As a wise man is wont to say, "Where you stand depends on where you sit."
This statement applies with full force to the recent, related opinions from Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas, addressing the effects of a so-called "uptier" liability management transaction.1
Procedurally, Judge Isgur's rulings denied in part and granted in part motions for summary judgment, permitting certain claims to proceed to trial beginning on January 25, 2024.
Substantively, Judge Isgur's rulings have been viewed with nearly undisguised glee in certain circles—notably by the opponents of "majority rules" transactions (where a majority creditor group extracts economic value or positional advantage from the minority group), or at least among those creditors left out of a particular deal. As detailed below, Wesco seemingly endorses a rule that might require all disputes around somewhat ordinary course, contractual provisions as questions that necessarily require fact finding and trial. In other words, aggrieved creditors may have a roadmap for litigation and delay under the rather vague specter of "ambiguity."
Conversely, Wesco may be viewed with some skepticism, if not alarm, by the proponents of such transactions—or at least those who read credit documents at face value. By its ruling, Wesco may be read to (i) disregard, if not ignore, accepted market practice and (ii) (explicitly or not) accept the notion that 'implied sacred rights' may be read into credit documents to thwart what are otherwise commonplace aspects of credit documentation.2
In this regard, Wesco determined that key credit document provisions, including fairly rote indenture provisions, utilized in non-pro rata, uptier transactions were sufficiently ambiguous as to require fact-finding and trial—as opposed to ruling on summary judgment. As Wesco stated:
- "There is not enough factual support surrounding the circumstances of the transaction to understand whether the 2022 Transaction could be a redemption" and "Wesco does not clearly point to undisputed facts surrounding the circumstances themselves that demonstrate the transaction was [an open market or privately negotiated transaction];"3
- "If the 2022 Transaction was not a redemption, [the indentures' provision requiring the indenture trustee to select notes for redemption or purchase pro rata] does not apply to the 2022 Transaction. There is a genuine dispute as to whether the 2022 Transaction was a redemption;"4 and
- "The term 'right of payment' is ambiguous. Does it mean the priorities listed in a promissory note, or the practical legal rights that allow secured creditors to be paid out of the proceeds of a lien interest before an allocation to an unsecured holder? It is unclear whether right of payment applies to changes in rankings of, or stripping of, liens."5
Wesco is a notable departure from In re Serta Simmons Bedding, LLC, Case No. 23-90020, 2023 WL 3855820 (DRJ) (Bank. S.D. Tex. Mar. 28, 2023), in which a sister court in the United States Bankruptcy Court for the Southern District of Texas disposed of similar (albeit not identical) legal challenges in somewhat perfunctory fashion at summary judgment.6 Indeed, Wesco surprised at least some market observers by the extent to which it departed so quickly and so directly from another court in the same jurisdiction.
More fundamentally, Wesco leaves non-participating creditors with a roadmap to litigate to judgment, or at least delay, non-pro rata liability management transactions. Wesco also follows form with the approach taken by certain non-bankruptcy courts, such as Boardriders,7 Trimark,8 and Mitel Networks9 in this regard. Put differently, bankruptcy courts may no longer be viewed as a 'friendly forum' for liability management transactions predicated on a non-pro rata exchange.
And, by also allowing claims against "Participating Noteholders" to proceed to trial, Wesco leaves open the possibility that creditors (and not just obligors) may bear the risk for a liability management transaction that is subsequently unwound in the courts.
Market participants should therefore think carefully as to how they can mitigate execution risks where non-participating creditors may believe they can inflict litigation costs on borrowers and their counterparties—regardless of the merit of the underlying arguments.
In this regard, Ropes & Gray has had continued success in structuring and executing such transactions effectively and efficiently. Now more than ever, structures that accent the appropriate terms, and are handled with appropriate care, are essential for an execution strategy that maximizes creativity and coordination. We encourage you to contact your Ropes & Gray team to discuss these matters more fully. Ropes & Gray will also provide you an update on the outcome of the Wesco trial upon its completion.
Background
Wesco Aircraft Holdings, Inc. ("Wesco"), a leading provider of supply chain management services to the global aerospace business, undertook a series of liability management transactions in 2022 to address, at least in part, approximately $2 billion of then outstanding debt (collectively, the "2022 Transaction").
