Priming Transactions Update: New Serta Developments

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Serta Simmons Bedding, LLC (“Serta”) was recently the recipient of a favorable ruling in its ongoing chapter 11 bankruptcy proceeding when the bankruptcy court found that the 2020 priming transaction (the “Transaction”) did not run afoul of the open market purchase provisions in Serta’s credit agreement. The decision is particularly notable because the bankruptcy court expressly disagreed with the rulings in New York courts that found the open market provision ambiguous as a matter of contract interpretation. With several other transactions (including Boardriders, Incora, and Mitel) the subject of pending litigation, the Serta decision adds another layer of uncertainty to parties looking to pursue priming and other liability management transactions.

Priming Recap

By way of background for those who have not read our prior alerts (COVID 19: Prime Time for Priming, Predatory Priming: How Can Investors Protect Their Priority?, Priming Transactions Update: Don't Sleep on Serta, Priming Transactions Update: TPC Group Inc. and Priming Transactions Update: Boardriders) and our priming guide (Lenders' Guide to Priming Exploitation), priming transactions have experienced a resurgence over the past few years as distressed borrowers incur contractual or structurally senior debt, which has the effect of “priming” the company’s existing debt. These are often times done with the cooperation of some, but not all, of the company’s existing lenders. For the company, the goal is to obtain additional liquidity and provide the necessary breathing room to bring the business back on track. For the lenders participating in these transactions the goals are to provide a financial fix while protecting the return on investment by lending at a senior position to existing debt.

Murray Energy Holdings (“Murray”), Boardriders, Inc. (“Boardriders), TriMark USA (“TriMark”), TPC Group, Inc. (“TPC”), Wesco Aircraft Holdings, Inc. (“Incora”) and Mitel Networks Corp. (“Mitel”) have all notably engaged in a similar up-tiering transaction as the one implemented by Serta. In this variety of priming transaction, the parties typically use a combination of existing debt and lien baskets and covenant exceptions, together with the right of majority lenders to amend certain covenants, to prime existing debt. TriMark, Boardriders and Incora took the additional step of concurrently removing many covenants, defaults, and other lender protections from the existing credit agreement.

Serta

The litigation history of the Serta Transaction is long and winds through multiple courts. Prior to the closing of the Transaction, a group of non-participating lenders filed a suit in the New York State Supreme Court for an injunction to prohibit Serta from moving forward. The court denied this request and found that the exchange did not appear to violate the terms of the 2016 credit agreement and therefore could proceed without the non-participating lenders consent. After the closing of the Transaction, the non-participating lenders filed a new lawsuit challenging the Transaction and seeking damages. The court in New York denied Serta’s motion to dismiss, finding that it could not conclude as a matter of law that the Transaction complied with the open market exchange provision.

On January 23, 2023, while the case was pending Serta filed for chapter 11 protection in bankruptcy court in Houston. In conjunction with the bankruptcy filing, Serta filed an adversary proceeding seeking a stay of the pre-bankruptcy litigation regarding the Transaction. Shortly thereafter, the bankruptcy court granted the temporary stay.

Serta separately filed a motion seeking a declaratory judgment that the Transaction was valid under the terms of the 2016 credit agreement. In the motion for summary judgment, Serta asserted that the plain language of the 2016 credit agreement authorized them to repurchase debt through non-pro rata open market repurchases. In response, the non-participating lenders argued that the transaction violated the “sacred right” to pro rata treatment under the 2016 credit agreement because the transaction did not comply with the open market provisions. In support of this position, the non-pro rata lenders contended that the purchase was not in fact an exchange and not open to all lenders.

Ultimately, in an oral ruling the court, with limited analysis, sided with Serta and found that the Transaction fit within the definition of an open market purchase as set forth in the 2016 credit agreement. The court made clear, however, the ruling was limited to that narrow question and no ruling was made as to whether or not the Transaction complied with all aspects of the 2016 credit agreement. The court also gave the non-participating lenders an opportunity to amend their counterclaims that assert the Transaction violated the implied covenant of good faith and fair dealing.

Takeaways

The Serta Transaction follows the same playbook that Murray, TPC, Boardriders and TriMark have recently utilized, which were all challenged by non-participating lenders on similar grounds. The outcomes in these cases continue to be a mixed bag. While the dispute in Trimark was settled after the New York State court denied a motion to dismiss, and the courts ruled in favor of the majority lenders in the Murray and TPC cases, the motions to dismiss filed by the non-participating lenders against Boardriders and TriMark were denied, and the claims against each of Incora and Mitel and the participating are still pending. Meanwhile, the recent announcement that Authentic Brands made a binding offer to acquire Boardriders for US$1.25 billion suggests that sometimes a borrower can buy enough runway to avoid bankruptcy altogether. Serta, along with Incora and Mitel, serve as the latest reminder of the importance of explicit drafting and the undesired outcomes that can flow from leaving provisions open to interpretation.

This memorandum is a summary for general information and discussion only and may be considered an advertisement for certain purposes. It is not a full analysis of the matters presented, may not be relied upon as legal advice, and does not purport to represent the views of our clients or the Firm. Daniel S. Shamah, an O’Melveny partner licensed to practice law in New York, Jennifer Taylor, an O’Melveny partner licensed to practice law in California, and Adam J. Longenbach, an O’Melveny counsel licensed to practice law in New Jersey and New York, contributed to the content of this newsletter. The views expressed in this newsletter are the views of the authors except as otherwise noted.

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