Serta bankruptcy has raised the stakes for those who draft credit agreements

Affirmation of ‘uptier rights’ of non-PTL creditors signals a likely continuation of creditor-on-creditor violence.

The resolution of the Serta Simmons bankruptcy by the bankruptcy court in the southern district of Texas, in June, has visited significant losses on some of the bedding company’s creditors and, more importantly, raised the stakes for the drafters of credit agreements.

It may matter considerably, going forward, whether a particular credit agreement does or does not have a so-called “Serta blocker” provision and what is the specific wording of that provision.

Serta blocking is not a new development demanded by this decision. Blocker language, with encouragement from the Loan Syndications and Trading Association, has been in use since 2020. That was the year Serta, which had severe liquidity difficulties though it had not at this point filed for bankruptcy, reached an agreement with certain “priority term loan” (PTL) lenders.

In the 2020 agreement, Serta reached what is known as an “uptier exchange” with the favoured creditors, including Advent International and a group of mutual fund companies. The PTL creditors agreed to lend Serta $200 million, and to exchange about $1.3 billion of old loans for $875 million of new loans. In return, the PTL funds demanded that new loans would have a first claim on all of Serta’s assets, pushing the non-PTL creditors, notably Apollo Global, to a lower position on the capital structure.

Serta filed its bankruptcy in January 2023. In March, as a preliminary matter, Judge David Jones upheld the uptier exchange.

In May, Apollo and Serta reached an agreement on a related but distinct issue, Serta’s claim that Apollo had no standing to litigate its debt instruments in the bankruptcy context, because it was on a “disqualified” list. The parties split the difference, allowing Apollo to push for recovery of $0.50 of every debt dollar.

In June, the court issued a final judgment, again upholding the uptier, against arguments by objecting creditors that it was prohibited by the language of a 2016 credit agreement. What was fatal to the arguments of the non-PTL creditors, in the view of the court, was in essence that they did not have what is now called Serta blocker language in that 2016 agreement. The creditors were sophisticated parties and they could have prevented the uptier exchange through unambiguous language in the original documentation doing so. Instead, they were “keenly aware” that the agreement was a loose document, and they “understood the implications of that looseness”.

Accordingly, the PTL were allowed to amend the credit agreement in such a way as to validate their uptick.

Serta blocker language would have required that the consent of all affected creditors be needed for amendments that “subordinate, or have the effect of subordinating, the obligations hereunder to any other indebtedness [or] the liens securing the Obligations to liens securing any other indebtedness”.  This language is taken from an LSTA template.

A recent in-depth discussion by Moody’s Investor Service looks at the likely effects of the Serta bankruptcy upon the markets, as a precedent.

Unfortunately, the Moody’s analysis says, the language in the “vast majority of loans” continues to fall short of the LSTA guidelines. It appears likely, then, that some first-lien creditors’ senior rights will continue to be usurped when companies in distress agree to such uptiers in the near future. Creditor-on-creditor violence will continue.