Benchnotes April 2025

By Bradley D. Pack, Aaron M. Kaufman and Christina Sanfelippo1

Fifth Circuit Decries “Lender-on-Lender Violence” and Invalidates Uptier Financing

In syndicated loan transactions, where several different lenders contribute money to fund a loan to the borrower, the principle of “ratable treatment” — under which each participating lender is entitled to receive its pro rata share of any payment made by the borrower — has long been thought of as a “sacred right.” The recent emergence of “uptier” financing transactions has challenged that notion and given rise to a spate of “lender-on-lender violence,” through which most of the participating lenders may secure priority treatment for themselves at the expense of the minority.

In a recent opinion, the Fifth Circuit Court of Appeals intervened to stop some of the bloodshed by invalidating an uptier on the grounds that the transaction did not qualify as an “open market purchase” exempt from ratable sharing under the terms of the syndication agreement.2 The court also held that equitable mootness did not bar the minority lenders’ argument on appeal that an indemnification provision in Serta’s chapter 11 plan violated the Bankruptcy Code, and ordered the indemnification to be excised from the plan.

In 2016, Serta obtained a $1.95 billion first-lien loan and a $450 million second-lien loan with a group of syndicated lenders. The syndication agreement provided for ratable sharing among participating lenders of all payments made by the borrower, with two exceptions: Any participating lender could sell its rights under the syndication agreement through two options: (1) a “Dutch auction” open to all participating lenders; or (2) “open-market purchases.” Under the Dutch auction option, Serta could buy a portion of the loan from the lender willing to sell it to Serta at the lowest price, subject to auction procedures described in extensive detail in the syndication agreement. In contrast, the syndication agreement did not define or otherwise discuss the phrase “open-market purchase.”

Serta entered into an uptier transaction in 2020 with a bare majority of the syndicated lenders (the “prevailing lenders”) whereby the prevailing lenders provided $200 million in new financing on a first-out super-priority basis, and swapped $1.2 billion of their existing first- and second-lien loans for $875 million of new debt on a second-out super-priority basis. Serta and the prevailing lenders also amended the syndication agreement to permit the uptier transaction, labeled the uptier an “open-market purchase,” and agreed that Serta would indemnify the prevailing lenders for any liabilities arising out of the uptier. The result was to lower Serta’s overall debt load and improve the prevailing lenders’ priority over the lenders that did not participate in the uptier (the “excluded lenders”), whose loans were effectively subordinated.

Serta filed a chapter 11 petition in January 2023. Serta and the prevailing lenders filed an adversary complaint against the excluded lenders for a declaratory judgment that the uptier did not violate the syndication agreement.3 The excluded lenders filed counterclaims for breach of contract and breach of the implied covenant of good faith and fair dealing.

The bankruptcy court entered partial summary judgment in favor of the prevailing lenders, finding that the uptier fell within the syndication agreement’s “open-market purchase” exception to ratable sharing. The court also confirmed Serta’s reorganization plan, which included a provision allowing the claims for indemnification of certain of the prevailing lenders or their successors.

On direct appeal, the Fifth Circuit reversed the rulings in the adversary case and ordered the indemnification provisions excised from the chapter 11 plan. Applying New York law, the court held that the phrase “open market” means “a specific market in which various parties may participate and the prices are set by competition,” and not “merely a general context where private parties engage in non-coercive transactions with each other.”

In this case, the applicable market was the secondary market for syndicated loans. Since Serta chose “to privately engage individual lenders outside of this market” rather than purchasing its loans on the secondary market or through a Dutch auction, the uptier transaction did not satisfy either exception to ratable treatment under the loan syndication agreement. The Fifth Circuit reversed the bankruptcy court’s summary judgment ruling to the contrary and reversed the dismissal of the excluded lenders’ breach-of-contract claims. In reaching its holding, the court expressly declined to adopt a more expansive definition of “open-market purchase” given in a guide published by a leading loan-syndication trade group, holding that its definition was not dispositive, and that even if it were, it did not apply in the context of a specific uptier transaction between Serta and the prevailing lenders.

