Serta Bankruptcy Court Holds Debt Exchange Was A “Payment,” Awards Excluded Lenders Significant Damages For Breach Of Pro Rata Sharing Provision

On July 7, 2026, Judge Christopher Lopez of the U.S. Bankruptcy Court for the Southern District of Texas held that the participants in Serta Simmons' 2020 uptier liability management transaction breached the credit agreement's pro rata sharing provision by receiving new first-lien second-out debt in exchange for their existing first-lien loans without sharing that value ratably with excluded first-lien lenders.  Serta Simmons Bedding LLC v. AG Centre St. P'ship (In re Serta Simmons Bedding, LLC), No. 23-90020, Adv. No. 23-09001, 2026 WL 1968535 (Bankr. S.D. Tex. July 7, 2026).  The decision arrives after the Fifth Circuit's holding that the Serta transaction did not qualify as a permissible “open market purchase” under the credit agreement, leaving the Bankruptcy Court to decide whether the participating lenders' receipt of exchange debt triggered the agreement's ratable sharing provision.

Now the bankruptcy court has answered this question, holding that the participating lenders received a “payment” within the meaning of Section 2.18(c) of the credit agreement because the provision was “drafted broadly” and covered a lender’s receipt of consideration “in any form and from any source in respect of its principal or interest.”  The Court stated that “Section 2.18(c) is designed to capture pro rata treatment for all consideration in respect of principal or interest on a loan,” and because Serta’s attempted open-market-purchase structure “didn’t work. . . . § 2.18(c) applies.”  

This ruling marks a vital strike against non-pro rata liability management transactions, particularly in the important Southern District of Texas Bankruptcy Court.  However, we nonetheless expect further efforts to successfully complete such transactions going forward.

Background

In November 2016, Serta borrowed approximately $1.95 billion under a first-lien term loan credit agreement.  Section 2.18(c) of the credit agreement provided that if any lender obtained a payment “through the exercise of any right of set-off or otherwise in respect of” the loans and received a greater proportionate payment than other lenders of the same class, that lender was required to purchase participations at face value in the loans of other lenders so that “the benefit of all such payments” would be shared ratably.  The credit agreement included some carve outs from pro rata sharing, including for an “open market purchase.”

In June 2020, Serta entered into an “uptier” transaction with certain participating lenders.  The transaction included $200 million of new-money “first-lien first-out” debt and an $875 million exchange tranche of “first-lien second-out” debt.  The participating lenders converted more than $990 million of existing first-lien term loans into approximately $734 million of new first-lien second-out debt.

The parties deemed the 2020 Transaction to be an “open market purchase” under Section 9.05(g) of the credit agreement in an effort to avoid triggering the pro rata sharing obligations in Section 2.18(c).  The Exchange Agreement itself stated that Section 2.18(c) would not apply to payments made as consideration for the assignment of existing first-lien loans under Section 9.05(g).  The Fifth Circuit rejected that premise, holding that the 2020 Transaction was not a permissible open market purchase.  It remanded the case to the Bankruptcy Court to determine whether the participating lenders breached Section 2.18(c)’s pro rata sharing obligations and, if so, the damages to which the plaintiffs were entitled.

The Bankruptcy Court’s decision

The debt exchange was a “Payment”

The Bankruptcy Court considered whether the participating lenders’ receipt of new first-lien/second-out debt in exchange for existing first-lien loans constituted a “payment” under Section 2.18(c) of the credit agreement.  The participating lenders argued that a “payment” under Section 2.18(c) meant only a cash payment and that a debt-for-debt exchange therefore did not trigger ratable sharing.  The participating lenders specifically pointed to section 2.18(a) of the credit agreement, which required the borrower to make payments in dollars.  The Court rejected that argument.

In the Court’s words, “Section 2.18(c) is drafted broadly and governs what happens when a lender receives consideration in any form and from any source in respect of its principal or interest.”  The Court explained that “this section is designed to protect ratable treatment between lenders in the same class of loans.”

The Court also relied on the phrase “whether voluntary, involuntary, through the exercise of any right of set-off or otherwise.”  Because setoff is itself a non-cash exchange, the Court reasoned that the surrounding language confirmed that Section 2.18(c) was not limited to cash payments.  The Court stated that the “or otherwise” catch-all was “open-ended and not limited to cash,” and that “[t]he debt exchange in the 2020 Transaction is covered by the ‘or otherwise’ catch-all.”

The Court found additional support in the carve-out structure of Section 2.18(c), which carved out transactions covered by other cross-referenced sections in the credit agreement, including incremental loans, extended loans, replacement term loans, and open-market purchases.  The Court reasoned that if debt exchanges did not otherwise trigger Section 2.18(c), there would have been no need to carve out these non-cash transactions, and the carve-outs would be surplusage.

The Court also rejected the plaintiffs’ reliance on industry standards that were not incorporated into the credit agreement.  Although the participating lenders pointed to a guidebook definition of “payment” published by the Loan Syndications and Trading Association, the Court held that “Payment . . . is not a technical term” and that the meaning of the agreement could be derived from the credit agreement’s text, rather than resorting to extrinsic evidence.

