Minority Lender Claims Against Serta Simmons Avoid Deep Sleep: Breach Of Contract And Lack Of Good Faith Claims Survive

• Published date: 12 April 2022
• Subject Matter: Finance and Banking, Corporate/Commercial Law, Insolvency/Bankruptcy/Re-structuring, Financial Services, Fund Management/ REITs, Insolvency/Bankruptcy, Contracts and Commercial Law
• Law Firm: Arnold & Porter
• Author: Mr Michael Messersmith, Alan Glantz and Maja Zerjal Fink

A recent decision in the Serta Simmons Bedding, LLC (Serta) saga provides valuable insights into the viability of non-pro rata uptier exchange transactions and may embolden minority lenders whose loans have become subordinated to those of the majority as a result of such transactions. In a win for non-participating lenders, US District Judge Katherine Failla of the Southern District of New York issued an opinion denying Serta's motion to dismiss the action challenging its uptier exchange and allowing the minority lenders to continue to pursue claims against Serta for breaches of the credit agreement and the implied covenant of good faith and fair dealing.¹ The court concluded, among other things, that Serta may have breached the credit agreement's "open market purchase" provisions in consummating the uptier exchange and violated standards of good faith and fair dealing in depriving the non-participating lenders of their seniority status in the debt structure. The court also found that the minority lenders had standing to bring such claims despite a no-action clause in favor of the administrative agent under the credit agreement.

The Uptier Exchange

In June 2020, Serta entered into a transaction (Transaction) with a majority of its existing first lien and second lien lenders (Participating Lenders) that created two new traches of debt (Priming Loans), both ranking ahead of Serta's existing first lien loans: (i) a $200 million new-money tranche; and (ii) an exchange tranche comprising $875 million of loans created through an exchange of the Participating Lenders' first and second lien loans. Serta and the Participating Lenders negotiated and executed a series of amendments to the loan documents including the First Lien Term Loan Agreement (Agreement), which allowed the Transaction to be consummated.²

Funds managed by LCM Asset Management (Plaintiffs) were not included in the negotiations resulting in the Transaction and their consent to the amendments was not sought by Serta or the agent.³

The Court Permits Claims for Breach of Contract and Lack of Good Faith and Fair Dealing

After the Transaction closed, Plaintiffs--holders of approximately $7.4 million of existing first lien loans--brought an action alleging, among other things, that Serta (i) beached the Agreement by structuring a debt exchange that did not qualify as an "open market purchase" and, accordingly, violated the lenders' rights to receive pro rata payments under the Agreement, and (ii) breached the implied duty of good faith and fair dealing by depriving the Plaintiffs of their senior secured position in Serta's debt stack.

Open Market Purchase Provision Does Not Expressly Allow Transaction. In deciding that the Plaintiffs' claims were properly...