The court also rejected the argument that the excluded lender’s appeal from confirmation of the chapter 11 plan was subject to dismissal pursuant to the equitable moot doctrine. This appeal focused on whether the plan’s allowance of certain of the prevailing lenders’ indemnification claims violated 11 U.S.C. § 502(e)(1)(B) (requiring disallowance of certain claims for reimbursement or contribution by creditors who are jointly liable with the debtor). The factors the Fifth Circuit considered in evaluating an equitable mootness claim of appellees included whether (1) the plan was stayed pending appeal; (2) the plan has been consummated; and (3) the court’s decision will impair the rights of parties not before the court to threaten the success of the plan.

The court acknowledged that the first two factors (lack of a stay and substantial consummation) weighed in favor of a finding of equitable mootness, but the third factor did not. First, the parties affected by the outcome of the court’s decision — Serta and the prevailing lenders who participated in the uptier transaction — were already before the court. The excision of the indemnification language might have some conceivable impact on those lenders who did not participate in the uptier but subsequently acquired super-priority loans on the secondary market. However, the court observed that they “never needed the indemnity in the first place,” and any nominal impact the court’s decision would have on those lenders could not justify declining the court’s “virtually unflagging obligation” to exercise its appellate jurisdiction.

In addition, the court held that excising the indemnification provision would not jeopardize the plan’s success. If anything, it would enhance the likelihood of success, because Serta would be relieved of its indemnification liability. The court also rejected the prevailing lenders’ argument that excising the indemnification provision would be unfair to them because their acceptance of the plan was based, at least in part, on the inclusion of the indemnification language. It held that such an argument “would effectively abolish appellate review of even clearly unlawful provisions in bankruptcy plans,” and that “adverse appellate consequences were foreseeable to them as sophisticated investors who opted to press the limits of bankruptcy confirmation rules.” Serta is likely to serve as a landmark opinion on the permissibility of uptier transactions and an important precedent in the emerging dispute over the continued viability of the equitable-mootness doctrine.

Second Circuit Adopts “Billing Date” Approach on Payment Obligations and Personal Property Leases

Under 11 U.S.C. § 365(d)(5), a chapter 11 trustee or debtor-in-possession generally must “perform all of the obligations of the debtor ... first arising from or after 60 days after the order for relief” under an unexpired lease of personal property “until such lease is assumed or rejected, notwithstanding section 503(b)(1).” In general, two different approaches to determining when an obligation “arises” for purposes of this subsection have emerged.

The “accrual approach ... requires the debtor to pay only those obligations that accrued post-petition, irrespective of when those obligations come due under the operative lease.” On the other hand, the “billing date” approach “requires the debtor to pay obligations once they come due under the operative lease, regardless of when the obligation can be said to have accrued.”4 In its opinion in In re Avianca Holdings SA, the Second Circuit Court of Appeals sided with the courts adopting the billing-date approach, and affirmed the bankruptcy court’s order for the debtor to pay more than $4.3 million in brokerage commissions that came due under the debtor’s aircraft leases more than 60 days after the chapter 11 petition date but before the aircraft leases were rejected.

Avianca Holdings SA, one of the largest Latin American airlines, filed a chapter 11 petition in May 2020. Many years earlier, Avianca retained brokers to find aircraft to lease. The brokers were successful in procuring 20 such leases. Their commissions were to be paid as “additional rental payments” under each aircraft lease, payable in accordance with a pre-set schedule over the life of the lease. By the time Avianca filed its chapter 11 petition, the brokers were no longer performing any services, but they were still entitled to payments coming due under the unexpired leases.

Avianca did not assume or reject the aircraft leases within the first 60 days of its bankruptcy case, although it ultimately rejected each of them over the course of two years. The brokers moved to compel payment of all commissions that came due under the leases between the expiration of the 60-day period and the rejection date, arguing that Avianca’s obligation to pay the commissions “first arose as the payments came due under the leases’ schedules.”

Avianca objected, arguing that its obligation to pay the brokers arose prior to the petition date because the brokers “rendered all of their brokerage services pre-petition and the payment terms in the leases were set prior to Avianca’s bankruptcy filing.” The bankruptcy court sided with the brokers, and the district court affirmed its decision on appeal.

The Second Circuit also affirmed, holding that under a plain-meaning approach, the phrase “timely perform all of the obligations” used in § 365(d)(5) assumes “the existence of some presently existing duty that the debtor must fulfill,” which “come[s] into being” at least 60 days after the petition. This reading aligns with the billing-date approach.

