On June 20, 2020, the New York State Supreme Court in North Star Debt Holdings L.P. v. Serta Simmons Bedding, LLC dismissed the plaintiffs` request for an injunction ordering Serta`s capitalization transaction. The court, which ruled that it could find no prospect of success for the infringement action, said that the seed amendment to the credit agreement only required the consent of the majority donor. The decision, as discussed below, raises some important considerations for private equity promoters, corporate borrowers and investors who are considering managing liabilities and improving liquidity. The plaintiffs` argument. The applicants claimed that the proposed transaction required their approval in accordance with the provision amending the credit agreement. They argued that the transaction would result in a cascading amendment to the provision in a manner that would modify the pro-rata sharing clause, the amendment of which would require the consent of all aggrieved lenders. In addition, the applicants emphasized that the proposed transaction would essentially release all of their collateral and guarantees because the transaction “amounted to transferring these senior lenders to unsecured lenders” and that such authorization would require the consent of 100% of the lenders. The plaintiffs also alleged a breach of the implied duty of good faith and fair trade. The plaintiffs said the transaction, if approved, would “cause chaos in the credit market for businesses” and called for a ban on the transaction. Serta`s situation shows that borrowers looking for cash are combing through their balance sheets and loan agreements to find ways to identify and take advantage of the additional availability.
In this context, secured lenders are well advised to carefully review their loan agreements, examine the interaction of restrictions, commitments and sacred rights, and ensure that their privileges cannot be altered, prepared or eroded through strategic negotiations with a subset of the group of lenders or with a new group of lenders. However, the court came to a different conclusion, noting that the debt swap was consummated in accordance with Article 9.05(g) of the 2016 Credit Agreement, which provides that “any lender may at any time assign all or part of its rights and obligations under this Agreement with respect to its term loans to [Serta] on a non-proportionate basis. through purchases on the open market. without the consent of the administrative officer. This is often referred to as the determination of the purchase on the open market and is often found in upper-mid-cap credit facilities. The pro-rata provision expressly excludes payments received by creditors in the context of open market purchases by the borrower. Given that the recapitalisation took place through this open market purchase mechanism, the Court did not conclude that the transaction breached the requirement of pro rata allocation. 5 “The De serta, de Boardriders, Superpriority Uptier exchanges can probably be replicated under most existing credit facilities; Simple draft modifications could block them in future facilities,” Reorg, September 22, 2020, at 4. Reorg Covenants Prime reviewed more than 200 individual-sponsored loan agreements between 2017 and 2019; Only five of these 200 privately sponsored loan agreements required approval from all lenders to change collateral priorities.
Id. Dispute. A number of minority lenders who did not have the opportunity to participate sued the New York State Supreme Court to block the transaction, arguing that it violated the terms of the loan agreement. (Specifically, some of the plaintiffs in this case had already proposed their own seed transaction and offered to provide additional debt in a “J-crew” transaction secured by part of the company`s intellectual property and would have moved the assets out of reach of other first-lien givers.) The plaintiffs alleged that the company and the majority lenders breached the loan agreement by entering into a transaction support agreement that would in fact release all or substantially all of the collateral and modify the cascading proportional distribution rules without obtaining the consent of all the lenders involved. The defendants replied that the proposed transaction required only a majority vote and not the vote of all the lenders concerned, since there was no “anti-subordination clause” in the credit agreement and subordination could be made by simple majority. They also argued that the remaining elements of the proposed transaction, including the creation of senior loans, could also be made with credit agreement amendments approved by only a majority of lenders. After a hearing, the court dismissed the plaintiff`s application for an TRO and an injunction. For an injunction to be issued, the plaintiff must determine the prospects for success in the case, the risk of irreparable damage in the absence of an injunction and the balance of the shares in his favor. The Tribunal found that none of those elements was applicable in the present case. While an analysis of the legal process is beyond the scope of this article, Covenant Review recently published an in-depth and thoughtful analysis. 4 Although there is no uniform definition of “required lenders”, credit agreements generally define the term as lenders holding more than 50% of the principal amount of the loan.
We note that the court`s decision in the Serta case was made in the context of the decision and rejection of an application for an order to complete the recapitalization. The level of case-law applicable to such a decision is different from that which would apply to a full-fledged dispute concerning the present questions. The plaintiffs did not meet the burden of the injunction, including the requirement to demonstrate a chance of success on the merits. This omission does not settle the final case, and it remains to be seen whether the plaintiffs will ultimately fail in their challenge to the recapitalization. However, the Serta transaction underscores the need for secured lenders to carefully consider the sacred protection found in their loan agreements and to push back those parts of the agreements that might void or terminate those collateral. The Serta case provides a dramatic example of the terrible economic consequences of such a final. If Serta had applied for chapter 11 insolvency protection and attempted to issue the new super-priority debt through a self-government facility, Serta would have been required to demonstrate that unexchanged lenders had adequate protection. On the other hand, and in the context of serta`s recapitalisation, non-exchanger lenders were prepared without substitution privileges or adequate protection of any kind. The non-participating lenders argue that various elements of upward transactions violate the pro-rata splitting provisions contained in existing credit documents.
For example, non-participating lenders argue that changing the loan documentation to (i) allow for new tranches of super-priority loans, (ii) subordinate existing loans, (ii) reduce the principal amount of existing loans (following the conversion of some existing loans into new super-priority loans), and (iv) approve inter-creditor agreements that govern post-transaction priorities, the right of each lender 6 Non-participating lenders argue that such changes require the consent of each lender concerned and cannot be approved by lenders holding a simple majority of existing loans. Given the unprecedented impact of the global pandemic, secured lenders could increasingly navigate the complexities of out-of-court debt swaps and the risk that these exchanges will reorganize rights and priorities under the Facility in a very damaging way. In fact, secured lenders should heed Metallica`s Enter Sandman warning: “Sleep with one eye open and grab your pillow tightly.” As Serta`s recapitalization shows, a borrower may use the flexibility provided by the loan agreement to find new sources of liquidity and, with the consent of a narrow majority of the required lenders, unexpectedly prefer some parts of the lender group to others. Lenders who sit outside the required group of lenders may find themselves sent “to the land of never-ever” without recourse or recourse. The court disagreed and concluded that the recapitalisation of Serta did not require any modification of this section of the credit agreement. Under its terms, the 2016 cascading provision only regulates the use of proceeds between lenders under such a 2016 loan agreement. This provision does not apply to a new class of secured lenders requiring payment, regardless of the terms of the 2016 credit agreement […].