Fifth Circuit Reverses Jones’ Serta ‘Open Market Purchase’ and Indemnity Decisions, Takes Swipe at Equitable Mootness Doctrine in Landmark Decision for LMEs

Relevant Document:
Opinion

In a unanimous decision today, a three-judge panel of the U.S. Court of Appeals for the Fifth Circuit reverses former judge David R. Jones’ March 2023 summary judgment decision rejecting excluded lenders’ breach of credit agreement claims arising from Serta Simmons’ 2020 uptier exchange on “open market purchase” grounds. The panel also reverses Jones’ approval of plan provisions requiring the reorganized debtors to indemnify the uptier participating lenders for any damages awarded to the excluded lenders and excises them from the plan.

The result is an almost complete victory for the excluded lenders and could chill the market for uptier exchange liability management transactions. The panel also endorses a narrow view of the doctrine of equitable mootness, meaning that creditors whose objections to plan confirmation are overruled by Fifth Circuit bankruptcy courts – including the popular complex case panel in Houston – may expect more substantive merits review of those decisions rather than the customary dismissal of appeals after a plan is substantially consummated.

In fact, limiting uptiers – or at least the acceptance of uptiers by bankruptcy courts in the Fifth Circuit – may be the appellate panel’s intended result. The decision, written by Circuit Judge Andrew S. Oldham and joined by Circuit Judges Catharina Haynes and Don R. Willett, starts by outlining the benefits and costs of uptiers and ends with a suggestion that the panel views the latter as outweighing the former.

“The 2020 Uptier was the first major uptier,” but “it was far from the last,” Judge Oldham concludes. “And while the loan market has seen an increase in contracts blocking uptiers (so-called ‘uptier blockers’) since 2020, there are doubtless still many contracts with open market purchase exceptions to ratable treatment. Though every contract should be taken on its own, today’s decision suggests that such exceptions will often not justify an uptier.”

The decision addresses two bankruptcy court decisions arising from the Serta uptier. First, the panel reverses Jones’ summary judgment decision, which rejected the excluded lenders’ claims for breach of the pro rata sharing provisions of the credit agreement by applying the “open market purchase” exception to pro rata treatment. Second, the panel reverses Jones’ approval of a plan provision requiring reorganized Serta to indemnify participating lenders for any damages owed to the excluded lenders – a potentially ruinous liability that the debtors said could trigger another chapter 11 filing.

On the breach issue, the panel concludes unequivocally that “the 2020 Uptier was not a permissible open market purchase” under that exception to pro rata treatment in the credit agreement (emphasis added). According to the panel, Jones erred by disregarding whether the company’s purchase of the participating lenders’ claims occurred on a specific “market” – here, the “secondary market for syndicated loans” – rather than merely in “a general context where private parties engage in noncoercive transactions with each other.”

“An open market is a designated market, not merely the background concept of free competition that characterizes much of modern American commerce,” Judge Oldham explains, and the secondary market for syndicated loans “is generally open to buyers and sellers, and its prices are set by competition.” By purchasing the participating lenders’ claims privately outside of this market, the judge concludes, Serta “lost the protection” of the open market exchange exception to pro rata treatment.

Judge Oldham adds that interpreting the open market purchase exception as Jones did – to include any private purchase of a select group of lenders’ claims after private bidding – would render the credit agreement’s off-market Dutch auction exception to pro rata treatment meaningless. “If an open market purchase is merely an acquisition of ‘something for value in competition among private parties,’ the Dutch auction exception does no work” because Serta “could call any arms-length transaction – including a Dutch auction – an open market purchase,” the judge explains.

Although the panel agrees with the excluded lenders that the summary judgment decision was flawed and the open market purchase exception does not apply, the panel sends the excluded lenders’ breach of contract claims back to the lower courts for further proceedings because Jones’ decision did not consider other issues. However, Judge Oldham notes that “the Excluded Lenders have a strong case” that Serta and the participating lenders breached the credit agreement.

That suggestion leads into the panel’s analysis of the second major question: whether Serta’s indemnification of the participating lenders in its confirmed plan was valid, as Jones found. The panel also disagrees with Jones on this issue, meaning Serta will not be liable for any damage award against the participating lenders on the excluded lenders’ breach of contract claims.

Judge Oldham first disposes of the debtors’ and participating lenders’ argument that the indemnity issue cannot be reviewed on the merits because it is equitably moot after substantial consummation of the plan. The judge finds that because the indemnification can be excised from the plan without disturbing Serta’s reorganization, the indemnity appeal is not equitably moot. In fact, the judge notes, excision of the indemnity provision would benefit reorganized Serta, which “would no longer be on the hook.”

Judge Oldham also rejects the participating lenders’ argument that excising the indemnity would be unfair because they agreed to support the plan in reliance on the indemnity. “If endorsed, the appellees’ argument would effectively abolish appellate review of even clearly unlawful provisions in bankruptcy plans,” the judge says. “Parties supporting such provisions could always argue they would have done things differently if they had known the provisions would later be excised.”

“From the moment the Prevailing Lender plaintiffs agreed to a controversial indemnity arising out of a contentious transaction, they could foresee the adverse consequences of an unfavorable appellate ruling,” Judge Oldham adds.

The judge more generally calls the doctrine of equitable mootness “a judge-made, atextual doctrine of pseudo-abstention” and warns that “to the extent equitable mootness exists at all, we affirm that it cannot be ‘a shield for sharp or unauthorized practices’” (emphasis added).

Turning to the merits of the indemnity issue, the panel concludes that the indemnity must be excised because it is an “end-run” around section 502(e)(1)(B) of the Bankruptcy Code, which requires disallowance of contingent prepetition indemnification claims. Judge Oldham specifically finds that Jones erred when he “bought” the debtors’ and participating lenders’ argument that the plan indemnity was a new postpetition “settlement indemnity” rather than a brazen repackaging of the indemnities in the prepetition uptier agreements.

“No party disputes that the settlement indemnity covers the same kind of losses as the pre-petition indemnity,” Judge Oldham explains, and the minor differences between the prepetition indemnity and the postpetition “settlement indemnity” cannot justify the end-run around section 502(e)(1)(B). The judge calls the participating lenders’ attempts to distinguish between the indemnities “sophistry.”

Even if the indemnity were not an impermissible end-run around section 502(e)(1)(B), Judge Oldham alternatively finds, it would have to be excised because it violates section 1123(a)(4) of the Bankruptcy Code, which mandates equal treatment for all creditors within each plan class. Although all members of classes 3 and 4 received the indemnity, the judge explains, the value of that indemnity was obviously dramatically greater for the participating lenders, who actually face breach of contract claims by the excluded lenders.

“To class members like the [participating lenders], the indemnity was potentially worth millions or even tens of millions of dollars,” but to other class members “that had no involvement with the uptier, the indemnity was worth little or even nothing,” the judge points out. “Thus, some class members received settlements with higher effective values than their co-class members,” violating section 1123(a)(4).