On Dec. 31, 2024, the U.S. Court of Appeals for the Fifth Circuit in Serta Simmons and the New York Appellate Division in Mitel each issued decisions concerning the validity of non-pro rata uptier transactions.¹ The uptiers that the borrowers in Serta and Mitel undertook were prototypical; the borrowers negotiated with a subset of their existing lenders for new financing that would prime the existing debt, the participating lenders amended the existing credit documents to permit for such financing and/or lien stripping/subordination, and certain participating lenders exchanged their existing debt for some of the newly issued priming debt.

Despite the similarities, the two courts reached opposite conclusions on the uptiers’ validity, based on the terms of the underlying debt documents. In Serta, the Fifth Circuit held that the non-pro rata exchange did not constitute an “open market purchase” and, as a result, the exchange breached the existing credit agreement. Conversely, in Mitel, the New York court upheld the non-pro rata exchange, finding no similar restriction on affiliate buybacks existed in the underlying credit agreement.

These decisions round out a year that included another important decision, this one from the U.S. Bankruptcy Court for the Southern District of Texas in Incora, where in July 2024 the court ruled that the challenged uptier violated multiple indentures.² 

Takeaways from these decisions, and considerations for lenders, include
 

Serta, Mitel, and Incora Rulings

In Serta, the Fifth Circuit held that the debt exchange undertaken in a 2020 uptier did not qualify as an “open market purchase,” the exception to the pro rata sharing requirement that permitted borrowers to purchase loans from their lenders, and upon which Serta relied on for its exchange. In reaching its decision, the Fifth Circuit defined an open market purchase to mean one “that occurs on the specific market for the product that is being purchased”—e.g., a secondary market for syndicated loans—and not privately pursuant to a negotiated exchange.

Conversely, the New York Appellate Division in Mitel upheld the non pro rata exchange, finding that the underlying credit agreement expressly authorized the borrower to purchase loans from its lenders. The court rejected the non-participating lenders’ arguments that the exchange triggered the sacred rights provision concerning any change to loan terms that “directly adversely affected” lenders. The court found that the exchange did not waive, amend, or modify any loan term, and that the exchange’s effect on the non-participating lenders was indirect.

The Bankruptcy Court’s decision in Incora dealt with both sacred rights and buyback provisions. There, the court ruled that the uptier violated the existing indenture’s sacred rights provision because it released collateral without the required supermajority consent. In doing so, the court found the series of amendments that the debtors and the participating noteholders entered to obtain supermajority consent ineffective as they “had the effect of releasing all or substantially all of the collateral securing the debt.” As a result, the court held that the rights, liens, and interests that benefitted the noteholders under this indenture remained in full force and effect.

Additionally, the Incora court held that another indenture was breached when the issuer’s sponsor purchased notes from the participating noteholders in connection with the uptier. While that indenture permitted the issuer and its affiliates to purchase notes, it required any such purchase to be pro rata if the purchase was for less than all outstanding notes. The court therefore found that the sponsor’s purchase violated the pro rata treatment required under the indenture.

Considerations

In light of these rulings, lenders should consider:

• Buyback/Loan Assignment Provisions. Uptiers – which often contain an exchange component – may be driven on the strength or weakness of the buyback/loan assignment provision. Incora and Serta show that buyback restrictions (in varying forms) may block non-pro rata exchanges; conversely, Mitel shows that an agreement with no restriction might be ripe for such an exchange. 

  Considering these rulings, borrowers and lenders may wish to expressly define “open market purchase” to align with the Fifth Circuit’s definition in Serta, and then negotiate whether to permit privately negotiated affiliated purchases (permitted in Mitel and Incora) specifying where pro rata treatment is required. Further, lenders may want to consider adding the definition of open market purchase and the buyback/loan assignment provisions to the enumerated list of sacred rights in credit agreements. It is worth noting that the Mitel transaction was not a broadly syndicated facility like Serta or Incora, meaning that there was less risk that the minority lenders would object to a debt exchange transaction.
   

• Umbrella LMT Provisions. In addition to now commonplace blockers, debt agreements are starting to include umbrella LMT provisions that expressly prohibit “uptiers” undertaken to contractually or structurally subordinate existing debt and/or otherwise cap the amount to a de minimis amount. 
   
• Sacred Rights. Incora demonstrates the importance of drafting a broad sacred rights provision to capture creatively manufactured LMTs. For instance, the indenture in Incora (unlike some other indentures in the market) blocked amendments that “have the effect of releasing” collateral, not just those that released collateral. Thus, the first step in the Incora uptier—an indenture amendment to permit a new notes issuance to participating noteholders with supermajority consent—coupled with the amendments that then stripped the liens, triggered the sacred rights provision. Conversely, in Mitel, the non-participating lenders’ reliance on the sacred rights provision, which was limited to amendments that “directly” adversely affected loan terms, was unsuccessful.
   
• Remedies. Due to the ineffectiveness of remedies against borrowers who frequently declare bankruptcy, the recent successful challenges to uptiers in Serta and Incora—and the potential use of these cases by non-participating lenders to threaten future lawsuits—may discourage lenders from engaging in the aggressive uptiers seen in the market the past few years.
   
• Cooperation Agreements. In response to the LMTs witnessed in the last few years, lenders are shifting from organizing into groups to entering into formal cooperation agreements among themselves. Generally, cooperation agreements require lenders to negotiate with borrowers as a united front. To that end, these agreements restrict lenders from (1) selling their debt to parties outside of the lender group, (2) independently communicating or negotiating with the borrowers, and (3) otherwise taking actions inconsistent with the cooperation agreements. Further, if a lender supermajority supports a certain transaction with the borrower, these agreements would require all the lenders to support that deal. At a minimum, cooperation agreements are meant to lock up lenders and avoid defections to thwart borrowers from pitting the various lender factions against each other.
   
• Understand the Market. Because LMTs are becoming more popular, even if loan documents contain protections for the lender group against a potential uptier transaction, it may still be challenging to entirely prevent the borrower from undertaking an LMT.