The approach also gives effect to the distinction between “when a creditor’s claim arises and when a debtor’s obligation arises,” which the accrual approach conflates. Under the Bankruptcy Code’s broad definition of a “claim” under § 101(10), a claim arises pre-petition if, prior to the petition date, “the relationship between the debtor and the creditor contained all of the elements necessary to give rise to a legal obligation — ‘a right to payment’ — under the relevant non-bankruptcy law.” For example, a claim for indemnification arises as soon as the debtor executes the indemnification agreement. However, § 365(d)(5) “speaks in terms of the debtor’s obligations, not the creditor’s claims,” and the use of different language in these two Code sections indicates that Congress intended different meanings. To account for the difference in terminology, the court must apply a different test to determine when the debtor’s obligations arose under § 365(d)(5). This test is “whether payment has come due under the terms of the lease.”

The billing-date approach also recognizes that § 365(d)(5) requires the payment of obligations arising more than 60 days after the order for relief “notwithstanding section 503(b)(1),” meaning that personal property lessors entitled to priority payment under § 365(d)(5) need not satisfy the requirements for administrative priority under § 503(b)(1), such as notice, a hearing, and a demonstration that the creditor conferred some post-petition benefit upon the bankruptcy estate.5 Finally, the court held that the legislative history of § 365(d)(5) reveals that it was intended to “tip the balance” between respecting a creditor’s state law rights to payment and the debtor’s rights under the Code to reorganize its debts slightly in favor of creditor protection — another factor weighing in favor of the billing-date approach.

Miscellaneous

• Chaudhary v. Ali (In re Riverstone Resort LLC), --- F.4th ---, 2024 WL 5036280 (5th Cir. Dec. 9, 2024) (adversary defendants lacked appellate standing as “persons aggrieved” by bankruptcy court’s judgment, because defendants were completely successful at trial due to plaintiff’s failure to file lawsuits before expiration of applicable statutes of limitations; bankruptcy court entered “take nothing” judgment in favor of defendants, even though opinion contained less-than-favorable findings about defendants (i.e., bankruptcy court explained that defendants likely defrauded plaintiff, but that plaintiff failed to bring action before filing deadline); court of appeals explained that it reviews judgments, not opinions, and defendants were not aggrieved by “take nothing” judgment; at appellant’s request, court of appeals remanded for bankruptcy court to consider whether grounds existed to equitably toll filing deadline; specifically, court of appeals explained that bankruptcy court did not consider whether plaintiff has been tricked or induced by defendants into allowing filing deadlines to pass, which, if true, would justify equitable tolling);

• In re Jackson, --- B.R. ---, 2024 WL 5064165 (B.A.P. 8th Cir. Dec. 11, 2024) (dismissal of involuntary petition was affirmed on appeal, but Bankruptcy Appellate Panel (BAP) remanded the case back to bankruptcy court to hold evidentiary hearing on alleged debtor’s motion for sanctions, damages and other relief; BAP specifically rejected appellees’ argument that sanctions and damages under §§ 303(i) and 303(k) can be awarded because bankruptcy court dismissed petition under § 305 rather than § 303; bankruptcy court had advised parties earlier in proceeding that it would hold evidentiary hearing on damages if petition was dismissed; because bankruptcy court ultimately dismissed petition under § 305, but then declined to hold promised evidentiary hearing on sanctions, BAP concluded that evidentiary record was incomplete and required remand); and

• In re Hardin, --- B.R. ---, 2024 WL 5055623 (Bankr. D.S.C. Dec. 5, 2024) (in debtors’ third bankruptcy filing, court addressed whether to extend the automatic stay under § 362(c); current case was filed on exact same day (Nov. 1), one year after debtors’ first case was dismissed, and there was second case filed and dismissed in intervening time; thus, court first addressed how many cases had been filed in the past 365 days; if it had only one case, then § 362(c)(3) would have applied, meaning that stay was in place for 30 days absent an order extending stay, but because court found that first case was still pending on first day of prior calendar year, court concluded that § 362(c)(4) applied, and it was debtors’ burden to rebut presumption of bad-faith filing as condition to getting order imposing automatic stay in newly filed case; here, debtors offered no evidence to rebut that bad-faith presumption; thus, court denied debtors’ motion for extension of stay).

Bradley Pack is a shareholder with Engelman Berger, PC in Phoenix. Aaron Kaufman is a partner with Gray Reed in Dallas. Christina Sanfelippo is an associate with Cozen O’Connor in Chicago.