Among other things, the 2022 Transaction: (1) amended indentures governing the approximately $2 billion of debt (the "Indentures") to cause participating noteholders (the "Participating Noteholders") to become supermajority holders of the notes under the Indentures by permitting Wesco to issue additional notes, (2) permitted the Participating Noteholders to exchange their notes into new notes with senior-priority liens, and (3) implemented a 'covenant strip' for non-participating holders (the "Non-Participating Noteholders"). Notably, the 2022 Transaction occurred on a non-pro rata basis in that only the Participating Noteholders were provided the opportunity to exchange into the 'uptiered' notes at issue.
The 2022 Transaction then became the subject of litigation in the New York state courts, but that litigation had only reached its initial phases as of Wesco's June 2023 bankruptcy filing.10
The Bankruptcy Litigation
Following some procedural jockeying by the parties, Wesco sought a declaratory judgment from the bankruptcy court that, in effect, the 2022 Transaction complied with the Indentures and applicable law.11 The Non-Participating Noteholders asserted various counterclaims against both Wesco and the Participating Noteholders, including that:
- the non-pro rata nature of the exchange breached the pro rata redemption mechanism required by the Indentures;12
- in its totality, the 2022 Transaction breached the implied covenant of good faith and fair dealing;13 and
- the Participating Noteholders and Wesco's equity sponsor tortiously interfered with the Non-Participating Noteholders' contractual rights under the Indentures.14
Wesco and the Participating Noteholders sought to dismiss these counterclaims on a motion for summary judgment.
The Bankruptcy Court's Ruling15
Perhaps unexpectedly post-Serta, the Wesco court denied summary judgment on key aspects of Wesco's and the Participating Noteholders' motions for summary judgment.
At core, the Wesco court determined that reasonable, factual disputes existed as to whether the 2022 Transaction constituted a "single, integrated transaction," which would require a two-thirds vote from pre-transaction noteholders under the Indentures to implement, thus defeating Wesco's execution of the 2022 Transaction where it took steps to issue additional debt to Participating Noteholders to "manufacture" a supermajority before amending the Indentures further to consummate the 2022 Transaction.16
Further, Wesco determined that whether the 2022 Transaction was subject to the pro rata redemption requirement under the Indentures—or was instead authorized under the Indentures as an "open market or privately negotiated transaction"—similarly required fact-finding and adjudication.17
Finally, the Wesco court denied summary judgment with respect to the Non-Participating Noteholders' tortious interference claims, similarly finding that such a determination would ultimately require a broader factual analysis as to whether the transaction was contractually permitted in the first instance.18
In sum, Wesco determined that whether key aspects of the 2022 Transaction were permitted as a matter of contract or law will require fact-finding, and no doubt such fact-finding will be both time-consuming and expensive.
Takeaways
As noted above, Wesco is likely a welcome addition to the caselaw on non-pro rata liability management transactions for creditors left out (or that opt out) of such transactions and their allies. If nothing else, Wesco falls in line with state court decisions such as Boardriders,19 Trimark,20 and Mitel Networks,21 that are contrary to Serta,22 where such state courts have found breach of contract claims arising from provisions in debt documents utilized by participating creditors in multi-step integrated uptier transactions can be "ambiguous and require extrinsic evidence at trial," making the summary judgment standard ill-suited to defeat the claims of non-participating creditors.23
Additionally, and more favorably for non-participating creditors than the decisions in Trimark and Mitel, the Bankruptcy Court allowed the tortious interference claims of the Non-Participating Noteholders against the debtors and the Participating Noteholders to proceed to trial.
On the other hand, Wesco may at least arguably be confined to its facts. The 2022 Transaction at issue in Wesco is arguably the most aggressive uptier transaction to be litigated to date and was predicated on the Participating Noteholders' ability to amend the operative Indentures (as opposed to a credit agreement), which then permitted Wesco to issue additional debt for the sole purpose of creating a supermajority vote. Viewed through this lens, Wesco's ruling is perhaps less surprising. Additionally, the Wesco court's analysis was limited to the operative Indentures, rather than credit agreements of the type implicated in other uptier transactions.
