Disqualified Lender Lists: The Bendable BlacklistsUpdated:
Something that I’ve tried to touch on – successfully or otherwise – through many of my longer posts over the past year is that the world of restructuring is one that can seem to be defined by a certain level of rigidity (e.g., debt docs all look the same at first blush, the in-court process has a somewhat conveyor belt feel to it, etc.). However, if you break below the surface level rigidity you’ll find yourself immediately immersed in a murky mix – where boundaries are bent and there’s a paucity of precedence.
You may think this murky mix just involves the permissibility, or lack thereof, of relatively novel types of transactions – in other words, situations where desperate companies bend the boundaries, try their luck with some new-ish style of transaction, and then prepare for litigation to see if courts will let what they’re trying to do fly. Nothing ventured, nothing gained.
This is certainly true, and we’ve seen this script play out many times over the past few years. Including right now with a circuit split developing regarding the permissibility of the Texas Two-Step as a strategy for companies grappling with, in some cases, tens of billions of mass-tort claims. If you read my post explaining the Texas-Two Step last year then you know my feelings here: bankruptcy is an appropriate venue for handling mass-tort claims and is the most equitable way to handle these situations from both the company and claimant perspective when an otherwise healthy company, with a diverse line of businesses, appears predestined to be dragged under by the weight of ever-escalating claims.
Regardless, the Third Circuit’s latest view is that our old friends at LTL Management initially filed in bad faith because, uh, they weren’t under enough “financial distress” – so, they purposefully tried to make themselves look, uh, more distressed and filed again but that filing was batted down too. This is the difficulty of circuit courts eschewing pragmatism in favor of navel-gazing “standards” that they’re so fond of cramming down, no pun intended, on bankruptcy courts – but we’ll save that talk for another day.
Note: If you’re curious, you can read Judge Kaplan’s opinion dismissing LTL’s second attempt at filing here that came down in late July (it has lots of great context setting and background info on both the case itself and mass tort cases more broadly). Importantly, Judge Kaplan did not dismiss LTL’s first attempt at filing when it came before him, as his views on bankruptcy being the appropriate venue for resolving all of this largely align with mine – so, obviously, he has the correct views. But the Court of Appeals for the Third Circuit disagreed and dismissed that first filing attempt in January 2023, and Judge Kaplan did the respectable thing of dismissing LTL’s second attempt to file utilizing the “financial distress” standard the Third Circuit laid out earlier this year. It would have been bittersweet for Judge Kaplan to write his latest opinion, especially after his initial support of LTL’s filing was excoriated in academic and judicial circles, so he deserves credit for earnestly engaging with the Third Circuit’s jerry-rigged standard, instead of passive aggressively poking holes in it.
Note: In case you’re even more curious, the circuit split referenced earlier is between the Third Circuit (dismissing LTL’s case) and the Fourth Circuit (upholding Bestwell’s asbestos-related case). Don’t look now, but SCOTUS could be making the final call on all of this.
Anyway, restructuring doesn’t just enter a murky mix when it comes to novel transactions and their permissibility. There are also many, for lack of a better turn of phrase, common practices in restructuring that courts haven’t really laid out clear and broadly agreed upon frameworks for handling – instead, these common practices are governed more by nebulous norms than bright-line rules and, as you can imagine, this can lead to scenarios where perceived violations of these norms can lead to bitter fights.
To make one final digression before getting into the meat of this post, this latter point regarding common practices can be seen in the never-ending, back-and-forth issue of the permissibility of third-party releases for the Sackler family in Purdue. These releases have become the definition of common practice in many chapter 11s: an extratextual appendage to the Bankruptcy Code, sure, but one that’s arisen and become accepted by some (not all!) circuits because it facilitates more efficient, expeditious, and effective reorganizations.
