Law Reviews, Dictionaries, and Uptiers: The Fifth Circuit Weighs In on Serta

Market participants might be wary of opinions that begin with a recitation of academic literature and then turn to dictionaries. The former tend to be authored with an eye toward systemic change rather than direct experience with current practice. The latter are, well, dictionaries.

And so, readers may have been similarly wary when the Fifth Circuit Court of Appeals introduced its long-awaited decision in In re Serta Simmons Bedding, L.L.C., Nos. 23‑20181 et seq., 2024 WL 5250365 (5th Cir. Dec. 31, 2024) (“Serta”), by recourse to the academy. To wit, Serta ruled that:

• an “open market purchase,” as that term is used in a New York law-governed credit agreement, occurs only where debt is acquired “on the secondary market for syndicated loans”;¹ and
• a “settlement indemnity” benefitting uptiered lenders would be stricken from a substantially consummated chapter 11 plan.²

This opinion, in substance, overrules the lower court’s opinion that had endorsed the “open market purchase” used to effectuate the Serta uptier.³

On the surface, it may be thought Serta will have significant repercussions on the leveraged loan market. By equating “open market” with “secondary market,” issuers may have lost a valuable and important tool to raise liquidity and address balance sheet challenges, while non-participating lenders may think themselves disproportionately empowered by recourse to that “open market.”

That being said, Serta is far from the end of uptier transactions in general, or non-pro rata transactions, in particular. Mechanisms such as Dutch auctions and the like will no doubt take on increased importance in transactions to come. Additional caselaw provides further guidance as to how credit agreements can be utilized, or perhaps amended, to achieve similar results.⁴

Anticipating Serta’s ultimate ruling, the liability management team at Ropes & Gray has already identified, developed, and executed on a number of alternative mechanisms in recent transactions that do not rely on the “open market purchase” mechanism rejected by the Serta court. We encourage you to contact your Ropes & Gray team for a better understanding of these approaches.

Background

Serta’s facts are relatively simple, although its procedural history is unduly complex. We assume baseline familiarity and otherwise simplify. In 2020, Serta Simmons, the bedding company, undertook a non-pro rata uptier transaction. Serta Simmons effectuated the underlying exchanges by, among other things, utilizing a fairly typical “open market purchase” provision in its New York law-governed credit agreements. This transaction led to subsequent litigation initiated by the non-participating lenders that continued into Serta Simmons’s 2023 bankruptcy filing.⁵ The bankruptcy court in the Serta Simmons proceeding affirmed the use of “open market purchase” as utilized in the 2020 transaction; the excluded lenders appealed and pursued related objections in connection with Serta Simmons’s chapter 11 plan.

Open Market Purchase

At core, Serta concluded that an “open market purchase” under a New York law‑governed credit agreement means the acquisition of debt in “the secondary market for syndicated loans.”⁶ While Serta does not precisely define the “secondary market,” the opinion suggests that the court had in mind a centralized marketplace like the New York Stock Exchange or the Chicago Board of Trade as being such a “secondary market.”⁷ Thus, a “secondary market” does not occur where a buyer transacts directly with a particular seller.

The court’s rationale in this regard is somewhat difficult to follow. Serta relies neither on a textual analysis of the underlying credit documents nor on market practice, with bilateral trades being fairly routine in the commercial loan market. Rather, the Serta court reached this conclusion in large part based on its reading of various dictionary definitions, including the 2002 edition of the Webster’s Third New International Dictionary, which defined the open market as “a freely competitive market,”⁸ and the 2004 edition of the Oxford English Dictionary, which definition the Serta court quoted as “an unrestricted market in which any buyer or seller may trade freely.”^9,10 Even under these definitions, it is not entirely unclear as to how a “freely competitive market” somehow precludes bilateral trades that routinely occur, freely, among competitive, commercial actors.¹¹

What market practice the Serta court did consider was focused on its reference to the “open market operations” undertaken by the Federal Reserve Bank. This analogy may perhaps surprise some market observers, if only since commercial loans fall well outside the “open market operations” mandated by the Federal Reserve Act. But in the Serta court’s view, the fact that the Federal Reserve Board is federally mandated to pursue “open market operations” was persuasive authority as to why bilateral trades cannot constitute an “open market purchase” as that term is used in New York law-governed credit documents.¹²

Here again, Serta’s rationale is not entirely clear. The opinion does not identify what, exactly, constitutes the open market nature undertaken by the Federal Reserve as applicable to the context of commercial loans, nor, as noted above, does the Federal Reserve traffic in commercial loans. As a result, the analogy between the Federal Reserve’s “open market operations” and the market for commercial loans may require subsequent clarification.

