particularly important. One, known as a no-action clause, prohibited individual holders from suing to enforce the indenture.
The “perhaps more important” provision, Judge Goldblatt said, would allow the majority of holders to amend the indenture, but with exceptions.
The third significant indenture provision was an exception to the majority’s ability to amend the indenture. Known as the “sacred rights” provision, it barred making any changes in the indenture “dealing with the application of proceeds of Collateral that would adversely affect the Holders.”
The fourth pertinent provision allowed a two-thirds vote of the bonds to release collateral.
In substance, the objecting bondholders argued that the “sacred rights” barred subordinating the 2019 bonds. Judge Goldblatt disagreed, explaining his reasoning in 30 pages on July 6.
No-Action Clause No Bar to Objection
The debtor contended that the no-action clause barred the minority holders’ objection, but Judge Goldblatt said that courts in New York and Delaware have expressed “strong skepticism towards reading a no-action clause to preclude the enforcement of rights that an agreement expressly grants to individual holders.”
Judge Goldblatt said that the “sacred rights” provision “would be rendered meaningless” if any action to enforce the indenture were barred by the no-action clause. So, he turned to the merits of the objectors’ arguments.
Commercial Norms Prevailed
Judge Goldblatt said that “reasonable arguments” could be made on both sides considering only “snippets of language” in the 2019 indenture. The objectors wanted him to rule that the “sacred rights” barred subordination of the 2019 debt.
To decide the outcome, Judge Goldblatt was persuaded by “commercial norms.”
When a debtor is in financial distress, Judge Goldblatt said that holders might have good reason to subordinate their debt voluntarily. For example, subordination well might be required to attract new financing, as it was in the case at hand.
If the “sacred rights” were to preclude voluntary subordination by a majority of the holders, Judge Goldblatt identified an anomaly in the indenture.
The indenture allowed a two-thirds vote of the holders to release all of the collateral, a less drastic act than subordinating the debt. “As a matter of ordinary logic, an agreement to subordinate thus seems far less drastic than releasing all of the collateral,” Judge Goldblatt said. [Emphasis in original.]
“It therefore would not make sense to read the document to permit a two-thirds majority to take a more drastic action but give every holder the right to block the less extreme measure.” [Emphasis in original.]
Judge Goldblatt held that the indenture “is primarily directed at protecting the holders’ rights to ratable treatment and should not be read as an anti-subordination provision in disguise.”
The Remedy in Future Deals
Judge Goldblatt said that the objectors’ complaints were “more directed” at the fact that they were not invited to participate in the 2021 financing. However, the objectors conceded that they had no right to insist on participating in the 2021 financing.
Judge Goldblatt laid out the solution:
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.
Judge Goldblatt overruled the objection, opening the door to approval of the proposed DIP financing.
Regarding the validity of so-called uptier transactions, Bankruptcy Judge Craig T. Goldblatt of Delaware said that “snippets” of language in the loan agreement read “in isolation” would make “plausible arguments” both ways.
Viewing the legal issues as a commercial matter, Judge Goldblatt validated the uptier transaction in the case before him. Otherwise, he said that an indenture provision ensuring ratable distribution among holders would become “an anti-subordination provision in disguise.”
Judge Goldblatt explained how loan indentures could be written to prohibit an uptier transaction.