Serta: Implications of the Fifth Circuit’s “Open Market Purchase” Holding in In re Serta

The reverberations from the Fifth Circuit’s decision in Serta will be felt for the next few months. Such direct commentary from the judicial branch on liability management transactions is a rare occurrence, and court’s opinion is unique for its direct repudiation of liability management transaction (LMT ) methodologies. Covenant Review’s timely report on this seminal decision will help market participants understand the court’s positions and will also break down the implications on LMTs going forward.

On December 31, 2024, the United States Court of Appeals for the Fifth Circuit handed down a hotly anticipated decision—In re Serta Simmons Bedding, L.L.C.—in which a three-judge panel addressed certain appeals that arose from Serta Simmons’ 2023 bankruptcy. The decision dealt with a number of bankruptcy-specific issues but also focused heavily on the validity of Serta’s infamous 2020 “uptier” liability management transaction. Such direct commentary from the judicial branch on liability management transactions is a rare occurrence, and this opinion is unique for its direct repudiation of at least certain LMT methodologies. As such, it is likely to prompt significant discussion among market participants over the next several months.

Background

We have discussed Serta’s 2020 LMT in a number of reports and also have discussed how uptiering liability management transactions typically work. Serta’s 2020 LMT can be described in simplified terms as
follows:

• Like most broadly syndicated loan facilities, Serta’s first and second lien credit agreements (referred to herein generally as the “2016 Credit Agreement”) included customary provisions requiring the ratable treatment of lenders vis-à-vis each other.
• The pro rata treatment requirement in the 2016 Credit Agreement included an express exception in the context of Dutch auctions and, more importantly, “open market purchases,” which allowed non-pro rata treatment in those circumstances.
• A bare majority of Serta’s lenders agreed to be subordinated to new supersenior debt because subordination was not considered a “sacred right” requiring unanimous or affected lender consent.
• In order to entice the consenting lenders to agree to subordination, the company offered to exchange the consenting lenders into the new supersenior debt via the “open market purchase” exception, thereby bypassing any pro rata treatment requirements.

See Annex I below for a graphic representation of the 2020 LMT.

Despite the 2020 LMT, the company eventually succumbed to its economic reality and filed for bankruptcy in January 2023. In connection with its bankruptcy, Serta also filed an adversary proceeding on January 24, 2023 seeking declaratory relief against non-participating lenders in the 2020 LMT, essentially requesting the court to declare that the 2020 LMT was in fact permitted under the terms of the pre-petition 2016 Credit Agreement. Judge Jones, who was presiding over Serta’s bankruptcy at the time, held that the term “open market purchase” was “clear and unambiguous” and that the 2020 LMT was indeed a valid open market purchase under the 2016 Credit Agreement. The bankruptcy court certified its decision for direct appeal to the Fifth Circuit. All appeals were then consolidated.