‘Creditor-to-Creditor Violence’ Brings Big Managers to Court

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A growing number of credit agreement amendments pit corporate lenders against each other, resulting in lawsuits with long lists of defendants – a trend one data provider has called “creditor violence” .

A lawsuit filed by lenders of food service provider TriMark USA on November 6 is the last example such cases. The plaintiffs in this case, including Audax, Golub Capital Partners and others, alleged that their fellow creditors – including Oaktree Capital Management and Ares Management – had improperly modified their loan agreement as part of a “cannibalistic assault. of a group of lenders from one syndicate to another “. . “This change would have resulted in the creation of a new class of lenders, which subordinated the plaintiffs’ claims on TriMark’s debt, according to the court record.

The lawsuit looks like a few others filed this year: UMB Bank’s lawsuit against Revlon that sparked the accidental repayment of the Citibank loan, the Serta Simmons lawsuit filed by Apollo Global and other creditors, and a lawsuit filed against surfwear brand Boardriders by Intermediate Capital Group and others. The common thread in these cases is that part of a company’s lenders unilaterally change loan agreements, which takes them to court with other creditors, who say they get a rough deal under the new terms. .

All of these lawsuits relate to so-called seed debt restructuring operations. In these deals, some members of a term loan syndicate who are already bound by an existing agreement band together to give the company a new loan to give it a lifeline. They create a new agreement based on the new loan, and that contract essentially subordinates the other lenders.

In other words, minority lenders are “award winning,” which means their debt is suddenly ranked below that of the majority in the repayment order, and some initial protections are removed. In industry jargon, this is also called up-tiering or covenant stripping. The end result: “a minority group of original lenders was primed by the majority” and thus “ended up with loans that were diminished in value after the restructuring transaction”, according to one. Engagement review report released this week.

Some contracts allow a majority of lenders, rather than all lenders, to modify the credit agreement and carry out this type of transaction. Engagement review called these types of agreements “creditor violence” in his report. And for some lenders, this so-called “violence” can be devastating.

“The proof is in what happened to the price of these loans,” said lawyer Andrew Dunlap, who represents the misplaced lenders in the TriMark case. He said that prior to the deal, loans were trading between 70 and 80 cents on the dollar. After the announcement, they were worth 20 or 30 cents.

Distressed businesses – and their lenders – are not new to finding creative ways to refinance existing debt, either to free up enough balance sheet capacity to issue more, or to gain more time to avoid default. But such measures have only accelerated as businesses ran into problems during the coronavirus pandemic, as was the case with TriMark, a major restaurant supplier.

Some of these techniques have come to be known as “traps” – for example, the now infamous 2017 transaction involving retailer J. Crew, which transferred its intellectual property to a different subsidiary, ostensibly putting it outside the reach of the public. existing creditors. While these types of transactions can help debtors avoid defaults, they can also cause existing lenders to see their debt subordinated to new debt installments.

In such transactions, “a familiar pattern emerges: a company will use a new method to contract or refinance existing debt, and other lenders in the market will react by trying to fill the corresponding gaps in their credit documentation,” the wrote. lawyers of the law firm O. ‘Melveny, in a Note titled “Covid-19: Prime Time for Priming”. “As lenders try to stay ahead of the curve, as liquidity and refinancing options become even more important for borrowers facing a pandemic, new traps continue to open.”

Even as the number of lawsuits involving these deals increases, experts are wary of calling it a trend. But, they say, market players are watching cases closely.

“The reason we are so interested in it and why there is so much noise around it is that there are aspects of these restructurings that are of great concern,” said Michael Pang, director and portfolio manager at Tetragon Credit Partners by phone. . “What concerns us most is this stripping of one of the sacred rights of loans.”

A report by Fitch Ratings on these types of transactions explained that they were seeking to bypass the pro-rated repayment requirements contained in the credit agreement. Credit agreements usually include these provisions to ensure that when a debt is paid, it is done on a pro rata basis to the same group of lenders.

Serta Simmons’ deal circumvented this because her contract allowed non-proportional repayment – or non-proportional repayment – for debt purchased on the open market, according to Fitch.

The result of these chord changes? Lawsuits with numerous defendants, from aggressive lenders to public pension funds.

The defendants in the lawsuits believe they have not violated their contracts and instead are doing what is in the best interests of their clients. Since these cases are ongoing, those contacted for this story, including Oaktree, declined to comment.

But Oaktree’s Howard Marks signaled the company’s thinking in an October appearance on Bloomberg Television.

“I don’t think it’s a scam,” he said after the host asked him if the deals were “outpacing” other investors. “I really resist this terminology,” Marks said. “We cannot be indulgent to another firm and fail in our duty to our clients, which is to consciously maximize their interests. ”

Lawyers for the plaintiffs in the TriMark case disagree.

“It’s like corporate lawyers are going wild,” said Jennifer Selendy, managing partner at Selendy and Gay. “They make something more complicated than most of us think.” She called these transactions “Hail Mary” to avoid incurring losses for investors.

Legal reactions to these cases have been mixed so far. According to Engagement review, courts usually focus either on the “precise technical wording of the agreement” or on the agreement “more generally and holistically”.

Over the summer, a New York Supreme Court judge ruled that Serta Simmons’ majority lenders, which included Credit Suisse and Barings, could proceed with their debt transaction, according to a June 22 court filing. The lawsuit brought against them by Apollo Global and Angelo Gordon continues to make its way through the court system, however, as they are still disputing the terms of the deal, the folder watch.

A similar court case in 2017 played out differently. That year, Octagon Credit Investors, a $ 26.2 billion corporate credit counseling firm, filed a lawsuit against fellow creditors and a company called Not Your Daughter’s Jeans.

The case was dropped after both sides decided to change the credit agreement, but not before Charles Ramos, the New York Supreme Court judge overseeing the case, shared his opinion on the deal. .

“It appears that this was not used as a way to convince other term lenders to participate in this refinancing,” Ramos said at a hearing, according to court documents. “It was more of a way to eliminate some of them without letting them know what was going on.”

According to Pang, lenders have started to notice the trend and have changed their credit agreements accordingly.

“We have seen recently that with the loans that have been issued in the past 6 weeks, most of them have anti-Serta provisions,” Pang said. “The market has started to retreat.

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