Liability Management Transactions: The Beginning of the End?

While corporate restructuring is an option financially distressed companies often proactively explore to reduce their debt burden, another alternative that has recently gained some notoriety is a liability management transaction (LMT). Put simply, an LMT is a seemingly clever maneuver to modify capital structures by shifting collateral around to benefit one set of creditors at the expense of others. This assists the company with fresh capital, suspended/waived debt service obligations, extended maturities, or some combination thereof.

The group of creditors benefiting from this trade typically receive secure senior priority, increased collateral and potentially stronger protection via favorable covenants. The remaining lenders are exposed to lower ranks in the repayment hierarchy with weaker protections, and the choice to litigate or swallow this bitter pill.

Some notable LMTs in the recent past include Serta, Rackspace, Apex Tool, Altice France and Cumulus Media. These transactions include the most common types of LMTs — such as uptiering, dropdown, amend and extend, and double-dips, which are defined as follows:

  • Uptier: An uptier transaction typically involves a subset of lenders amending financing documents and securing a senior position in the capital structure in exchange for offering fresh capital to the borrower.
  • Dropdown: In a dropdown transaction, borrowers utilize the restricted payments provision in credit documents to shift collateral from restricted subsidiaries to unrestricted ones. Since unrestricted subsidiaries are not controlled by credit documents, this collateral can now be used to raise fresh capital while simultaneously weakening the recovery potential of existing creditors of restricted subsidiaries.
  • Amend and Extend: The least controversial tactic, this includes borrowers working together with creditors to amend credit documents to extend maturities. This additional runway helps borrowers preserve cash flow to invest in the business, but might not be sufficient in a distressed environment.
  • Double-Dip: A double-dip transaction is used to solidify the claims of lenders by raising capital at a nonguarantor subsidiary, which then lends the amount to the restricted subsidiaries in exchange for an intercompany receivable. The lenders to the nonguarantor subsidiaries have a guarantee from the parent, as well as a claim on the intercompany receivable, which improves the potential for maximum recovery twofold in a restructuring.

One LMT that recently garnered some attention is the uptiering exercise by Serta. The company’s credit agreement required pro rata treatment for similarly situated lenders, with the exception of open-market purchases. The company, facing some operational headwinds, decided to raise additional capital from certain lenders in 2020 by offering them senior positions in the capital structure. The remaining lenders litigated, claiming violation of good faith and breach of pro rata treatment covenant.

While the bankruptcy court ruled in favor of Serta in 2023, the Fifth Circuit reversed that decision in 2024 by adjudicating a violation of open-market purchase and pro rata-treatment requirements. While borrowers and their counsel could be expected to continue attempting workarounds, the Serta decision would no doubt compel companies considering LMTs to revisit their strategies.

Of late, one defensive play by lenders who anticipate subordination as a result of LMTs is entering into cooperation agreements. These agreements effectively require creditors to negotiate collectively, instead of make individual side deals with the borrower. Lenders who are part of cooperation agreements are restricted in their ability to participate in the borrower’s debt, whereas those who opt out have unrestricted participation, but risk economic loss should the cooperation agreement group prevail in a restructuring event.

The impact on the borrower is potentially limited liquidity on its debt given restrictions on cooperation-agreement creditors. This results in separate market prices for debt invested by creditors as part of cooperation agreements and instruments outside of these agreements — instructive for potential investors in distressed companies in terms of market confidence (and therefore demand) in debt that is a vital part of cooperation agreements.

In order to mitigate any risk of LMTs by cooperation agreements, companies and sponsors have attempted modifying credit documents to prohibit cooperation agreements, introduce nondisclosure agreements among creditors, and limit the voting ability of creditors in debt transactions and in credit documents. In an age where all parties to a credit agreement are backed by their respective armies of lawyers, whose hourly fees could easily accumulate to exorbitant amounts, it is not unreasonable to assume that the number of LMTs could drastically reduce in the future, since these are typically undertaken by financially distressed and highly leveraged companies that might find the entire exercise cost-prohibitive — especially given the frequent and protracted volleys among creditors, courts, lawyers and the borrower. In case an LMT is one of the limited options for a borrower, its executives will need to comb though credit agreements to appreciate LMT opportunities (as well as assess litigation or relationship risks), and proactively address any concerns by working together with counterparties and ensuring impervious documentation along with unambiguous interpretation.

In summary, while LMTs have been common over the last few years, the recent Serta verdict — along with preemptive strategies like cooperation agreements among creditors, as well as lengthy (and expensive) legal disputes — could very well force borrowers and lenders to align on credit document interpretation, thereby causing LMTs to perish naturally.