I. Executive Summary
A recent U.S. District Court for the District of Delaware (“the District Court”) opinion provided another instance of an uptiering transaction withstanding legal scrutiny and provides further support for the view that courts generally avoid “reading-in” language not expressly stated in debt documents, especially when such documents were negotiated at arms-length by sophisticated parties. In re TPC Grp. Inc., No. 22-10493-CTG, 2022 WL 2952518, at *6 (D. Del. July 26, 2022) (“District Court Opinion”), available here.
In TPC, certain noteholders were afforded the opportunity to participate in a transaction where TPC Group, Inc. (the “Company”) would issue senior secured “uptiering” notes, the 10.875% Notes1, secured by liens that would be senior to the liens securing the Company’s existing secured notes, the 10.5% Notes. Shortly thereafter, the Company commenced a chapter 11 proceeding and sought approval of debtor in possession financing that rolled up the new 10.875% Notes into the superpriority DIP loan – which would give the 10.875% Notes superpriority status in the Chapter 11 case. Certain minority noteholders challenged the pre-filing uptiering transaction, arguing that “10.5% Notes Indenture required a 100% vote of the holders of the 10.5% Notes to make any change “dealing with the application of proceeds of Collateral that would adversely affect” the holders of the 10.5% Notes. Based upon a plain reading of the 10.5% Notes Indenture, the Delaware Bankruptcy Court (the “Bankruptcy Court”) found that the issuance of the 10.875% Notes did not require such a 100% vote. The Bankruptcy Court explained that the “sacred rights” provision of the 10.5% Notes Indenture requiring unanimous consent to alter a provision “dealing with an application of proceeds of Collateral” could not be read as an anti-subordination provision2 that prevented a new, senior secured class of notes from being issued, and instead only required unanimous consent to modify the ratable distribution of collateral proceeds among the holders of the 10.5% Notes as a class. In re TPC Grp. Inc., No. 22-10493 (CTG), 2022 WL 2498751 (Bankr. D. Del. July 6, 2022) (“Bankruptcy Court Opinion”), available here. The minority 10.5% Noteholders appealed.
On July 26, 2022 the District Court Opinion denied the challenging noteholders’ attempts to stay the underlying bankruptcy pending an appeal of the Bankruptcy Court Opinion, finding that the challenging noteholders could not demonstrate a “better than negligible” likelihood of success on the merits because there was “little support” that a court would read in an anti-subordination provision as a sacred right absent an express inclusion as a sacred right. The District Court reasoned that the “application of proceeds of Collateral” provision only addressed waterfall distributions among the holders of the 10.5% Notes, and did not address the relative rights among different tranches of debt. The District Court supported its reasoning noting that the amendment provisions of the 10.5% Indenture should be read in light of a “hierarchy of consents.” Specifically, as the 10.5% Notes Indenture provided for only a 66-2/3% vote for a release of liens, it would be inconsistent to require a 100% vote to subordinate those liens, which is a less drastic curtailment of the rights of the holders of the 10.5% Notes. This view could be read as contrary to the courts recent holding in Trimark, but the District Court Opinion noted that the Trimark court did not reach a definitive decision with respect to the interplay between an uptiering transaction and the sacred rights provisions in the related credit agreement. This reasoning contributed to the District Court finding the balance of the equities weighed against granting a stay of the underlying bankruptcy proceeding.
Considering the court’s guidance in TPC3 and Serta4, and considering the Bankruptcy Court’s and District Court’s commentary regarding the Trimark decision, lenders may be more willing to participate in uptier transactions or liability management transactions similar to those that were consummated in TPC and Serta if the applicable debt documents do not expressly provide that subordination or any such other transaction requires unanimous consent. The case also reiterates the all-to-familiar lesson to drafters of debt documents to include explicit protections if such protections are desirable, or to understand the repercussions of leaving out such language. Following the Serta and Trimark decisions, the TPC uptiering fight is an essential lesson for companies and lenders in stressed and distressed situations regarding lender’s rights.
