A growing number of credit agreement amendments are pitting corporate lenders against each other, resulting in lawsuits with long lists of defendants — a trend that one data provider has dubbed “creditor-on-creditor violence.”
A lawsuit filed by food service provider TriMark USA’s lenders on November 6 is the latest example of such cases. The plaintiffs in that case, including Audax, Golub Capital Partners, and others, alleged that their fellow creditors — including Oaktree Capital Management and Ares Management — improperly changed their loan agreement in a “cannibalistic assault by one group of lenders in a syndicate against another.” That change allegedly resulted in a new class of lenders, which subordinated the plaintiffs’ claims on TriMark’s debt, according to the court filing.
The lawsuit looks like a few others filed this year: UMB Bank’s lawsuit against Revlon that triggered the accidental Citibank loan repayment, the Serta Simmons suit filed by Apollo Global and other creditors, and a complaint filed against surf wear brand Boardriders by Intermediate Capital Group and others. The common thread in these cases is that a portion of a company's lenders are unilaterally changing loan deals, which is landing them in court with other creditors, who say they get a raw deal under the new terms.
All of these suits concern so-called priming debt restructuring transactions. In these deals, some members of a term loan syndicate who are already bound by an existing agreement band together to make a new loan to the company to give it a lifeline. They they create a novel agreement based on the new loan, and this contract essentially subordinates the other lenders.
In other words, the minority lenders are “primed,” which means their debt is suddenly ranked below the majority’s in repayment order, and some original protections are stripped away. In industry parlance, it’s also called up-tiering or covenant stripping. The end result: “a minority group of original lenders were primed by the majority” and thus “left with loans whose value was diminished after the restructuring transaction,” according to a Covenant Review report published this week.
Certain contracts allow for a majority of lenders, rather than all the lenders, to change the credit agreement and complete this type of transaction. Covenant Review called these types of deals “creditor-on-creditor violence” in its report. And for some lenders, that so-called “violence” can be devastating.
“The proof is in what happened to the price of these loans,” said lawyer Andrew Dunlap, who is representing the displaced lenders in the TriMark case. He said that ahead of the deal, loans were trading at 70 to 80 cents on the dollar. After it was announced, they were worth 20 or 30 cents.
Distressed companies — and their lenders — are not new to seeking out creative ways refinance existing debt, either to free up enough balance sheet capacity to issue more of it, or to buy more time to avoid default. But such moves have only accelerated as companies ran into trouble during the coronavirus pandemic, as was the case with TriMark, a major supplier to restaurants.
Some of these techniques have become known as “trap doors” – for example, the now-infamous 2017 transaction involving retailer J. Crew, which transferred its intellectual property to a different subsidiary, ostensibly placing it out of the reach of existing creditors. While these types of transactions can help debtors avoid defaults, they can also result in existing lenders seeing their debt subordinated to new tranches of debt.
In such transactions, “a familiar pattern emerges: a company will utilize a new method to incur or refinance existing debt and other lenders in the market will react by trying to close those corresponding loopholes in their credit documentation,” wrote attorneys for law firm O’Melveny, in a note entitled “Covid-19: Prime Time for Priming.” “While lenders attempt to stay ahead of the curve, as liquidity and refinancing options become even more important to pandemic-challenged borrowers, new trap doors keep opening.”
Even as the number of lawsuits involving these agreements is growing, experts are circumspect about calling it a trend. But, they say, market participants are keeping a close eye on the cases.
“The reason we’re so interested in it and why there’s so much noise around it is that there are some aspects of these restructurings that are very concerning,” said Michael Pang, principal and portfolio manager at Tetragon Credit Partners, by phone. “The one for us that is most concerning is this stripping of one of the sacred rights of loans.”
A Fitch Ratings report on these types of transactions explained that they seek to get around so-called pro-rata repayment requirements contained in the credit agreement. Credit contracts typically include these provisions to ensure that when a debt is paid, it is done so on a proportional basis to the same group of lenders.
The Serta Simmons agreement got around this because its contract allowed non-pro-rata repayment — or non-proportional repayment — for debt purchased on the open market, according to Fitch.
The result of these agreement changes? Lawsuits with many defendants, from aggressive lenders to public pension funds.
Defendants in the lawsuits believe that they have not breached their contracts and are instead doing what is in their clients’ best interest. Given that these cases are ongoing, those contacted for this story, including Oaktree, declined to comment.
But Oaktree’s Howard Marks did signal the firm’s thinking in an October appearance on Bloomberg TV.
“I don’t think of it as screwing,” he said after the host asked him whether the deals “screw over” other investors. “I really resist that terminology,” Marks said. “We can’t go easy on another firm and fail to carry out our duty to our clients, which is to conscionably maximize their interests.”
The lawyers for the plaintiffs in the TriMark case disagree.
“This is like corporate lawyers run amok,” said Jennifer Selendy, managing partner at Selendy and Gay. “They’re making something seem more complicated than most of us would think it needs to be.” She called these deals a “Hail Mary pass” to avoid taking losses for investors.
Judicial reactions to these cases have been mixed so far. According to Covenant Review, courts usually focus on either the “precise technical wording of the agreement” or look at the deal “more generally and holistically.”
During the summer, a New York Supreme Court judge ruled that the majority lenders to Serta Simmons, which included Credit Suisse and Barings, could go ahead with their debt transaction, a June 22 court filing shows. The lawsuit filed against them by Apollo Global and Angelo Gordon continues to make its way through the court system, though, as they're still challenging the terms of the deal, the docket shows.
A similar 2017 court case went differently. That year, Octagon Credit Investors, a $26.2 billion corporate credit advisory firm, filed a lawsuit against its fellow creditors and a company called Not Your Daughter’s Jeans.
The case was discontinued after the two sides decided to amend the credit agreement, but not before Charles Ramos, the New York Supreme Court judge overseeing the case, shared his opinion on the deal.
“It seems that this was not used as a way of convincing other term lenders to participate in this refinancing,” Ramos said during a hearing, court documents show. “Rather, it was a way of cutting some of them out without letting them know what’s going on.”
According to Pang, lenders have started to notice the trend and have changed their credit agreements accordingly.
“We have seen recently that loans that have been issued over the past 6 weeks, more of those have anti-Serta provisions,” Pang said. “The market has started pushing back.”