As almost everyone knows by now, Serta executed in July 2020 a liability management transaction with some of its first lien lenders. They received in exchange for their loans andamendments to the credit agreement super priority first lien loans and left non-participating lenders with a subordinated lien on the Collateral. Borrower purported to effect theexchange by making open market purchases from the exchanging lenders and paying them with the super priority debt. Serta then filed for a prepackaged bankruptcy in the Bankruptcy Court for the Southern District of Texas.

Ultimately the Fifth Circuit Court of Appeals ruled that the loans were not purchased in the open market and remanded the case to the bankruptcy court. On July 7, 2026 the Court ruled that the exchange violated the pro rata sharing provisions of the existing credit agreement and entered judgment for the plaintiffs – those lenders shut out of the exchange.

The pro rata sharing provisions stated that: “If any Lender obtains payment . . . in respect of any principal of or intereston any of its Loans of any Class held by it resulting in such Lender receiving payment of a greater proportion of the aggregate amount of its Loans of such Class and accrued interest thereon than the proportion received by any other Lender with Loans of such Class, then the Lender receiving such greater proportion shall purchase (for Cash at face value) participations in the Loans of other Lenders of such Class at such time outstanding to the extent necessary so that the benefit of all such payments shall be shared by the Lenders of such Class ratably in accordance with the aggregate amount of principal of and accrued interest on their respective Loans of such Class.”

Carved out of that requirement were open market purchases. The Agreement also provided that the section with those provisions could not be amended without the consent of all adversely affected lenders.

The problem for almost everyone else is that the pro ratasharing provision quoted above is used in most agreementsbut for years has included an exclusion for any provision in the agreement that provides for other than pro rata sharing. Only amendment of that section requires consent of alladversely affected lenders and not other provisions in the agreement. We have long interpreted that as ineffective protection of pro rata sharing rights since it does not actually require pro rata sharing on its own and other provisions that do require pro rata sharing are not included in the amendment limitations.

We suggested in a special report dated October 13, 2017, optimistically titled “Fixing Pro Rata Sharing Provisions” that the overall pro rata sharing section be changed so that it would have a carve out only for other provisions that allow other than pro rata sharing on the date of the agreement. Simple right? It could have been if that approach had been followed, but instead the provisions were not changed or made worse by excluding non-pro rata sharing provisions inthe agreement, “as it may be amended from time to time.”

As a result, the Court’s decision, while welcome to the nonexchanging lenders, should have little impact on the market.

One side note. The Court also held that the exchange constituted payment on the original debt and that a payment need not only be made in cash unless it specifically says so. The court in the Del Monte bankruptcy sided with the favored lenders on the basis that an exchange was not a payment since it was not made in cash. Since bankruptcy courts frequently allow claims to be paid in a combination of cash and equity or even only equity, the Del Monte judge seems to have just wanted the proceeding to end.

by Vince Pisano

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