Note: There's a wide diversity of third-party releases -- some tightly tailored, some extremely expansive. But the simplest way to explain third-party releases is that they prevent non-debtors who have been given a release (e.g., officers, lenders, directors, guarantors, subsidiaries, etc.) from being sued by existing creditors or (sometimes) non-debtors for their actions either directly or (sometimes) indirectly related to the filing. The rationale invariably being that these releases are a necessary precondition of the debtor being able to reorganize in line with the plan of reorganization. So, in Purdue’s case the non-debtors at issue are the Sackler family, and the plan contemplates that in return for contributing $6.0 billion to support the plan they’ll receive third-party releases that will have the effect of releasing them from all current and future liability for opioid-related and derivative claims (e.g., deceptive marketing, fraudulent transfer, etc.).
Note: It’s worth briefly mentioning the distinction between consensual and non-consensual third-party releases – both varieties, upon plan confirmation, are binding on all creditors. The Purdue third-party releases are non-consensual as they release the Sackler family from all current and future liability for opioid-related and derivative claims and will be binding on even those who did not vote on the plan.
Anyway, Purdue’s filing has taken on a life of its own given that its rise and fall has become the subject of bestselling books, docuseries, etc. And this has resulted in the pragmatism of third-party releases in Purdue being subordinated to more lofty considerations – namely, that it’s unjust that a family that built their fortune largely off of opioids is being released from further liability in return for contributing $6.0 billion of their personal funds to the plan (contributions that obviously would not be forthcoming were it not for being granted the releases in the plan).
In other words, the view of many is that it should be the prerogative of those harmed by Purdue’s actions to continue extracting every pound of flesh from those enriched by Purdue’s actions – even after Purdue exits bankruptcy, and even if that flesh resides in locales that can’t be easily extracted from – and taking the family off the hook, regardless of how much they contribute to a plan in exchange for the releases, smacks of injustice.
And, I suppose, it is unjust. But that’s bankruptcy, as the Court of Appeals for the Second Circuit’s Judge Lee stated perfectly in a recent majority opinion upholding the bankruptcy court’s approval of Purdue’s third-party releases: “Bankruptcy is inherently a creature of competing interests, compromises, and less-than-perfect outcomes. Because of these defining characteristics, total satisfaction of all that is owed – whether in money or in justice – rarely occurs.”
I’ll probably write a post on third-party releases sometime in the coming months given that Purdue’s utilization of them – a prerequisite to getting the plan put together, as it was a prerequisite to getting the Sackler family to pony up billions of dollars – may result in their downfall. Because the aforementioned Court of Appeals for the Second Circuit’s decision that upheld the bankruptcy court’s approval of Purdue’s third-party releases reversed the ruling from Judge McMahon of the Southern District of New York. This left folks clamoring for SCOTUS to step in and make the final call, and they were more than happy to oblige: last week they granted cert and arguments will commence in December of this year.
Given the extratextual nature of third-party releases and the textualist majority now ruling the roost at SCOTUS, this could shape up to be the end of third-party releases as we know them. If this is the end, it’ll be a mess. And it’ll all be because a common practice – rooted in pragmatism and past precedence, but not much else – managed to raise the ire and indignation of enough people to get it in front of SCOTUS. The nail that sticks out gets hammered.
Disqualified Lender Lists: Reasonable Rationale, Rickety Rules
In last month’s post I took you through a deep-dive on Serta – bringing the story full-circle from when we first talked about Serta’s transaction nearly three years ago. In typical fashion, the length of the post got completely out-of-hand. However, there was one thing that I wanted to touch on that I decided to save for another day: the disqualified lender list and how it was used and abused to Serta’s benefit and to Apollo’s dismay.
In the original adversary complaint, plaintiffs sought determination not only that the uptier transaction was permitted under the Credit Agreement and didn’t violate the implied covenant of good faith and fair dealing, both of which we discussed at length in last month’s post, but also that Apollo was a “disqualified institution” under the Credit Agreement.
In most credit agreements for syndicated loans there will be disqualified lender provisions that allow the borrower to put together a disqualified lender list – basically, a list of institutions that the borrower (company) does not want, in any context, holding their debt in the future.
Note: The terms “disqualified institution” or “disqualified lender” are a bit of a misnomer, as the reality is that any entity, or affiliate of an entity, that’s disqualified can purchase debt if they get the written consent of the company and administrative agent beforehand. But that’s relatively rare as the borrower, obviously, has the disqualified lender on their list for a reason.
