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Welcome to the 111th Pari Passu newsletter.

Today, we are talking about a name that nearly everyone knows in restructuring: Serta Simmons. This company paved the way for companies to pursue a new avenue of restructuring via liability management restructuring, namely, uptiers. In a revolutionary move in 2020, a group of Serta’s lenders (the participating lenders) engaged in this uptier maneuver. This move was heavily contested by the group of lenders (known as the non-participating lenders) who were not offered the opportunity to participate in this restructuring. 

In 2023, Serta Simmons filed for Chapter 11 bankruptcy, where the approved plan of reorganization had features that benefited the participating lenders while hurting the non-participating lenders (i.e., the plan of reorganization upheld the 2020 tier as a valid transaction). However, at the start of 2025, the United States Court of Appeals for the 5th Circuit held that the uptier transaction was a violation of the credit agreement (i.e., the 2020 uptier was not a valid transaction), sending shockwaves through the restructuring community as this case sets a precedent for many companies who have engaged in uptier transactions in recent years.

Note: This paper is not meant to dive into the history of Serta Simmons / the 2020 Uptier, given the widespread discussion of the case already available in the media. Rather, we are looking at the recent ruling and the implications on liability management transactions.

Table of Contents

• The 2020 Transaction

• Permissibility and Litigation

• Indemnification of Uptier Litigation

• 5th Circuit Review

• Credit Language and LME Implications

The 2020 Transaction

To fully understand the uptier transaction, we have to go back to 2016 where the first and second lien debt tranches were created. In 2016, Serta Simmons refinanced their debt, where the company issued $1.95bn of 1L debt and $450mm of 2L debt (by the time of the transaction, these amounts decreased to approximately $1.8bn and $420mm as they were paid down). Serta Simmons's financials deteriorated over the next four years after the refinancing. As the effects of the COVID-19 pandemic were beginning to set in, the company needed to engage in a restructuring. The company chose an uptier transaction involving the participating lenders from the first and second lien tranches [1].

As a brief review, a few key elements allow an uptier to be effectuated. Fundamentally, an uptier transaction occurs when a company incurs additional, super senior secured debt that sits senior to any pre-existing secured debt in the capital structure. Most credit documents restrict a company's ability to raise debt, often requiring its lenders' unanimous consent to permit the capital raise. This makes it very difficult for a company, especially a distressed company, to raise new capital, as lenders only want to provide capital if they can come in at the top of the capital structure. Thus, in an uptier transaction, a company will amend the underlying credit documents to permit the incurrence of new super senior debt (this amendment only requires majority consent of lenders) [6]. As seen in Figure 1, an uptier transaction features at least two tranches. The first is a new money tranche, which will sit at the top of the capital structure. The second is the existing debt tranche. The participating lenders typically exchange their debt at a discount for new debt. In exchange for this, participating lenders now sit right below the new money tranche of debt [6]. For the non-participating lenders, they are effectively pushed down to the bottom of the capital structure. Thus, it is very lucrative for creditors to be a part of the participating group (which, as we will discuss with Serta, is not always an option) [6]. 

Looking at Serta, Figure 2 below depicts the capital structure before and after the uptier transaction. The uptier saw the creation of three new tranches of debt: a First Out Tranche, a Second Out Tranche, and a Third Out Tranche (this tranche is not depicted as it was unused at the time of filing, i.e, no debt outstanding). The Participating Lenders consisted of Eaton and Invesco, among other creditors, and the Non-Participating Lenders consisted of Apollo and Angelo Gordon, among other creditors. Under the proposed uptier, Eaton would provide $200mm in new money for the First Out tranche. The Second Out tranche consisted of exchanged debt, where the 1L debt for participating lenders would be exchanged at 74 cents, while the 2L debt for participating lenders would be exchanged at 39 cents [1],[2]. 

Permissibility and Litigation Surrounding the Uptier Transaction

A key concept surrounding uptier transactions is the concept of pro-rata sharing. If a company were to offer an uptier that was available to all lenders (i.e, the non-participating lenders were non-participating by choice), there would be no issues with the transaction. Pro-Rata Sharing means that all recoveries / payments should be made available and equal to all lenders in a class of debt. While Pro-Rata uptiers exist (an example is Shuttefly’s pro-rata uptier in May 2023), it is less common because of the difficulties in getting the required voting class. To effectuate an uptier, a majority of creditors (who are offered the uptier) have to consent / participate in the transaction. Thus, it is easier to get a majority of votes if you can control who is voting (i.e., non pro-rata).

Per Section 2.18 of the 2016 Credit Agreement [1], 

In addition to this section, the credit document required that any changes to the pro-rata sharing provisions would require unanimous approval. What this means for non pro-rata uptiers is that, for a company to only offer the uptier to select lenders, they would first need all lenders to agree to remove the pro-rata sharing provision that would require all creditors to be treated equal. 

However, in Section 9.05(g), the 2016 Credit Agreement outlined two exceptions for the pro-rata sharing provisions [1].

As seen from the excerpt above, the two exceptions are 1) Dutch Auctions and 2) Open Market Purchases. More simply put, this exception is saying if either a Dutch Auction or Open Market Purchase is used when a company repurchases debt, the company does not have to offer the repurchase to all holders of said debt - this means a non pro-rata purchase is possible.

In today’s paper, we will only focus on open-market purchases as that is the exception the Participating Lenders argued allowed for a non pro-rata uptier to be effectuated. The reason the open market purchase was used in the case of Serta was because of the ambiguity surrounding the definition of an open market purchase, as the credit documents never provided a specific definition or interpretation of this term. Generally, an open market purchase is when a company purchases credit in an open market, like the secondary bond market. In an uptier transaction, the company uses an open market purchase when deciding whose debt to repurchase. The participating lenders argued that if the company and creditors intended for open market purchases to be available to all lenders, it would have explicitly stated that, and thus, a company could purchase select lenders' debt on the open market [1].

The non pro-rata transaction was proposed mid-2020, and as you would imagine, the non-participating lenders immediately challenged the transaction's validity from this open-market repurchase on June 11, 2020. Specifically, Apollo challenged two main parts of the transaction. First, they argued the uptier “effectively” stripped the collateral securing the non-participating lender’s debt. Secondly, Apollo argued that participating lender’s use of open market purchases did not fit the ‘conventional’ definition. Both these arguments can be seen in Figure 3 and 4 below.

Judge Andrea Masley of the New York State Supreme Court was presiding over the non-participating lenders' claims. However, Judge Masley immediately dismissed this argument in mid 2020 because no collateral had been stripped - all that was changed was that more senior pieces of debt were issued/created. Even if this new issuance put the non-participating lenders out of the money in a liquidation or bankruptcy, the transaction could not be reversed unless an actual violation of rights had occurred (such as actually stripping collateral) [1],[2]. Additionally, Judge Masley stated that it was not the place of the court to make a judgment on what open market purchases consist of, as the term on its own is too ambiguous (we will touch on this more in our bankruptcy analysis section).

While Apollo initially dropped their claims after Judge Masley’s decision…

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