At the same time, the Serta court dismissed out of hand guidance from the Loan Syndications and Trading Association (“LSTA”) that endorsed the “open market purchase” mechanism as permitting the sort of exchange utilized in the Serta uptier.¹³ Uninformed observers might be excused for assuming that the LSTA would have a more direct sense of market understandings than, for example, the editors of the 2002 edition of Webster’s Third New International Dictionary. But in the Serta court’s view, the LSTA’s guidance was simply not compelling when weighed against that authority and the “open market” nature of the Federal Reserve Bank’s mandate.¹⁴ Thus, Serta found that “open market purchase” means “purchased its loans on the secondary market,”¹⁵ and not “privately engag[ing] lenders outside of this market . . . .”¹⁶

Indemnification Claims

The background here is somewhat complicated; again, we simplify. Namely, Serta’s original chapter 11 plan proposed to preserve Serta’s pre-bankruptcy indemnification obligations benefiting those lenders participating in its 2020 uptier transaction—effectively a form of insurance should that uptier be unwound or claims be asserted against the participating lenders by the excluded lenders. Relevant here:

• an initial attempt to incorporate the pre-bankruptcy, preexisting indemnity in favor of participating lenders was disallowed;
• the debtor and participating lenders subsequently incorporated a new indemnity as part of a post-petition “settlement indemnity,” authorized per section 1123(b)(3) of the Bankruptcy Code; and
• this “new” indemnity was available to a broader universe of lenders, including lenders that did not participate in the uptier and, as a result, would be unlikely to have any meaningful indemnification claims.

In the Serta court’s view, this purported attempt to recast a disallowed pre-petition indemnity as a permissible “settlement indemnity” was impermissible “sophistry.”¹⁷ Under a functional analysis, the indemnities were equivalent and therefore still disallowed and would be simply line-edited from the already consummated chapter 11 plan.¹⁸

Here, Serta’s ruling has implications that may go well beyond uptier transactions. Namely, the Serta court determined to rewrite the terms of a plan of reorganization that had been substantially consummated 18 months prior. The Serta court’s rationale in this regard was its determination that striking the offending indemnity was “good for the company and bad for the [formerly] indemnified lenders.”¹⁹ But the notion that appellate courts can line-edit plans of reorganization on the premise that it is “good for the company” is somewhat unexpected. To this end, Serta did not offer a clear limiting principle as to whether or how such appeals should be cabined in the future—after all, any number of plan provisions may be struck on the basis that striking such provisions are “good for the debtor.”

Takeaways

At initial pass, it may be thought that Serta will have significant implications for practitioners. Non-pro rata uptier transactions relying on the “open market purchase” mechanism will require careful scrutiny. This result was clearly intentional, with the Serta court stating in its conclusion that “[t]hough every contract should be taken on its own, today’s decision suggests that such exceptions will not often justify an uptier.”²⁰

But to be sure, it might be more accurate to state that such exceptions do not justify a “non-pro rata” uptier under Serta’s logic. Nor will Serta somehow be the death knell for uptier transactions in particular, or liability management more broadly. Rather, Serta will likely put an increased emphasis on, among other things:

• the “open” in “open market” transactions: pro rata transactions should be unaffected as Serta may be read to mean that “open market” means “open to everybody;”
• the utilization of Dutch auction mechanisms to implement transactions; and
• the implementation (by amendment or otherwise) of credit provisions that permit an obligor to “purchase by way of assignment and become an assignee with respect to [loans] at any time,” as recently endorsed by a New York appellate court in Mitel.

Ropes & Gray is at the forefront in not only developing, but already deploying these alternatives and others. We encourage you to contact your Ropes & Gray team to address these matters more fully.