Introduction
At the close of 2024, when the Fifth Circuit rejected one of the original liability management maneuvers employed by creditors of Serta Simmons, it was an open question as to whether it would slow down aggressive liability management transactions. The first quarter of 2025 has proved that complex debt restructurings are still forging ahead, with a number of new liability management transactions launched or closed in the first quarter. Borrowers and their advisors have simply adjusted tactics or relied on other methods, such as adding extra structuring steps to bypass the limits imposed by the Serta ruling, or relying on other exceptions in credit documents that were not curtailed by the Serta decision. Our analysis below focuses on matters of U.S. law governed loan documents and court decisions. While liability management trends in the United States can influence practices in Europe, it's important to note that U.S. legal outcomes are not binding in the U.K. or Europe.
In In re Serta Simmons Bedding, the U.S. Fifth Circuit Court of Appeals ruled that the 2020 Serta transaction – which elevated certain lenders' debt claims above others – breached the credit agreement's terms by misusing the "open market purchase" exception. The court found that an "open market" debt purchase must truly occur in the open secondary loan market, not via a privately negotiated side deal among select lenders. This decision invalidated Serta's prior tactic of privately arranging a non-pro rata exchange under the guise of an "open market" buyback.
The Fifth Circuit's Serta opinion was a landmark win for minority lenders who had been primed by the exchanging lenders. By rejecting Serta's interpretation of an "open market purchase," the court effectively closed one loophole to typical pro rata sharing provisions that companies used – i.e., engage in non-pro-rata debt exchanges without the lender consent needed to amend pro rata sharing provisions in credit agreements. In plainer terms, the court held that any debt exchange favoring some lenders over others on a non-pro rata basis can no longer be justified by calling it an "open market" purchase unless it's genuinely conducted in a competitive open market (which, by definition, would be available to all lenders). However, this ruling did not ban all out-of-court restructurings. Companies can still pursue exchanges – they just cannot rely on the "open market purchase" exception that Serta had stretched beyond its original intent.
Non-Open Market Purchases
When analyzing loan documents to determine what may be permissible in terms of liability management and non-pro rata exchanges, it is always important to pay attention to the specific drafting in the underlying credit agreement. Although the Serta court limited the ability to exploit the "open market" exception to pro rata sharing provisions, many credit agreements include other language that is distinguishable from the Serta decision. In fact, on the same day that the Serta decision was handed down, another court (in the Mitel Networks case) upheld a similar uptier exchange under that company's contract language, which explicitly permitted privately negotiated debt purchases. This split outcome signaled that while outright "open market" loopholes are curtailed, creative borrowers could find alternative contractual pathways to achieve the same result.
Extend-and-Exchange
Another recent response to the Serta decision came in the form of what is being referred to as "Extend-and-Exchange" transactions. In many credit agreements, the requirement that all payments be shared on a pro rata basis is limited to loans within the same "class" of loans. Using a novel structure that requires a two-step maneuver, such credit agreements would allow a borrower to complete a non-pro-rata term loan exchange without the need to rely on an open-market purchase exception, thus not implicating the Serta decision. It would be implemented as follows:
- Step 1: Extend. The company offers a maturity extension to certain lenders (usually an ad hoc majority group) and not to others. Participating lenders consent and exchange their loans into a new extended loan tranche under the existing credit agreement. By doing so, these participating lenders form a separate debt "class" with a later maturity date, while any lenders who don't accept the extension remain in the original class.
- Step 2: Exchange. Relying on provisions that allow different classes to be treated on a non-pro rata basis, the borrower then exchanges the extended loans for new super-priority debt, with seniority over the non-exchanged loans. Because the exchange is available to all the lenders in the extended tranche, it is considered pro rata within that class, avoiding any violation of equal treatment rights in any other class. In essence, the deal achieves the same result as Serta's uptier (participating lenders gain senior claims over others) but through a structure that does not rely on an open-market loophole and thus is immune to the same arguments that prevailed in the Serta case.
