Liability management transactions
Providing new capital and laying the groundwork to cramdown of those left behind
Our global restructuring team has released its quarterly International Restructuring Newswire, which features articles from the US, Singapore, the Netherlands, UK/Germany and Australia on a range of recent developments in jurisdictions around the globe.
In this edition, our US team examines trends in "liability management" and considers potential pitfalls, strategies, and issues important to both borrowers and creditors, including a discussion of recent decisions in the Serta Simmons chapter 11 case and their implications for clients and practitioners.
The "go-to" LMTs: Drop-downs and uptier transactions
Liability management has emerged as a favored strategy for private companies facing financial challenges and seeking long-term restructuring solutions. These "liability-management transactions" (or LMTs) typically involve a borrower that uses their existing financing documents to unlock value and secure new-money financing while circumventing unanimous creditor voting requirements and other negotiated protections. LMTs often lead to litigation between the borrower and participating creditors, on the one hand, and non-participating creditors on the other. This litigation, however, can motivate borrowers to consider a more comprehensive restructuring, which might see the borrower and supporting parties (e.g., the new, post-LMT senior-secured creditors) pursue a pre-negotiated chapter 11 plan that could lock out non-participating creditors and impact their recoveries.
Although a variety of transactions fall withing the ambit of "liability management," the two most common LMTS are "drop-down" and "uptier" transactions:
"Drop-down" transactions |
"Uptier" transactions |
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– Borrower uses "basket capacity" in existing debt covenants to transfer collateral to an "unrestricted subsidiary" not bound by existing financing agreements – Unrestricted subsidiary then obtains new secured debt using the now unencumbered assets – Non-participating creditors become "structurally subordinated" when assets are moved outside the credit group |
– Borrower, together with its supporting creditors, amends existing financing documents – Borrower, under the amended documents, obtains new-money, senior-secured financing from participating creditors, which effectively subordinates non-participating creditors' existing (or "old") debt – Participating creditors may also be invited to exchange their now-subordinated debt for discounted "1.5" lien debt, junior to new money but senior to old debt |
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Serta Simmons: A potential model for liability management through chapter 11
The Serta Simmons (Serta) chapter 11 case provides useful insight for parties planning or defending an LMT. Faced with economic challenges in 2019, and after negotiating potential alternatives with various stakeholders, Serta pursued an uptier transaction, supported by its majority lenders, which included a new-money, super-priority term loan and a debt-for-debt exchange. Non-participating lenders opposed the transaction, and after months of litigation, Serta filed for chapter 11 protection with a prenegotiated plan that favored participating lenders. The proposed plan offered significant recoveries for participating lenders but minimal recoveries for others. During the case, the bankruptcy court effectively took over the prepetition LMT litigation and, within a few months of the bankruptcy petition's filing, ruled in Serta's favor, confirming both the legitimacy of Serta's uptier transaction and, ultimately, the chapter 11 plan.
Takeaway
Although several of the bankruptcy court's decisions are being appealed, the outcome in Serta suggests that distressed borrowers and favored creditors could, under the right circumstances, execute an LMT that heavily favors one group of lenders without violating the implied covenant of good faith and fair dealing or specific requirements in debt documents, and then turn to specialized courts to quickly resolve potential challenges, insulate themselves from the expense and uncertainty of ongoing litigation.
For more, you can view the full article, "Liability management transactions: providing new capital and laying the groundwork to cramdown of those left behind."
