Tue 11/08/2022 09:22 AM
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On Nov. 3 funds affiliated with Angelo Gordon, Contrarian, Gamut, Z Capital, Alcentra and Apollo filed a new complaint in the New York State Supreme Court to void the uptier exchange recapitalization transaction undertaken by Serta Simmons in June of 2020 and to recover damages for breach of contract. The plaintiffs accuse Serta and participating lenders of an “unlawful scheme to rob certain of Serta’s lenders, including Plaintiffs, of their bargained-for rights under a credit agreement while providing special benefits to a group of favored lenders who agreed to participate and assist in the scheme.”

Prior to the transaction closing, Apollo, Angelo Gordon and Gamut sued for an injunction to prohibit Serta from going forward with the transaction, but New York State Supreme Court Judge Andrea Masley denied that request, finding that the exchange did not appear to violate the plaintiffs’ “sacred rights” and thus require their consent. The plaintiffs dismissed the action shortly thereafter but have been considering refiling the lawsuit for some time, as reported by Reorg.

The refiled suit, like the Incora uptier exchange action filed Oct. 31, follows a series of recent decisions from New York courts allowing challenges to uptier exchange transactions to proceed to discovery. On March 29, U.S. District Judge Katherine Failla denied Serta’s motion to dismiss a similar federal action challenging the Serta transaction brought by other non-participating lenders against the company (but not participating lenders).

In August 2021, New York Supreme Court Justice Joel Cohen allowed non-participating lenders’ breach of contract claims against participating lenders to proceed to discovery in the TriMark uptier exchange litigation.

Finally, on Oct. 17 Justice Masley - the judge that denied the Serta plaintiffs’ request to halt the Serta transaction in 2020 - denied motions to dismiss non-participating lenders’ breach of contract claims against Boardriders and participating super senior lenders. The new Serta action has been assigned to Justice Masley, in line with her prior directive that if the plaintiffs were to refile their lawsuit in New York state court, the action should be assigned to her.

The non-participating Serta lenders bring claims against Serta and the “favored lenders” that participated in the transaction: Eaton Vance, Invesco, Credit Suisse, Boston Management and Research, Barings and numerous unknown “Does.” The plaintiffs are first lien lenders that collectively own over $600 million of the $1.9 billion in first lien term loans.

The complaint relies heavily upon the pro rata sharing provisions of the credit agreement for the first lien loans, which the plaintiffs contend memorialize “a bedrock principle ... that the First Lien Lenders share ratably in all payments of principal or interest on their First Lien Term Loans.”

The complaint summarizes the recapitalization by providing the following quote from Serta’s June 2020 press release, which described the transaction as creating:
“(a) $200 million of new money super-priority ‘first out’ debt, funded by the Favored Lenders, which would rank ahead of the existing First Lien Term Loans;

“(b) Up to $875 million of super-priority ‘second out’ debt, issued in exchange for First Lien Term Loans and Second Lien Term Loans ... held by the Favored Lenders, which also would rank ahead of the existing First Lien Term Loans; and

“(c) An unspecified amount of capacity to incur still more superpriority debt, which would be ‘third out’ and would also rank ahead of the existing First Lien Term Loans.”

The complaint includes the following diagram illustrating the changes to Serta’s capital structure allegedly produced by the recapitalization (labeled by plaintiffs as the “unlawful exchange transaction”):

The transaction’s consequence, according to the plaintiffs, “is nothing less than the stripping of Plaintiffs’ collateral and right to ratable repayment, for the sole benefit of the Favored Lenders.” To underscore their plight, the plaintiffs note that “soon after the transaction, and as a result of it, Moody’s Investors Service downgraded the credit rating of the First Lien Term Loans from Caa3 to Ca, Moody’s second lowest rating.”

The plaintiffs’ first lien loans retain “‘junk’ ratings today,” asserts the complaint. If a default occurs, the complaint continues, “there now are at least $850 million in new Priority Term Loans in line ahead of the First Lien Lenders asserting rights to collateral that is supposed to be distributed pro rata” (emphasis added).

To effectuate the recapitalization, numerous amendments were made to the credit agreement without the unanimous consent required under the credit agreement, according to the plaintiffs. Although the plaintiffs concede that “new money loans could be given priority without a unanimous vote,” they maintain the “non-pro rata payment” of the favored lenders’ first lien loans violated the credit agreement’s requirement that all lenders share ratably in payments.

Serta and the favored lenders allegedly defend their actions by relying upon contract provisions permitting Serta to make “open market purchases” of the first lien loan on a non-pro rata basis. The plaintiffs maintain, however, that the recapitalization transaction “was not an open market purchase” and was instead “a wholly private, exclusionary transaction - an exchange, at a substantial premium to market prices, in which Serta handpicked a group of its lenders (excluding the remainder)” (emphasis added). The plaintiffs further claim that the defendants cannot point to any comparable precedent transaction that has qualified as an open market purchase.

Acknowledging the court’s prior denial of the funds’ separate request for injunctive relief in the earlier lawsuit, the plaintiffs claim that they now have more of the underlying transaction documents that they did not have previously and which purportedly support their claims.

Additionally, the complaint alleges that Serta has delayed and interfered with Apollo’s efforts to close on its prior purchase of $192 million of first lien loans from a third-party lender. As a result, Apollo says it is “in limbo” and “saddled” with $192 million in loans that it can neither close nor dispose of.

Although the complaint lists multiple causes of action that are repeated separately against Serta and the favored lenders, the principal relief requested in the complaint is as follows:
  • A declaratory judgment that the recapitalization transaction and all agreements purporting to implement it are invalid;
  • Monetary damages for (i) alleged breaches of contract relating to the first lien credit agreement and (ii) alleged breaches of the implied covenant of good faith and fair dealing;
  • Specific performance requiring the favored lenders to purchase “(for cash at face value) participations” in the first lien term loans held by the plaintiffs so that the benefits of the exchange transaction are shared by the lenders ratably; and
  • A declaratory judgment that Apollo has a valid assignment of the $192 million in face amount of first lien loans that it purchased.
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