Reorg’s Analysis of 11 Non-Pro-Rata Uptiers

An analysis of recent non-pro-rata uptier transactions for which exchange information is available suggests that transactions have become less aggressive in terms of transferring value to ad hoc groups and away from non-ad-hoc groups.

Reorg analyzed 11 non-pro-rata uptier transactions dating back to March 2022, estimating the level of aggression by calculating the amount of value transferred between creditor groups utilizing trading prices of the capital structure immediately before the transaction.

The six most recent transactions move an average of 18% of value away from non-ad-hoc creditors who participate, with Apex Tool being the most aggressive at 38% of value moved while Valcour moved only 12% of value away from non-ad-hoc creditors. This stands in sharp contrast to five earlier transactions including Wesco, which has been at least partially invalidated by Judge Marvin Isgur in its bankruptcy case, and Mitel, both of which moved 100% of value away from dissident creditors.

The charts below include 11 uptiers for which the exchange information is publicly available and show a marked shift, over time, in the amount of value moved away from non-ad-hoc creditors, potentially as a function of commentary from Judge Isgur casting doubt on the viability of Wesco’s uptier during a monthslong trial in its bankruptcy case. It remains to be seen whether this is the start of a meaningful trend or if it is possible value transfers could move up from here as participants continually test the market.

During day four of the Wesco/Incora uptier exchange trial on Feb. 1, Judge Isgur repeatedly suggested during questioning of a board member that the transaction was not fair to nonparticipating noteholders. At the end of that trial day, the judge provided the parties with his initial impressions regarding the case, noting that “the debtor raised the $250 million by taking away rights from” noteholders outside of the ad hoc group. He further stated his belief that management’s authority to act in the best interest of the company should not include taking away “someone’s property rights.”

It seems that the market has responded to Judge Isgur’s suggestions, which are consistent with his July 10 oral ruling overturning part of the transaction. The judge insinuated that the Wesco deal may have gone too far, and uptier exchanges since those comments have not included lien stripping and moved far less value from the non-ad-hoc creditors. At the same time, these more recent transactions have tended to have very high participation rates, possibly minimizing costly and protracted litigation like the Wesco transaction.

It may be that the market has found a new equilibrium point for these types of transactions with a lower level of aggression and therefore a lower volume of dissent. It is also possible that Judge Isgur’s apparent blessing of the lien stripping of the 2024 notes, where there was no gerrymandering issue, may lead to a return of more-aggressive transactions where ad hoc creditors have the requisite votes to strip liens going into the transaction – in other words, the Wesco decision may be an outlier applicable only to gerrymandering transactions.

It seems possible that future transactions will seek to move more value to ad hoc creditors, with the potential return of lien stripping, as the market looks to determine a “squeal point.” This is something Reorg will be watching intently.

Another factor that may have influenced sponsors to pursue less-aggressive transactions is the resignation of former judge David R. Jones in October 2023. Jones’ decision approving the Serta-Simmons uptier transaction as an “open market purchase” on summary judgment suggested a high level of tolerance for aggressive liability management deals and set the precedent for expedited and favorable resolutions of liability management disputes in the Houston bankruptcy court.

Jones’ Serta decision is on appeal to the U.S. Court of Appeals for the Fifth Circuit, which heard oral argument on July 10 – the same day Judge Isgur issued his Wesco ruling. A reversal of that decision by the Fifth Circuit could lead to further tempering of aggressive transactions.

At the time Jones resigned, Judge Isgur had left the Houston complex panel, replaced by Judge Christopher Lopez – and sponsors may have been more confident in Jones or Judge Lopez affirming aggressive transactions than Judge Isgur, generally viewed as a less-reliably debtor-friendly judge (at least by Houston standards). Sponsors and ad hoc creditors may have felt confident undertaking aggressive transactions with these two judges ready to rule in their favor – or at least rule quickly – should they file in Houston.

For example, Judge Lopez found on June 20 that Robertshaw’s December 2023 payoff of Invesco’s first-out loans to transfer “Required Lender” status to an ad hoc group breached the applicable credit agreement, but unlike Judge Isgur, he decided not to rearrange the company’s capital structure as a remedy and granted Invesco possibly worthless monetary relief. This allowed the debtors to go ahead with a plan that effectively validates the transaction, as in Serta.

In contrast, Judge Isgur remarked in Wesco that limiting non-ad-hoc creditors to a monetary claim for breach would be “the worst thing I could do.” Instead, he restored the liens of the non-ad-hoc creditors, potentially dooming a proposed plan premised on those liens remaining stripped.

The Wesco/Incora bankruptcy was originally assigned to Jones, who heard summary judgment arguments just a few days before he resigned. At that point, the company and the ad hoc creditors would likely have been very confident they would prevail, based on the Serta decision – which probably contributed to their decision to file in Houston. When Judge Isgur replaced Jones, he denied summary judgment, allowed the case to proceed to a very lengthy trial and decided to modify the company’s capital structure, defeating those expectations.

Judge Isgur is expected to leave the Houston complex panel again once new Judge Alfredo Perez, who is being sworn in today, officially takes his seat. At that point, sponsors and ad hoc creditors may be more confident in their chances of success, or at least a quick ruling, in the Houston bankruptcy court – leading to more-aggressive transactions. Reorg will of course closely monitor these judicial dynamics.

Wesco and Mitel Top List of Most Aggressive Non-Pro-Rata Uptier Transactions

Eleven different private and public non-pro-rata uptier exchanges we have analyzed, ranked by the amount of value that non-ad-hoc group creditors had moved away from them, are shown in the table below. On the basis of Reorg’s valuation assumptions, Wesco, Mitel and Robertshaw resulted in the most transferred value, with creditors not in the ad hoc group transferring 100% of their value to the ad hoc group.

Conversely, in the Valcour transaction, creditors outside the ad hoc group lost only 12% of their value to the ad hoc group, while in EyeCare Partners and GoTo Group, participating creditors outside the ad hoc group lost only 13% of their value.