“Liability Management Transactions” continue to grab headlines. Companies in distress are turning to the out-of-court restructuring of their debt in ways that leave lenders who made loans on the basis of a senior secured position either with certain assets no longer available as collateral pursuant to a “drop down financing” or subordinate to new tranches of debt pursuant to an “uptiering transaction.” This article takes a look at the arguments being made in some of the litigation that has often followed on such uptiering transactions and in particular the June 2023 decision of the Bankruptcy Court in the Serta case.

Although there were some earlier cases, “liability management exercises” surfaced in a conspicuously notorious way with the headlines of 2017 on the “drop down financings” in J. Crew, Chewy and Neiman Marcus. In 2020, the earlier wave of “drop down financings” were joined by Travelport, Revlon and Cirque de Soleil along with another category of liability management exercises now known as “uptiering” in the cases of Serta, Trimark and Boardriders. With each year since, more cases have surfaced continuing to confound the expectations of lenders who thought the loans owing to them held a first priority position in the borrower’s capital structure.

Just as J. Crew has become the watchword for “drop down financings,” so the Serta case has become the catch phrase for “uptiering.” Given its prominence, the decision by the Bankruptcy Court in the Southern District of Texas in connection with the exit of Serta from Chapter 11 in June of 2023 takes on even greater significance.

The consistent theme in all of these cases is the use by distressed borrowers of interpretations of credit agreement terms to engage in out-of-court restructurings of their debt that results in lenders who made loans with the understanding that they had a senior position on the borrower’s assets either

• ending up without critical assets as collateral that were the basis for the financing in the case of the “drop down” exercise, or
• ·only with recourse to such assets on a subordinate basis in the case of the “uptiering” exercise.

In each of these cases, the fundamental expectation of senior secured lenders is defeated by specific interpretations of credit agreement terms that the borrowers, and certain of the original lenders, assert permit the debt restructuring without the consent of the lenders adversely affected and all outside of a bankruptcy case. 

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