The rationale for creating disqualified lender (DQ) lists is pretty straight-forward and entirely sensible. First, they make sure that a borrower’s competitors, assuming that the borrower is private, can’t just buy up some of the borrower’s debt and thus get a sneak peek at their financials. Second, they allow the borrower to preclude more “aggressive” funds from holding their debt if it’s believed those funds wouldn’t be, to use a euphemism, overly constructive if the borrow falls on hard times and needs to begin working collaboratively with its current lenders.
Given this, it won’t surprise you to know that sponsors typically put together the most comprehensive (read: aggressive) DQ provisions and put together the most comprehensive DQ lists. Because, obviously, if you’re a sponsor you don’t want other sponsors getting a peak at your PortCo’s financials and you definitely don’t want certain kinds of distressed funds mucking around in your PortCo’s capital structure if it begins to creak and crack under too much leverage.
The DQ provisions in credit agreements – like much else of the standard language in credit agreements – mostly align with the guidance of the Loan Syndications and Trading Association (LSTA). The idea behind the guidance is to ensure that all DQ lists have a relatively uniform structure and are limited to a reasonable number of entities as to not gum up secondary market liquidity. Additionally, the stipulates, among other things, that the administrative agent should promptly provide any prospective lender the list and make sure they keep the list up-to-date.
In practice you’ll see a wide swath of DQ provisions – some short and sweet, some long and lugubrious. For example, we’re increasingly seeing DQ provisions in sponsor-backed credit agreements that, to put it generously, are aspirational in spirit: sometimes trying to broadly disqualify swaths of funds instead of specific entities, or not making it overly clear if an institution can be added to the DQ list after it’s been created.
More importantly, there are limited hard and fast (read: enforceable) rules vis-à-vis the day-to-day usage of disqualified lenders lists – instead there’s a set of norms for how they’re used that have a tendency to be ignored or sidestepped. And in recent years we’ve seen a number of examples of this, with DQ lists having been used and abused much to the consternation of those on both the sell-side (e.g., loan trading desks at GS, JPM, etc.) and the buy-side (e.g., Apollo, King Street, etc.).
This is because, in practice, secondary trades happen in a competitive environment typified, to put it lightly, by lackluster liquidity. So, if DQ lists aren’t immediately accessible – either by the sell-side trading desk or by the buy-side buyer – then you end up in a situation where the prospective lender needs to undertake a leap of faith hoping that they aren’t on it. Then if it turns out, in retrospect, that the prospective lender was on the DQ list – but no one realized it – some kind of resolution needs to be reached.
When you add on top of this the aforementioned aspirational (read: vague) wording often present in DQ provisions – especially regarding what happens when a buyer on the DQ list manages to purchase debt – it can become a mess. So, much like third-party releases, DQ lists have become a common practice despite their limits still being an unanswered question – thereby opening the possibility for bitter battles when things go sideways and a resolution needs to be found.
Serta’s Disqualified Lender List and Apollo’s Ambiguous Assignment
So, with that quick and dirty overview of DQ lists out of the way, let’s get back to Apollo and Serta. Apollo, as happens occasionally, was purportedly on Serta’s DQ list because they’re a sponsor themselves and they may or may not have a bit of a rabble-rousing reputation.
If you read through the complaints, opinions, etc. linked in last month’s post, you’ll see an oscillation between folks mentioning North Star or Apollo. Apollo is North Star’s parent entity and because of this were also, by extension, purportedly on the DQ list.
Technically, in every document North Star should probably be exclusively referenced with it just being footnoted that Apollo is the parent entity. But invoking North Star doesn’t quite generate the same implicit understanding that invoking Apollo does. If you say that Apollo is a disqualified institution, everyone kind of nodes their head and says, “sure, sure, makes sense they’re always up to something and I wouldn’t want them poking around my PortCo either.”
Anyway, in March of 2020, as the drop-down was being dreamt up, North Star began buying up the 1L TL to the tune of $192mm. Because Apollo was purportedly a disqualified institution and purportedly didn’t get the requisite consent to effectuate the purchase, the purchase was, after much dilly-dallying, rejected.