Further, Wesco may be read to conflate the existence of a commercial dispute between sophisticated parties as necessarily resulting in ambiguity where such ambiguity does not clearly exist on its own. This logic does not clearly hang together. The existence of a contractual dispute does not typically mean "ambiguity"; oftentimes it means one party is just wrong. After all, the meaning of terms such as "redemption" and "open market" have not historically been matters of great debate. And any market participant claiming to be unaware of their potential uses in liability management transactions would seem to have been enjoying a long winter's slumber since at least well before J. Crew's 2017 dropdown.
Regardless, Wesco serves as another cautionary reminder that non-pro rata transactions may well invite litigation, if only for its own sake, and that such litigation may survive summary judgment and proceed to trial—even in bankruptcy court—where aggrieved creditors may find a sympathetic judge. Companies and creditors alike should therefore continue to factor these likely outcomes into their strategies when designing and pursuing liability management transactions.
Footnotes
1 See Wesco Aircraft Holdings, Inc. v. SSD Investments Ltd. (In re Wesco Aircraft Holdings Inc.), Case No. 23-3091 (Bankr. S.D. Tex. Jan. 14, 2024); Wesco Aircraft Holdings, Inc. v. SSD Investments Ltd. (In re Wesco Aircraft Holdings Inc.), Case No. 23-3091 (Bankr. S.D. Tex. Jan. 23, 2024).
2 Cf. ICG Global Loan Fund 1 DAC v. Boardriders, Inc., 2022 WL 10085886, *19 (N.Y. Sup. Ct. Oct. 17, 2022) ("While there is nothing in the sacred rights provision that expressly prohibits the subordination of any lenders' liens, the court rejects the Company's narrow reading of the sacred rights provision. Accepting the Company's argument would essentially vitiate the equal repayment provisions set forth in [the credit documentation] . . . .").
3 In re Wesco Aircraft Holdings Inc., Case No. 23-3091 (Jan. 14, 2024), *41.
4 Id. at *43. "[U]nder the canon of expression unjus est exclusion alterius, [the pro rata redemption section of the Indentures] may apply only in cases of redemptions, not purchases." Id.
5 See id. at *44.
6 See In re Serta Simmons Bedding, LLC, Case No. 23-90020, 2023 WL 3855820 (DRJ) (Bank. S.D. Tex. Mar. 28, 2023). Notably, the Serta ruling is subject to an ongoing appeal. See In re Serta Simons Bedding, LLC, No. 23-01482 (Bank. S.D. Tex. April 19, 2023).
7 See Boardriders, Inc., 2022 WL 10085886 at *18-25.
8 Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., No. 565123/2020 (N.Y. Sup. Ct. Aug. 16, 2021).
9 Ocean Trails CLO VII v. MLN TopCo Ltd., No. 651327/2023 (N.Y. Sup. Ct. Dec. 5, 2023) [NYSCEF Doc. No. 146].
10 See Langur Maize L.L.C. v. Platinum Equity Advisors, L.L.C. et al., Case No. 0651548/2023 (N.Y. Sup. Ct. Mar. 27, 2023).
11 See Wesco (Jan. 14, 2024), at *3.
12 See id. at *40.
13 See id. at *49.
14 See id. at *54.
15 Other elements of the Wesco opinions address claims related to the indenture trustee under the Indentures and issues of jurisdiction unrelated to the discussion here.
16 Id. at *39.
17 Id. at *41. Note that the Wesco court did dismiss the Non-Participating Noteholders' good faith and fair dealing claims as duplicative of the breach of contract claims. Id. at *52.
18 See id. at *54.
19 Boardriders, Inc., 2022 WL 10085886 at *18-25.
20 Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., No. 565123/2020 (N.Y. Sup. Ct. Aug. 16, 2021).
21 Ocean Trails CLO VII v. MLN TopCo Ltd., No. 651327/2023 (N.Y. Sup. Ct. Dec. 5, 2023) [NYSCEF Doc. No. 146].
22 In re Serta Simmons Bedding, LLC, Case No. 23-90020, 2023 WL 3855820 (DRJ) (Bank. S.D. Tex. Mar. 28, 2023).
23 Wesco (Jan. 14, 2024), at *37.
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