In a remarkable opinion, the Fifth Circuit banned so-called uptier financings. The decision by Circuit Judge Andrew S. Oldham included an equally remarkable discussion of equitable mootness where the Fifth Circuit had no hesitation in reversing confirmation of a consummated chapter 11 plan that may mean millions of dollars in losses for some creditors.

Given the gravity of the December 31 opinion, we will deal with uptier financing today. Tomorrow, we will cover equitable mootness and issues related to relief that an appeals court can grant on reversing plan confirmation.

The Norm of Ratable Treatment

Judge Oldham began his opinion by saying, “Ratable treatment is an important background norm of corporate finance.” It is, he said, “a lender’s ‘sacred right’ under syndicated loan agreements.”

“The norm of ratable treatment,” Judge Oldham said, “provides that the borrower may not choose to repay only one of its lenders. Rather, it must proportionally allocate [the repayment] among the relevant lenders according to their share of the outstanding debt.”

“Uptiers,” Judge Oldham said, “are a relatively new and controversial exception to the ratable treatment norm . . . . They are controversial because, according to critics, uptiers create a zero-sum game of ‘lender-on-lender violence.’”

Judge Oldham said that an uptier financing works by amending 

the terms of a credit facility to allow the issuance of new super-priority debt. Because a majority of lenders in the existing facility must typically consent to such an amendment, the borrower purchases consent by allowing these lenders to exchange their existing debt for new super-priority debt, often at an above-market price . . . . Since not all of the lenders participate in the uptier, the uptier is a non-pro rata transaction that violates the norm of ratable treatment.

Judge Oldham said that the advantages of an uptier include “play[ing] lender groups off of each other and avoid[ing] the expense of dealing with holdouts.” Furthermore, “[t]he costs of an uptier transaction are borne entirely by the minority lenders, who end up with subordinated debt worth less than before.”

The Serta Simmons Uptier Financing

Having extolled the virtues of ratable treatment, Judge Oldham described the uptier financing by bedding-maker Serta Simmons Bedding LLC.

In 2016, the company had sold a series of syndicated loans yielding $1.95 billion in first lien debt and $450 million in second lien loans.

To protect “the sacred right of pro rata sharing,” Judge Oldham described the 2016 loan agreement as having a provision preventing the company from “pay[ing] its obligations to one lender while offering nothing to the rest.” As further protection, he said that the agreement included another provision that “generally requires [the] unanimous consent of any affected lender to waive, amend, or modify” the pro rata sharing requirement. Other provisions in the agreement could be modified by a simple majority vote of lenders.

There were two exceptions to the pro rata repayment requirement. One was a “Dutch option,” and the second was an “open market purchase.” The loan agreement, Judge Oldham said, did not define “open market purchase.” The “patent ambiguity in the undefined term,” he said, “forms the foundation of this case.”

With the company facing financial difficulty, Judge Oldham described how the company cobbled together an uptier financing in 2020 with some but not all of its first and second lien lenders. The parties and Judge Oldham called them the “Prevailing Lenders.”

The Prevailing Lenders provided new $200 million financing in the form of first-out, super-priority debt. They traded $1.2 billion in existing financing for $875 million in second-out, super-priority debt. Overall, the deal gave the company more cash and less debt. However, Judge Oldham said that the deal allowed the Prevailing Lenders “to jump the creditor line and get paid before their erstwhile first and second lien comrades.”

Anticipating litigation in the future, the Prevailing Lenders voted by a bare majority to amend the 2016 loan agreement to allow the uptier financing. They also labeled the uptier financing an “open market purchase.”

There was more. The company agreed to indemnify the Prevailing Lenders for any losses or liabilities they might incur as a consequence of the uptier financing.

The Serta Simmons Chapter 11 Case

The company filed a chapter 11 petition in early 2023 in Houston. The case was assigned to Bankruptcy Judge David R. Jones, who resigned several months later.

Immediately, the debtor filed an adversary proceeding seeking a declaration that the uptier financing did not violate the 2016 loan agreement. Opposition came from lenders in the 2016 financing who were not among the Prevailing Lenders. The parties and Judge Oldham referred to the opponents as the “Excluded Lenders.”

The bankruptcy court granted summary judgment to the Prevailing Lenders and held that the uptier financing was a permitted “open market purchase.” The bankruptcy court certified a direct appeal, which the Fifth Circuit accepted.

After dismissing counterclaims for breach of contract asserted by the Excluded Lenders in the adversary proceeding, the bankruptcy court entered final judgment in favor of the debtor and the Prevailing Lenders. Again, the Fifth Circuit accepted a direct appeal.