However, Apollo says they made the purchase fair and square...
So, let’s talk about what happened here. Because, as you’ll see, there’s a reason why in my writing on Serta over the years I’ve been more defensive of Apollo. Serta played their leverage extremely effectively throughout the process of (ultimately) effectuating the uptier. But their dealing with Apollo wasn’t standard operating practice and, in my view, sets a bad precedence...
Somewhere in the bowels of one of the guides, there’s reference made to the distinction between “assignment” and “participation” when buying a term loan on the secondary market (e.g., calling up a trading desk at GS or Barclays or wherever and purchasing $Xmm of ABC 1L TL.).
But let’s do a quick recap. With assignment, a purchaser effectively has the rights they would’ve had if they had bought up the term loan at issuance. In other words, the purchaser becomes the lender of record, has the right to vote, etc. With participation, a purchaser gets the economic rights (e.g., the interest payments and limited voting rights) but doesn’t become the actual lender of record. Instead, the actual lender of record will remain whoever sold the economic rights.
If you’re at Apollo and are looking at doing a more “creative” transaction – or think one could occur and want to participate – you want to (obviously) become the lender of record (e.g., have full voting rights). So, mechanically, here’s a rough outline of what happens…
- First, a trade is confirmed between the assignor (current lender) and the assignee (purchaser).
- Second, an assignment agreement is executed, and a copy is delivered to the administrative agent (in the context of a syndicated loan, just think of the administrative agent as being a middle-man between the borrower and their diverse, ever-changing set of lenders – handling communications, voting issues, payments, etc.).
- Third, the administrative agent seeks the consent of the company, usually a formality, and assuming that the assignee isn’t on the DQ list (something the administrative agent should check) the assignment agreement is accepted, and the assignee officially becomes the lender of record.
Note: Importantly, it’s really the job of the administrative agent to keep an up-to-date copy of the DQ list and to act as a gatekeeper (e.g., not allow those on the DQ list to become an assignee). However, almost all credit agreements specify that there’s no liability for an administrative agent not, like, having an up-to-date list or even looking at the list prior to signing off.
So, here’s where things get a bit interesting. Apollo was on Serta’s DQ list originally but was removed in October of 2016. Then, over the next two years, they bought and sold millions of Serta’s 1L TL. So, in other words, the administrative agent, UBS, was constantly dealing with Apollo and Serta was, as a formality, signing off on their trading in and out of their 1L TL position.
Then on March 12 2020 Apollo reemerged for the first time in a few years: executing trade confirmations with Barclays (the assignor) in the 1L to the tune of $192mm. Apollo reached out to UBS in the days following the trade confirmations to confirm they weren’t on the disqualified list and were told twice that they were not (once verbally, once in writing).
Note: Again, notice the timeline here. They reached out after the trade confirmation, because if you’re actively trying to buy up loans you’re operating in a competitive environment – this is doubly so when other distressed funds are sniffing around the situation and are also trying to weasel their way into the capital structure. So, if you know the administrative agent is going to take time to get back to you, then you feel compelled to act now – and Apollo had good reason to believe, based on their previous trades, that they weren’t erring here.
Following the typical process, Apollo sent over the executed assignment agreements – between themselves and Barclays – to UBS. By April 14, with no response from Serta coming forth, its Apollo’s contention that consent was granted by omission of objection due to i) them being told they weren’t on the disqualified list by UBS and ii) the company not objecting within fifteen days.
But alas the trade didn’t settle, and the excuses from UBS began to pile up. UBS initially told Apollo that they were, like, being ghosted by Serta, so that’s why they couldn’t get the requisite sign off. And, per Apollo, with their suspicions now raised they confirmed multiple times again in mid-April, a month after first executing the trades with Barclays, that they weren’t on the DQ list.
Apollo is nothing if not persistent, and on April 24 Serta finally communicated an ostensible rationale to UBS for the delay: because of the pandemic, getting signatures was proving difficult. But they allegedly assured UBS that they would provide their consent for the purchases.
Several days later, in a bizarre whiplash of events, UBS executed the assignment agreements before, just hours later, retracting them saying it was done in error (to be fair, administrative agents making baffling errors isn’t exactly unprecedented – see Citi mistakenly paying $900m to lenders and then having to litigate to get it back).
