On November 19, 2024, Judge Craig T. Goldblatt of the United States Bankruptcy Court for the District of Delaware found that a proposed non-pro rata roll-up of prepetition term loan claims against American Tire Distributors, Inc. (together with its affiliated debtors, “American Tire” or the “Debtor”)[1] into superpriority DIP loan claims likely violated the Debtor’s prepetition term loan credit agreement’s requirement that any pay down of term loans be on a pro rata basis. While Judge Goldblatt did not expressly decline to approve the proposed DIP loan facility and non-pro rata roll-up, he did state that he would require that any DIP approval order preserve the rights of excluded term loan lenders to bring a suit against the participating term loan lenders for potential breach of the prepetition credit agreement as a result of the non-pro rata roll-up. Thereafter, the DIP lenders and the Debtor agreed to strip the proposed roll-up feature from their DIP facility. Judge Goldblatt’s recognition of the potential tension between non pro-rata roll-ups and credit agreement protections that apply to or for the benefit of all lenders has implications for lenders negotiating for heightened protections amidst frequent out-of-court liability management transactions and DIP financings. These protections should include limitations on non-pro rata roll ups that are increasingly seen in DIP financing facilities.

Like many recent credit agreements, American Tire’s prepetition term loan credit agreement (executed in October, 2021) included a number of provisions designed to protect the Debtor’s term loan lenders from being contractually or structurally subordinated through a non-pro rata liability management transaction. These protections, while now common, have not stopped liability management transactions that favor a subset of participating lenders over non-participating or excluded lenders. As one commentator aptly put it, “[for] every contractual provision that lenders attempt to strike down by adding a “blocker” or another type of protective provision, it seems that two more potential holes will spring forth.”[2]

One such blocker that was included in the Debtor’s credit agreement was the “Serta” blocker. The blocker is named for the well known “up-tiering” transaction executed by Serta Simmons in 2020. [3] In Serta, a majority of term loan lenders participated in a distressed exchange where existing first and second lien term loans were exchanged into superpriority first and second out term loans. The participating lenders executed a so-called exit consent to amend the existing term loan agreement to permit new superpriority first and second out term loans, relegating the excluded formerly senior term lenders to third and fourth lien status.[4] The Serta blocker, among other things, is intended to prevent this sort of exit consent amendment from being executed by requiring that all affected lenders consent to any amendment that would subordinate liens or claims to other indebtedness not otherwise permitted under the applicable credit agreement.

The Serta blocker included in the American Tire credit agreement featured a carve out to permit an out-of-court uptier transaction if the transaction was offered to all affected lenders on a pro rata basis. The Serta blocker in the American Tire credit agreement further provided that this pro rata offer requirement did not apply in connection with “any “debtor-in-possession” facility (or similar financing under applicable law)”. Thus, even with a Serta blocker, the Debtor’s minority lenders were not, under the express terms of the credit agreement, protected fully from a non-pro rata up-tiering transaction, particularly in the context of a DIP financing.

Fortunately for the Debtor’s minority lenders, the credit agreement’s pro rata payments provision did not include a carve out for any non-pro rata roll-up of term loan claims pursuant to a DIP facility. Judge Goldblatt’s indication that he believed the minority lenders might ultimately prevail in a litigation challenging the non-pro rata roll up as a violation of the requirement that payments be pro rata was enough to cause the Debtor and participating DIP lenders to abandon the proposed roll-up in the final DIP approval order. Nevertheless, Judge Goldblatt’s views as to the merits of the minority lender’s potential claims regarding the proposed non-pro rata roll-up are non-precedential. Arguments like those advanced by the majority lenders in American Tire in support of the non-pro rata DIP roll-up may be found persuasive by another judge if tested in connection with a different credit agreement. Such a result would leave the minority, non-participating lenders subordinated not just to new cash provided under a DIP financing, but to the non-pro rata roll-up of prepetition term loans held by participating DIP lenders.

Judge Goldblatt’s decision on the proposed American Tire non-pro rata DIP roll-up comes as lenders and their advisors continue efforts to improve upon the various liability management protections included in credit agreements. In addition, superpriority debtor-in-possession financing facilities increasingly feature a mix of new money loans and non-pro rata roll-ups of prepetition loans available only to a select group of prepetition lenders, even though roll-ups are “of questionable validity under the general bankruptcy principle favoring equal treatment of similarly situated creditors.”[5] Lenders negotiating credit agreement protections should account for the prospect of a non-pro rata roll-up in any future debtor-in-possession financing facility to be incurred by their borrower(s). At a minimum, lenders should focus on tightening Serta carve-outs to exclude debtor-in-possession financing facilities that feature non-pro rata roll-ups, or otherwise expressly require that any priming DIP financing allowed under a Serta carve-out (with or without a roll-up) require pro rata participation rights.

[1] Case No. 24-12391 (CTG).

[2] See Justin Forlenza, Covenant Review, Special Feature: Liability Management Wack-a-Mole, Creditors Rights Coalition, March 31, 2024.

[3] Other transactions that have given rise to eponymous “blockers” include Chewy, J Crew, Envision, Pluralsight, At-Home, and Wesco. In addition to these, other protections seek to limit or eliminate borrower and guarantor flexibility with respect to investments or other transactions with unrestricted subsidiaries or non-guarantor restricted subsidiaries.

[4] Whether the Serta exchange transaction was a valid “open market purchase” under the Serta credit agreement is currently under consideration by the United States Court of Appeals for the Fifth Circuit.

[5] See 3 Collier on Bankruptcy, ¶ 364.06 (Richard Levin & Henry J. Sommer eds., 16th ed.).