On December 31, 2024, the United States Court of Appeals for the Fifth Circuit and the New York Appellate Division, First Department, both issued decisions evaluating the validity of so-called “uptier” transactions under New York law. In re Serta Simmons Bedding, LLC, Excluded Lenders, No. 23-20181 (5th Cir. Dec. 31, 2024) (“Serta“); Ocean Trails CLO VII, et al. v. MLN TopCo Ltd., et al., No. 2024-00169 (N.Y. App. Div. 1st Dep’t Dec. 31, 2024) (“Mitel“). These types of transactions, the structures of which vary significantly, generally involve granting certain lenders enhanced priority on their loans, relative to other lenders’ loans, in exchange for extending new financing to the borrower pursuant to the terms of the relevant credit agreement. Each decision focused carefully on the precise wording of the controlling credit agreements to determine whether the challenged conduct was permitted.

In Serta, the Fifth Circuit rejected arguments that the borrower’s purchase of the majority lenders’ pre-existing loans qualified as an “open market purchase” under the relevant credit agreement, governed by New York law. Specifically, drawing on both dictionary definitions and caselaw, the Court held that to qualify as an “open market purchase,” the loans must have been acquired for value in a market with competition among participants, whereas the challenged transaction was a direct acquisition by the borrower, agreed on a bilateral basis with the relevant lender. Having concluded that the transaction was not an open market purchase, the Fifth Circuit ruled that it violated the specific terms of the at-issue credit agreement and remanded the case to the district court.

In Mitel, the New York First Department ordered dismissal of all claims in a lawsuit challenging the borrower’s purchase of existing loans because the credit agreement permitted the borrower to “purchase” by way of assignment and become an assignee with respect to the term loans. Plaintiffs in Mitel argued that the transaction was actually a “refinancing” or “exchange” of existing loans for new loans because the “purchase” was completed with debt, and thus could not be considered a “purchase” under the credit agreement. The First Department disagreed, however, finding that there was “no indication in the agreements that a refinancing or exchange cannot include a purchase, nor [was] there any indication that a purchase requires payment in full, upfront, in cash, or that debt cannot constitute payment.” The Court further noted that several other provisions in the credit agreement supported defendants’ interpretation and that, in any event, construing the agreement to require a cash payment would “not be consistent with the common understanding of the word ‘purchase.'” As such, the First Department determined that the disputed transaction complied with the “purchases” exception to the pro rata sharing provisions in its credit agreement, which allowed the borrower to purchase loans at any time.

The somewhat conflicting decisions of both courts share one theme, which is consistent with the various structures used for these transactions: courts will give careful review to the specific language of the at-issue agreement to determine whether these types of transactions are permitted