On remand from the Fifth Circuit, the Bankruptcy Court for the Southern District of Texas (the “Court”) held in the Serta Simmons Bedding (“Serta”) liability management exercise (“LME”)[1] dispute that a credit agreement’s pro-rata sharing provision applied to noncash payments, in this case, a debt-for-debt exchange, and not solely to cash payments. The Serta Court held that a majority of first lien term holders who participated in the uptier liability management transaction (the “Participating Lenders”) breached this provision by receiving greater than their pro rata share of the exchange loans and failing to purchase participations from certain minority first lien holders who were excluded from the uptier transaction (the “Excluded Lenders”). Ultimately, the Court entered a judgment in favor of the Excluded Lenders for $161.5 million. Sponsors and lenders participating in an LME should carefully review Serta to avoid making the same costly errors.
The Uptier Transaction:
The genesis of the dispute in Serta stems from a 2016 credit agreement executed between Serta, as the borrower, and a syndicated group of lenders. The credit agreement contained a pro rata sharing provision that would apply to any “payment” and specifically stated as follows:
If any Lender obtains payment . . . in respect of any principal of or interest on any of its Loans of any Class held by it resulting in such Lender receiving payment of a greater proportion of the aggregate amount of its Loans of such Class and accrued interest thereon than the proportion received by any other Lender with Loans of such Class, then the Lender receiving such greater proportion shall purchase (for Cash at face value) participations in the Loans of other Lenders of such Class at such time outstanding to the extent necessary so that the benefit of all such payments shall be shared by the Lenders of such Class ratably in accordance with the aggregate amount of principal of and accrued interest on their respective Loans of such Class.
In June 2020, Serta executed an uptier LME (the “Up tier Transaction”) with the Participating Lenders whereby such Lenders exchanged approximately $990 million of their existing first lien term loans for $734 million of new, superpriority first lien debt at a much higher interest rate. The Uptier Transaction resulted in these new, superpriority loans priming the old loans held by the Excluded Lenders.
Litigation from the Uptier Transaction:
In November 2022, certain Excluded Lenders sued, arguing that the Uptier Transaction violated the credit agreement’s pro rata sharing provision. The dispute was litigated in New York state court before Serta filed for chapter 11 bankruptcy. The Participating Lenders, along with Serta, then filed an adversary proceeding against the Excluded Lenders seeking a declaration that the Uptier Transaction was permissible under the “open market purchase” exception in the credit agreement. As we previously reported, the Fifth Circuit reversed the Court’s grant of the declaratory judgment, holding that the Uptier Transaction was not a permissible “open market purchase.”[2] The Fifth Circuit remanded to the Court to determine whether the Participating Lenders breached the pro rata sharing provision.
The Court’s Decision:
Central to the Court’s analysis was whether the Uptier Transaction’s exchange of the old first lien term loans for the new superpriority term loans should be considered a “payment” under the pro rata sharing provision. The Participating Lenders argued that the debt exchange was not a “payment in respect of such principal” since it was not “cash based.” However, after conducting a robust analysis of the credit agreement and New York law (which governed), the Court held that the term “payment” should be construed broadly to apply to exchanges like the Uptier Transaction and other considerations received on account of the subject debt, not merely to cash payments, and that such payment was “in respect of principal” of the old first lien debt. To buttress this position, the Court noted how the pro rata sharing provision included certain exceptions for non-cash payments, which would not have been necessary if the provision only related to cash payments.
Because the Uptier Transaction was deemed a “payment” and the Participating Lenders received more than their pro rata share of the new, first lien priority debt and did not purchase the necessary participations from the Excluded Lender, the Court held that the Participating Lenders had breached this provision of the credit agreement. Moreover, the Court rejected the Participating Lenders’ equitable objections, e.g., that the Excluded Lenders first proposed a similar transaction and offered Serta $30 million to terminate the LME, holding that the “sophisticated parties accepted the litigation risk that came with [consummating the Uptier Transaction].” The Court held that the Excluded Lenders did not maintain “litigation rights” against Serta and that the Participating Lenders were entitled to $161.5 million of damages for their pro rata share of the $734 million exchange.
Conclusion and Key Takeaways:
Since the Fifth Circuit’s ruling, practitioners have known that they should not rely on the “open market purchase” exception to a pro rata sharing provision when conducting an LME. Now, the Serta court has closed a potential loophole that cashless exchanges may not be “payments” which was not addressed by the Fifth Circuit. By broadly interpreting what constitutes a “payment” to a subset of lenders and rejecting equitable arguments, the Court relied on the plain language of the credit agreement to address what, at bottom, was a straightforward breach of contract claim. Of potential significance for venue selection purposes, this holding is in contrast with the recent Del Monte decision in the Bankruptcy Court for the District of New Jersey, which held that the term “payment” did not include a cashless exchange. In light of the Court’s ruling, sponsors and participating lenders should carefully consider, and, if possible, draft clarifying language concerning, how “payment” is defined in the loan agreement before engaging in an LME.
[1] In re Serta Simmons Bedding, LLC, Adv. Pro. No. 23-09001 (S.D. Tex. July 7, 2026)
[2] In re Serta Simmons Bedding, L.L.C., 125 F.4th 555 (5th Cir. 2024).