Then the dilly-dallying all became clear, in case it wasn’t before. On April 30 Apollo signed an NDA to explore doing a drop-down, and in this NDA Serta acknowledged Apollo’s loan holdings (e.g., the $192mm 1L position we’ve been discussing above). But the next day they threatened to reject Apollo’s assignments – as they had still never actually consented in writing to them – unless Apollo allegedly made “a new money investment in Serta” (e.g., participated in a drop-down).
This would’ve been all water under the bridge if the drop-down had actually occurred, as it seemed likely that it would in those days. The hard-balling by Serta rankled Apollo, sure, but it was obviously a petty leverage play that was made possible due to the ambiguity inherent to DQ lists.
However, as you know from last month’s post, the PTL Lenders swooped in – offering something, to the surprise of everyone else, that couldn’t be matched by the Non-Participating Lenders. So, with that offer now in hand, the leverage Serta had on Apollo vis-à-vis the assignment consent was suddenly moot.
Anyway, the reason why this whole saga wasn’t discussed last month – beyond the fact that I can’t be writing 10,000 word posts every month – is that during the evidentiary trial a resolution to the Apollo disqualification was announced. So, the only question really remaining from the original adversary complaint was if the transaction breached the implied covenant of good faith and fair dealing – and, as you know, Judge Jones made his views clear on all that.
You can read the brief agreement here. The gist of it is that 50% of Apollo’s purchases will be consented to (e.g., they’ll actually have a $93mm position in the original 1L TL) and the remaining 50% of purchases will “be deemed null and void” (e.g., remain owned by the assignor, Barclays).
And, importantly, the agreement does not preclude Apollo (North Star) from continuing to litigate the uptier issue moving forward.
In the end, this agreement may seem a bit uncompelling from Apollo’s perspective. But it’s important to remember the alternative: leaving it in the hands of Judge Jones who, based on his rumblings and ruminations in the prior few months, was likely to side with the debtor’s view that all that matters here is that Apollo’s purchase was never consented to by either the company or the administrative agent – case closed.
So, in this instance, the issue surrounding Serta’s DQ list ended with a whimper not a bang. However, the issue highlights an important point that for all the superficial rigidity that credit agreements can appear to have, there exists a murky mix residing just beneath the surface. Not only as it pertains to the interpretation of language in credit agreements (e.g., the open-market purchasing language we spent so much time talking about last month) but also as it pertains to the practical ramification of language in credit agreements (e.g., how DQ provisions are actually put into practice).
Today, we’re seeing sponsors increasingly expand DQ provisions – seeing it as a way, if nothing else, to maximize leverage down the road should the need arise. This expansion includes providing borrowers more tools if someone ostensibly on the DQ list manages to slip through the cracks: making it clear that they may be provided a more limited set of information, that their entitlement to vote and have enforcement rights may be rescinded, and even that they may be forced sell their loans back at par, what they paid, or the current market price.
Under the expanded DQ provisions in some credit agreements there’ll be situations in the future where borrowers aren’t too perturbed if someone does slip through the cracks and ends up in their capital structure: for example, if the new lender’s voting rights get crimped if they were on the DQ list then it could make it easier for the borrower to push through a more “creative” transaction that leaves the new lender on the outside looking in. The less nay votes, the better.
The aforementioned quote from Judge Lee – stating that bankruptcy is inherently a creature of competing interests, compromises, and less-than-perfect outcomes – can be extended to how credit agreements or indentures come to be in the first place. The things that really matter in debt docs, and the things that can cause an uproar down the road, are the result of the borrower and initial lenders reaching some kind comprise on their naturally competing interests.
It just so happens that often borrowers and lenders have different interpretations of what things in the credit agreement really mean and what they really allow for – both at the time the debt docs are drafted and thereafter. This is really what Serta’s saga boiled down to and it’s this murky mix of issues, whether it be the open-market purchasing language or the DQ list shenanigans, that keeps things interesting and keeps bankers, lawyers, and those on the buy-side well-fed or at least well-medicated.