DIP Rollups: The Final Frontier for Creditor-on-Creditor Violence?

The DIP rollup, once a controversial incentive for DIP lenders, is now so common we are surprised when we don’t see one in a chapter 11 case. In this analysis, we spotlight the dominance of rollups in existing lender chapter 11 DIP facilities and how they provide valuable benefits to participants. We then springboard to a favorite Octus theme, creditor-on-creditor violence, in the form of the much more controversial non-pro-rata rollup.

The benefits of DIPs and rollups, combined with a market environment that constantly pushes the bleeding edge of “what is possible?” begs the question: “Can such benefits be reaped exclusively, and in zero-sum fashion?” The question is all the more relevant today as we have seen non-pro-rata rollups proposed by two of the largest recent filers: First Brands and Anthology. Could we be seeing the beginning of a wave of non-pro-rata rollup cases ushering in a new “in-court LME” era?

Delaware Bankruptcy Judge Craig Goldblatt touched on the issue in the American Tire case, espousing the view that non-pro-rata DIP rollups are permissible under the Bankruptcy Code but that the prepetition credit agreement would govern potential claims between lenders. Crucially, Judge Goldblatt was not willing to release such lender-versus-lender claims.

American Tire came down before the Fifth Circuit’s December 2024 Serta Simmons decision, which suggested that the principle of equal treatment of similarly situated creditors in bankruptcy requires courts to look carefully at how value is allocated among creditors in the same class under a plan (without addressing whether that principle applies at the DIP stage).

Just last month, a district judge in Texas interpreted Serta as barring a non-pro-rata plan rights offering backstop in ConvergeOne. The Serta and ConvergeOne decisions emphasize that non-pro-rata rewards, at least those tied to a chapter 11 restructuring plan, must be market tested. Whether this extends to all stages of chapter 11 – especially DIP financing – is thus a crucial next test for courts.

The case law governing out-of-court liability management exercises is arguably more mature. Rulings since 2020 have allowed parties to craft specific contractual language permitting, throttling or leaving ambiguous their LME options, and litigation has slowed.

American Tire, Serta and ConvergeOne may be the beginning of a similar process for “in-court LMEs.” Until recently, there seemed to be a tacit understanding that, generally, rollups had to apply to every lender or noteholder’s prepetition claim pro rata, with majority holders securing outsized returns via fees and premiums tied to backstops or new-money investments. Now that debtors and their preferred creditors are challenging this norm, bankruptcy courts are just beginning to respond.

On Oct. 27 a lender excluded from participating in Anthology’s $100 million DIP (including a $50 million rollup) filed an objection that draws on Serta, ConvergeOne and American Tire. The stakes are high, not just for the excluded lender in Anthology, but potentially for the viability of these transactions as a whole.

In this article we discuss the state of play on DIP rollups and the potential for non-pro-rata rollups. In a follow-up article, Octus will provide an analysis with a focus on credit agreement covenants.

DIP Rollup Benefits and Trends

A DIP rollup occurs when an existing lender or noteholder conditions new-money financing to a debtor on the elevation of its existing debt to the DIP facility. The practical effect is similar to an out-of-court uptier: Prepetition “senior” debt is exchanged for “super senior” postpetition debt.

The benefits are numerous in chapter 11. Rollup loans, which may yield lucrative economic terms beyond already lucrative DIP yield rates, are typically afforded “superpriority” administrative expense status, with priority either alongside, or just behind, the new-money DIP loans. Absent the lender’s consent, the superpriority debt must be repaid prior to the debtor exiting chapter 11 under a confirmed plan.

Rolled-up debt is also no longer susceptible to a nonconsensual cramdown plan, where a debtor amends and extends a loan on unfavorable terms to the lenders or noteholders without their consent. A lender or noteholder that rolls up a significant portion of its prepetition debt into a DIP can obtain substantial leverage over a debtor’s restructuring.

By elevating its prepetition debt to the DIP, a lender or noteholder also enhances its negotiating position vis-à-vis other creditors, and gives itself an edge when credit-bidding in a sale of the company or for plan sponsorship.

While rollups are not mentioned in the Bankruptcy Code, judges typically authorize rollups at a debtor’s request under section 364 of the Bankruptcy Code so long as they are negotiated in good faith and are a reasonable exercise of the debtor’s business judgment.

The DIP rollup – once viewed as a relatively controversial tool – has evolved to become a standard term in large chapter 11 cases. Of this year’s prepetition lender or noteholder DIPs in middle-market and larger cases, approximately 82% involved rollups.
 

Rollups have become so prevalent that the question is less whether they are appropriate and more about how much prepetition debt can be rolled up compared with the new-money portion of the DIP – commonly referred to as the “rollup ratio.” The average rollup ratio has steadily increased throughout the years. Excluding revolving and ABL DIPs, ratios exceeding 2:1, 3:1 and even 4:1 of rollup debt to new money are becoming increasingly common, as shown in the chart below.
 

These ratios should be familiar to connoisseurs of prepetition LME exchanges, if a bit more restrained. For example, in Serta Simmons’ 2020 uptier, the participating lenders “rolled up” $1.3 billion in first and second lien debt into a super senior facility while providing $200 million in new money – a ratio of more than 6:1.