Two recent transactions illustrate how the extend-and-exchange workaround has been put into practice. Better Health, a physician network company, completed an uptiering deal in January 2025 that was reported to have used this approach. A few weeks later, Oregon Tool, an industrial manufacturer, was reported to have executed a similar extend-and-exchange uptier, effectively following the Better Health template. The fact that two major deals in Q1 2025 utilized this strategy confirms that the market has quickly adjusted post-Serta. Uptiering is still on the table, but with new mechanics.
Preemptive Amendments
Another approach that may be taken when a distressed borrower is working with a majority lender group is to amend loan terms directly. Notably, many credit agreements do not list the assignment provisions (which include the "open market purchase" provisions) as a sacred all-lender consent item. This means a majority of lenders could agree to either simply rewrite the open market purchase provision, or to add a clause explicitly allowing a "privately negotiated" debt repurchase. Such an amendment can enable a Serta-style transaction without breaching the credit agreement, essentially adopting the more permissive Mitel precedent for that particular deal.
Incentives to Secure Lender Participation
In many recent deals, lenders who agree to support the restructuring are rewarded with better economics or priority. For instance, members of the majority ad hoc group often receive priming first-lien claims, higher interest or upfront fees, or a better exchange rate for their existing debt, while those joining later might get less favorable second-lien positions or a larger haircut on their exchanged debt.
A trend in recent liability management exercises is to offer incentives to lenders that are not in the majority lender group to support the transaction (or at least to minimize the risk of opposition). The issuer can do this by offering such lenders lower-ranking debt or pari passu debt, but at a worse exchange rate than the majority lender group. These types of offers can coax lenders outside the preferred majority group to participate in the transaction since the alternative is often worse treatment and/or expensive litigation. When faced with the decision to participate in a transaction, even when the economic terms offered to them are less enticing than those being offered to the group of lenders leading the structuring of the transaction, many lenders will elect to take what is being offered rather than get left out altogether. The benefit to the issuer in such structuring is to minimize litigation risk since the lenders will either participate or be left with weaker litigation claims (since they passed up the opportunity to join in the transaction).
Drop-Downs
Distressed borrowers are also turning to or threatening "drop-down" transactions as part of their toolkit. In a drop-down, a company transfers valuable assets (such as brands or other intellectual property) out of the original lenders' collateral pool and into an unrestricted subsidiary, which can then borrow new debt secured by those assets. This effectively raises new priming debt outside of the existing loan agreement's constraints, enabling a borrower to access liquidity when the debt markets would otherwise be very difficult for it. A combination of provisions involving the use of non-guarantor or unrestricted subsidiaries, together with flexible investment and restricted payment baskets, give the borrower the ability to move valuable collateral away from existing creditors.
Key Takeaways
For borrowers and lenders navigating this landscape, there continue to be options notwithstanding recent court decisions that initially had the potential to put the brakes on liability management transactions. Most importantly, read your documents. When it comes to the art of the possible on liability management transactions, minor nuances in the drafting of the underlying credit documents can have far-reaching consequences.
In addition, aside from the recent decisions impacting commonly used provisions in this space, market participants have also introduced protections in loan documents to address common forms of liability management transactions. However, those protections are generally reactive. Sophisticated market participants and their counsel continue to find innovative ways to thread the needle of loan document provisions to benefit lender groups at the expense of other lenders. Attentive lenders can address many of these issues at the outset of a transaction by paying careful attention to the drafting, while enterprising creditors will continue to take advantage of weak provisions to benefit their investments.
Both borrowers and lenders are advised to consult counsel early, understand their loan terms and weigh the long-term implications. Collaborative solutions can preserve value and relationships, while other solutions may lead to drawn-out fights. The first quarter of 2025 has proven that the uptiering playbook is more nuanced and far from obsolete. All market participants must keep adapting alongside these fast-evolving strategies.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