The payment was “in respect of” principal

The Court next held that the payment was “in respect of” principal on the participating lenders’ term loans.  The Court read “in respect of” broadly to mean “concerning,” “regarding,” or “in connection with,” based on the phrase’s repeated use throughout the credit agreement.  Applying that ordinary meaning, the Court held that the new debt was in respect of the participating lenders’ first-lien loans because it was issued in exchange for those loans and satisfied principal on those loans.

The Court stated that “[t]he direct connection between the debt exchange effected during the 2020 Transaction and the satisfaction of the Participating Lender’s First Lien Term Loans could not be clearer.”  The Court also found that the signature pages to the Exchange Agreement showed the principal amount of first-lien loans each participating lender transferred to Serta and the corresponding amount of first-lien second-out debt each lender received in exchange.  The Court concluded that “[t]his contemporaneous evidence leaves no doubt the new First Lien Second Out debt was a payment in respect of the First Lien Term Loans.”

The participating lenders breached the sharing provision

Having found a payment in respect of principal, the Court held that the remaining elements of Section 2.18(c) were satisfied.  The participating lenders received a payment on their first-lien loans, the excluded lenders received nothing, and the participating lenders did not purchase participations in the excluded lenders’ first-lien loans.  The Court stated that “[t]he fact that the Participating Lenders exchanged their First Lien Term Loan at a discount is irrelevant” because Section 2.18(c) focuses on whether the participating lenders recovered a greater proportion of their loans than other lenders, and here, the plaintiffs received nothing.

The Court also rejected the participating lenders’ argument that a later majority-lender amendment had ratified the transaction.  Once the Fifth Circuit held that Section 9.05(g) did not authorize the transaction as an open market purchase, any amendment purporting to confirm the transaction’s validity had “no operative effect on § 2.18(c).”  The Fifth Circuit had recognized the unanimous-consent requirement for changes to Section 2.18 as a protection designed “to prevent [Serta] from repaying one lender to the prejudice of the others, and to prevent a majority of the lenders from bargaining away the ratable-sharing provision that protects all lenders.”

Damages and interest

In its Memorandum Opinion, the Court awarded total damages of $261.13 million, subject to certain adjustments.  The damages analysis started with the approximately $734 million face amount of first-lien second-out consideration received by the participating lenders.  The Court calculated the plaintiffs’ ratable share of that amount by reference to their share of the total first-lien class, resulting in a $348 million base participation.  The Court then accepted the plaintiffs’ expert’s time-of-breach “but-for versus actual world” methodology, which treated the $348 million as the cash participation the participating lenders failed to purchase, valued the plaintiffs’ remaining first-lien loans at the 25-cent closing-date market price, and compared that but-for position against the value of the first-lien loans the plaintiffs actually retained.  That calculation produced the Court’s $261.13 million damages award, before adjustments and prejudgment interest.

The Court rejected the participating lenders’ argument that this measure made no economic sense because it required payment at face value for participations in distressed loans.  The Court reasoned that Serta and the participating lenders structured a transaction that “always had a risk of not complying with § 2.18(c),” and therefore “having to pay face value for participations in distressed First Lien Term Loans to the Plaintiffs was always a possibility.”  The Court also stated: “[s]ophisticated parties accepted the litigation risk that came with it.  And it almost worked.”

The Court also awarded prejudgment interest at 9.00% per annum under New York law from June 22, 2020 through July 7, 2026.  The Court rejected the participating lenders’ equitable arguments to reduce or waive prejudgment interest, and held that “[e]quitable considerations don’t come into play in this breach of contract case because prejudgment interest is mandatory.”

On July 20, 2026, the Court entered a final Judgment implementing the Memorandum Opinion’s damages ruling after applying certain adjustments. The Judgment modified the order to award Plaintiffs $104.6 million in damages and $56.9 million in pre-judgment interest. The reduction from the $261 million gross damages figure reflects, among other things, the exclusion of amounts attributable to defendant lenders who are no longer party to the case through dismissal or settlement.  It does not substantively modify the opinion.

Key takeaways

• The Serta Court held that a debt exchange can itself be a “payment” even if no cash changes hands.  The Court found support for its conclusion in the text of the ratable sharing provision, which applied to any payments, including through the exercise of set-off or otherwise.  
• The case varies with a recent ruling in the Del Monte bankruptcy case, which we addressed previously.  Although the ratable sharing provision in Del Monte also applied to payments resulting from set-off, the court there held that a DIP roll-up did not qualify as a payment because it was a cashless exchange.  The Del Monte court did, however, find that payments on the DIP roll-up loans could qualify as a payment subject to the ratable sharing provision when ultimately paid.  The Del Monte ruling is on appeal.
• Courts will look to synthesize these varied rulings and may reach different conclusions in future litigation—especially if the ratable sharing provision includes materially different language from the provision addressed in Serta.
• The Serta court notably awarded damages based on the face amount of the loans, even though Serta’s loans were trading at distressed levels.  The Court measured the benefit by the face amount of the new first-lien second-out debt the participating lenders negotiated and accepted, rather than by making equitable or economic adjustments to account for overall transaction benefits. 
• As with other material liability management transaction case developments, this holding will likely influence future credit document drafting to better accommodate non-pro rata transactions in a manner that would not necessarily have the same result as in Serta.