In terms of timing, bankruptcy judges also are becoming more comfortable with partial rollups on interim approval: See, for example, First Brands, Del Monte and Exela.

As always, check out Octus’ Credit Cloud database to gain more insights on DIPs.

The In-Court LME and Potential for Non-Pro-Rata Rollups

DIPs – as well as DIP rollups – present the opportunity to bring “creditor-on-creditor violence” to chapter 11, via an “in-court LME.” To the uninitiated, creditor-on-creditor violence refers to situations where majority lenders utilize contractual loopholes to improve their position over excluded minority lenders, typically via either an uptier exchange or a drop-down transaction (where collateral is removed to an unrestricted entity and encumbered with new debt issued to a favored group). Generally, DIP rollups resemble uptier exchanges.

Like out-of-court LMEs, non-pro-rata DIPs shift value (enhanced priority, enhanced negotiating leverage, enhanced credit-bidding and plan sponsorship power) from one group of similarly situated lenders or bondholders to another. The rules for accomplishing LMEs outside of bankruptcy are crystallizing – but what about in-court LMEs? Here’s what we’ve learned from recent decisions in American Tire and ConvergeOne.

The Prepetition Agreement Applies

Judge Goldblatt considered the non-pro-rata rollup issue in American Tire. In that case, the debtors proposed a DIP that would roll up only a favored group’s prepetition debt, shifting value to the group from holders of about 7% of the credit. The excluded lenders understandably objected.

At a Nov. 19, 2024, hearing, Judge Goldblatt laid down a rule: Section 364 of the Bankruptcy Code allows the debtor to take out loans featuring a non-pro-rata rollup. However, according to the judge, between lenders or bondholders, the prepetition credit agreement or indenture continues to govern. In other words, the same rules applicable to an out-of-court LME apply to the in-court LME, and those rules are found in the credit agreement:

“[M]y way of thinking about that is that the work of protecting yourself against [the DIP exclusion] is done by contract, not by bankruptcy law, and therefore the problem with this is a problem of contract, not bankruptcy law,” the judge said. In other words: If the DIP breaches the prepetition agreement, that is an issue for litigation between the lenders, not approval of the DIP.

The judge told the parties that he would not decide the litigation issue at the hearing. Instead, he told the parties that they could proceed with the non-pro-rata rollup, which he would approve. Judge Goldblatt added, however, that he would not provide any findings of fact (let alone releases) that would protect majority participants from a breach of contract suit.

Judge Goldblatt then gave parties his preliminary views of who would win that suit: “I’m inclined to believe that what this [rollup] does is in breach of that agreement. And I think that what will happen, if I approve this, is that the minority lenders will sue, and that they will win and that they will be entitled to damages that … they would suffer on account of the breach.”

Key to Judge Goldblatt’s view was the prepetition credit agreement’s pro rata sharing provision, which stated that proceeds from collateral would be shared equally among lenders. Judge Goldblatt reasoned that the non-pro-rata rollup transaction would violate that provision because “what the rollup is, is a draw on the DIP to pay down the prepetition credit agreement.”

Judge Goldblatt’s conceptualization of a rollup as a paydown of prepetition debt with DIP debt is not universal, and the majority lenders argued that the rollup does not have to be deemed a draw on the DIP loan to pay prepetition credit agreement claims. Instead, the parties can structure a rollup as a “cashless conversion.”

“For each one dollar of new-money DIP advanced,” counsel said, “an equivalent amount of prepetition term loan is being exchanged for a DIP loan.” Counsel underscored that “there is no payment.”

The argument did not seem lost on Judge Godblatt, who responded: “I hear you saying that it might be more complicated than my gut-level reaction because I was thinking of it under the structure, frankly, as described in the debtors’ papers of the way I grew up understanding what a rollup was. You’re now telling me it’s actually something different from that. I don’t know if that’s right, if it’s too cute by half.”

Judge Goldblatt said he thought “commercial reality” would back his interpretation of how a pro rata sharing provision applies to a rollup DIP transaction. According to the judge, “[I]t would be preposterous to enter into an agreement that provided for an exception to pro rata sharing in this context” because it “would turn every prepetition agreement into what is fundamentally a game of Russian roulette such that anytime you find yourself standing when the music stops, you go to zero. And I don’t see how anyone in their right mind would enter into such an agreement; it makes zero commercial sense to me.”

The parties did not dispute that the prepetition credit agreement’s “Serta Blocker” had a built-in exception for DIPs, meaning the blocker did not prevent the transaction.

Ultimately, the issue was never litigated. The majority lenders abandoned the non-pro-rata rollup entirely – but there was a rollup of $90 million of first-in, last-out claims, which helped the lenders succeed in a credit bid for the company. Check out Octus’ first analysis on American Tire HERE, which includes a fulsome discussion of other bankruptcy cases where non-pro-rata transactions sparked issues (Spoiler Alert: Most settled).

