Excluded Lender Group Wins Important Appeal Against Serta Simmons Reaffirming Proportional Treatment in Syndicated Debt Deals

Paul, Weiss won a significant appeal on behalf of a group of Serta Simmons lenders excluded from a 2020 debt restructuring deal. The opinion by the Fifth Circuit reversed the Houston bankruptcy court’s decisions in the mattress-maker’s chapter 11 cases that had validated the 2020 uptier transaction with a subset of favored lenders and rejected the excluded lenders’ counterclaims against the favored lenders. The Fifth Circuit also remanded the dispute for further proceedings on the excluded lenders’ counterclaims.

The bankruptcy court’s opinion last June was the first ruling on the merits of so-called uptier restructuring transactions, in which a majority of lenders in a single syndicated credit agreement enter into an amendment with the borrower, to the exclusion of other similarly situated lenders, that provides the favored lenders with preferential lien priorities and other consideration, to the disadvantage of the excluded lenders. As a result of Serta’s uptier transaction, Serta’s favored lenders moved the liens securing their credit agreement claims (and also leapfrogged their subordinate, second-lien claims) ahead of the liens securing the credit agreement claims of the excluded lenders, effectively putting the excluded lenders in a third-lien position.

Litigation partner Kannon Shanmugam presented oral argument in July on behalf of the excluded lender group, arguing that the bankruptcy court was wrong to find that the 2020 transaction qualified as an “open market purchase” under the governing transaction documents and was therefore exempt from a provision in the 2016 credit agreement that said all the lenders must share pro rata in any payment or other recovery on the 2016 credit agreement debt. He argued that affirming the bankruptcy court’s decision would upend the fundamental right to proportional treatment in the syndicated loan market and allow a group of lenders in a single credit agreement to enter into side deals and deprive other lenders of their pro rata recovery rights. The Paul, Weiss team also argued that the court should disallow a provision that was part of Serta’s bankruptcy plan that indemnified the favored lenders against claims related to the uptier transaction.

The Fifth Circuit agreed, concluding that the bankruptcy court erred in finding that the uptier transaction constituted an open market purchase under the 2016 credit agreement. An “open market purchase,” the panel concluded, is one that occurs on the specific market for the product being purchased. In the context of syndicated debt, such a purchase would occur on the established secondary market for such debt, not merely in any privately negotiated transaction between the borrower and a subset of lenders, even if such transaction was arms-length.

The court further concluded that the plan indemnity protecting the favored lenders from liability violated the Bankruptcy Code’s express provision requiring disallowance of certain contingent indemnity claims and should be excised from the bankruptcy plan.

The Paul, Weiss team included litigation partners Kannon Shanmugam, Andrew Ehrlich, Lewis Clayton and William Marks, and restructuring partners Brian Hermann and Ken Ziman; and litigation counsel Robert Kravitz and Robert O’Loughlin.