The Chapter 11 Plan

Because the prepetition indemnification of the Prevailing Lenders would not survive confirmation of the debtor’s chapter 11 plan, the plan gave the Prevailing Lenders a new indemnification. The bankruptcy court confirmed the plan and approved “the settlement indemnity [as] a fair and equitable component of a § 1123(b)(3) settlement,” Judge Oldham said.

The Fifth Circuit accepted a direct appeal of the confirmation order.

Appellate Jurisdiction

Having consolidated four appeals, Judge Oldham first addressed the Fifth Circuit’s appellate jurisdiction and the jurisdiction of the bankruptcy court. Meticulously but quickly, he decided that the bankruptcy court had jurisdiction and power to enter final judgments, with one exception.

The exception was state law breach-of-contract claims by the Excluded Lenders against the Prevailing Lenders, where the bankruptcy court did not have constitutional power to enter a final judgment under Stern v. Marshall, 564 U.S. 462, 482 (2011). However, Judge Oldham held that the lack of objection by the debtor and the Prevailing Lenders was implied consent under Wellness International Network, Ltd. v. Sharif, 575 U.S. 665 (2015), allowing the bankruptcy court to enter final judgment dismissing the Excluded Lenders’ counterclaims.

Judge Oldham also held that the Fifth Circuit had appellate jurisdiction under 28 U.S.C. § 158(d).

It Wasn’t an Open market Purchase

On the merits, Judge Oldham first undertook de novo review of the bankruptcy court’s decision on summary judgment holding that the uptier financing was a permissible open market purchase. Under New York law governing the 2016 financing, he explained why the uptier financing was not an open market transaction.

By referencing dictionaries and by analogy to the Federal Reserve’s open market activities, Judge Oldham concluded that “an open market purchase is a purchase of corporate debt that occurs on the secondary market for syndicated loans.”

Judge Oldham added that “the words ‘open market’ point to a specific ‘market,’ not merely a general context where private parties engage in non-coercive transactions with each other.” He rejected the idea “that there is an open market wherever there is competition.” Properly, he said, “an open market is one tied to a specific market, like the stock market or the commodities market or the securities market.”

Applied to the case at hand, Judge Oldham said that “an open market purchase occurs on the specific market for the product that is being purchased . . . , and the market for that product is the ‘secondary market’ for syndicated loans.”

If the company had wanted to effect an “open market purchase and thereby circumvent the sacred right of ratable treatment,” Judge Oldham said, “it should have purchased its loans on the secondary market. Having chosen to privately engage individual lenders outside of this market,” he said that the debtor “lost the protection of” the provision in the 2016 loan agreement that gave an exception for open market purchases.

For the same reason that the uptier financing was not an open market transaction, Judge Oldham decided that it also was not subject to the exception for Dutch auctions.

Other Rejected Arguments

Of significance in future cases dealing with syndicated loans, Judge Oldham rejected the Prevailing Lenders’ reliance on “a guide published by the Loan Syndications and Trading Association” (LSTA) to show “that industry usage supports their expansive definitions of ‘open market purchase.’”

While the “LSTA guide carries some weight,” Judge Oldham said, “it is not binding authority.” Even if it were dispositive, he said that “its discussion of open market purchases does not support the 2020 Uptier.”

Holding “that the 2020 Uptier was not a permissible open market purchase within the meaning of the 2016 Agreement,” Judge Oldham reversed “the bankruptcy court’s contrary ruling.”

In one paragraph, Judge Oldham ruled in favor of the Excluded Lenders in their appeal from the bankruptcy court’s denial of their counterclaims for breach of contract. He said that the counterclaims were “largely based” on the issue of open market purchases.

Judge Oldham reversed and remanded for reconsideration of the Excluded Lenders’ breach of contract claims. In words the bankruptcy court likely will not ignore on remand, he added that “the Excluded Lenders have a strong case that [the debtor] and the Prevailing Lender plaintiffs breached the 2016 Agreement.”

Observations

Prof. Stephen J. Lubben provided ABI with the following commentary:

The Court’s ruling on “open market purchases” was refreshingly sensible, compared to the typical hyper-literalism we normally see in corporate finance decisions. Too often courts say [that] “while the parties might not have intended this result, it was not technically prohibited, and the parties are sophisticated, so too bad for you.”

That just encourages even more outrageous abuse in the next case. I am hopeful that the Serta decision will reset the situation with regard to aggressive “liabilitymanagement transactions,” which are often little more than a flagrant attempt to favor one group over another in the forthcoming chapter 11 case.

Among the commentators cited in his opinion, Judge Oldham included Prof. Lubben’s “Holdout Panic,” 96 Am. Bankr. L.J. 1 (2022). Prof. Lubben occupies the Harvey Washington Wiley Chair in Corporate Governance & Business Ethics at Seton Hall University School of Law.