ConvergeOne Puts Equal Treatment Provision and Fairness Principles in Play

So what can be said about bankruptcy law and non-pro-rata DIP LMEs? At least in Judge Goldblatt’s court, there is no Bankruptcy Code impediment to approval of a non-pro-rata DIP rollup. But Judge Goldblatt decided American Tire before the Fifth Circuit’s decision in Serta and the district court’s ConvergeOne ruling in late September. That decision interprets Serta as prohibiting majority lenders from reserving for themselves the exclusive right to backstop an equity rights offering.

In ConvergeOne, Judge Andrew Hanen reasoned that by providing preferred lenders with an exclusive opportunity to participate in a lucrative plan equity rights offering backstop, the Bankruptcy Code’s equal treatment requirement was triggered. The equal treatment requirement (found in section 1123(a)(4) of the Bankruptcy Code) generally provides that claims within the same class under a plan of reorganization must receive the same treatment.

A lender excluded from a DIP or DIP rollup could argue for inclusion based on ConvergeOne, but that would require extending ConvergeOne outside the plan context. So there is an argument that the Bankruptcy Code’s equal treatment requirement would not be triggered in DIP transactions (at least those not tied to plan equity).

The ConvergeOne decision is on appeal to the Fifth Circuit, but litigants are not waiting to test the application of equal treatment to DIP financing.

First Brands and Anthology

The First Brands debtors said in their DIP motion that “[a]ll First Lien Lenders have been or will be offered the opportunity to participate in the syndication” of their $1.1 billion new-money DIP, which would roll up an additional $3.3 billion of prepetition debt (a 3:1 rollup). However, the devil is in the details.

As Octus reported HERE, while the new-money DIP is generally open to all lenders, lenders are not participating equally. A steerco of ad hoc group lenders worked out deals with other lenders that will give them the right to fund most of the $385 million new-money portion. Whether that deal was made with the specter of a potential objection and reached to avoid litigation is unknown. Octus reporters did ascertain, however, that the final deal reached with minority lenders was an improvement from the initial offer.

Contrast the First Brand DIP lenders’ “negotiated solution” with the Anthology case. In Anthology, an ad hoc group of first-out lenders opened up participation in the $100 million DIP (with 2:1 rollup) to all first-out lenders – except one, “first-out” revolving credit lender Vector.

Vector maintains that it was excluded from the DIP at the debtors’ behest because it declined to fund a $100 million prepetition draw request based on an “uncured event of default.” There is pending New York state court litigation on that allegation.

In its Oct. 26 DIP objection, Vector notes that the credit agreement has a pro rata sharing provision similar to the one found in American Tire. It relies heavily on Judge Goldblatt’s statements from that case in support of its argument that the DIP rollup would violate the pro rata sharing provision. Vector also notes that its agreement contains a Serta Blocker, which it argues precludes subordination of its liens under the DIP.

Vector also cites a 2010 Delaware bankruptcy court decision – In re Capmark – where retired judge Christopher Sontchi shares Judge Goldblatt’s view on the nature of rollups (albeit in an unrelated context).

Vector took a more creative angle to shoehorn the Serta/ConvergeOne equal treatment principle into the DIP context. According to Vector, Judge Alfredo Perez must consider the equal treatment issue at the DIP stage because the DIP facility is, at least with respect to Vector, a sub rosa plan of reorganization. Approval of the DIP, Vector says, would essentially require that its prepetition pari passu claim be classified separately and treated less favorably at the plan stage – meaning equal treatment must be considered now, before that is a fait accompli.

Vector also argues that the “weaponized” nature of the DIP exclusion means the DIP is not being proposed “in good faith” and is not “fair and reasonable,” which DIPs must be for purposes of section 364 of the Bankruptcy Code.

The final DIP hearing is scheduled for Nov. 12. The debtors and ad hoc group have yet to publicly respond, but the declaration they filed in support of DIP (prior to Vector’s objection) indicates that their arguments may center on the contractual consequences of Vector being a “Defaulting Lender.”

Declarant Brent Herlihy, the debtors’ investment banker states: “[T]he DIP Facility is available to all non-defaulting Lenders under the First Lien Credit Agreement who are party to the RSA and have not breached their obligations under the Prepetition Superpriority First Lien Credit Agreement” (emphasis added).

In other words, the debtors are accepting Judge Goldblatt’s position in American Tire that the prepetition credit agreement continues to apply to creditor-on-creditor violence after the petition date, perhaps foreshadowing an argument that the credit agreement does not prevent them from icing out Vector on the facts. We will have to await their arguments on the equal treatment issue.

Conclusion

DIP rollups are extremely valuable not just for economic reasons but strategic reasons as well. We expect that dynamic to fuel an “in-court” LME environment in which we increasingly see majority lender groups attempting to squeeze out minority lenders from participation in DIPs. That strategy needs to be considered from a credit agreement perspective and on a case-by-case basis as jurisprudence on the issue continues to develop.

Either way, the bottom line is this: Any non-pro-rata DIP rollup transaction involving a pro rata sharing covenant similar to American Tire’s carries litigation risk, just like an out-of-court LME. There is no magic bankruptcy bullet to circumvent pro rata sharing provisions in prepetition documents, and the equal treatment principle may make it more difficult to do in-court LMEs.