II. TPC District Court Opinion Declines to Stay the Underlying Bankruptcy Court Opinion
A. Issuances of New Debt Subordinating Existing Debt
In 2019, TPC Group, Inc. (“TPC”) issued $930 million in notes at 10.5% interest (“10.5% Notes” and such indenture, the “10.5% Notes Indenture”, along with any such holders the “10.5% Noteholders” and the liens securing such notes, the “10.5% Notes Lien”). Relevant to this dispute, the 10.5% Notes Indenture contained the following voting thresholds to amend the 10.5% Notes Indenture and 2019 Intercreditor Agreement (defined below):5
Voting Requirement (principal outstanding)
Resulting Amendment and Applicable Section of Indenture
One hundred percent (100.0%) approval (“sacred rights”)
Amendments that impact the amount of principal, the way principal is repaid, or “change the provisions in the 2019 Intercreditor Agreement or [the 10.5% Notes Indenture] dealing with the application of proceeds of Collateral that would adversely affect the Holders.” (Section 9.02(d) of the 10.5% Notes Indenture)6
Two-thirds percent (66.7%) approval
Amendments that allow the indenture trustee to release the collateral or modify the 2019 Intercreditor Agreement (defined below). (Section 9.02(e) of the 10.5% Notes Indenture)
Fifty percent (50.0%) approval
Any other amendment of the 10.5% Notes Indenture. (Section 9.02(a) of the 10.5% Notes Indenture)
TPC also had an asset-based revolving loan facility (the “ABL facility”). The 10.5% Notes and the ABL facility entered into an intercreditor agreement setting forth the parties’ respective rights (the “2019 Intercreditor Agreement”). The 2019 Intercreditor Agreement was a split collateral arrangement in which the parties acknowledged that the ABL facility was secured by a first lien on certain of the Debtors’ assets, such as inventory and accounts receivable, while the 10.5% Notes had first lien priority over most of the Debtors’ other assets.
In 2021 and 2022, TPC issued a combined $204.5 million in new notes at 10.875 percent interest (“10.875% Notes” and such indenture, the “10.875% Notes Indenture,” along with any such holders, the “10.875% Noteholders” and the senior liens securing such notes, the “10.875% Notes Lien”).7 The 10.875% Notes were secured by the same collateral as the 10.5% Notes, but with a lien senior to the lien securing the 10.5% Notes. At the time of these transactions, the 10.875% Noteholders also owned more than 67% of the then-outstanding 10.5% Notes, giving such crossover holders the authority to amend the 10.5% Notes Indenture so long as such amendment did not fall under the scope of the “sacred rights” provision that required unanimous consent under the 10.5% Notes Indenture. Consequently, 67% of the 10.5% Noteholders’ consented to (i) the amendment of the 10.5% Notes Indenture through a supplemental indenture (the “10.5% Notes Supplemental Indenture”) that permitted the issuance of the 10.875% Notes and the incurrence of the 10.875% Notes Lien, and (ii) a new intercreditor agreement which subordinated the 10.5% Notes Lien to the 10.875% Notes Lien.
B. Bankruptcy and Adversary Proceeding8
Accordingly, on June 2, 2022, certain minority holders of the 10.5% Notes who did not hold 10.875% Notes (the “Challenging Noteholders”) filed an adversary proceeding against the Debtors seeking a declaratory judgment that TPC breached the 10.5% Notes Indenture and 2019 Intercreditor Agreement. The Challenging Noteholders, pointing to the sacred rights provision in the 10.5% Notes Indenture, argued that the subordination of the 10.5% Notes Lien to the 10.875% Notes Lien required unanimous consent as it constituted an amendment that made a “change in the provisions in the  Intercreditor Agreement or th[e] [10.5% Notes Indenture] dealing with the application of proceeds of Collateral that would adversely affect the Holders” (such provision, the “Application of Proceeds Sacred Right”). Prior to final approval of the DIP Financing, the Bankruptcy Court agreed to hear the adversary dispute on an expedited basis because it served as a gating issued for the approval of the DIP Financing. A group of crossover holders holding 10.875% Notes (the “Ad Hoc Noteholder Group”) that supported the DIP Financing proposal intervened in the adversary proceeding to support the Debtors’ efforts.
The Bankruptcy Court Opinion granted summary judgment in favor of the Debtors and Ad Hoc Noteholder Group, finding that the 10.875% Notes were validly issued, senior secured notes with liens ranking senior to the 10.5% Notes Lien). The Bankruptcy Court Opinion rejected the Challenging Noteholders’ arguments that the subordination of the 10.5% Notes Lien to the 10.875% Notes Lien involved an amendment governed by the Application of Proceeds Sacred Right, instead holding that the Application of Proceeds Sacred Right was meant primarily to protect the rights of the 10.5% Noteholders to receive a ratable distribution of proceeds among themselves and should not be read as an anti-subordination provision in disguise.9
C. District Court Opinion Affirms Initial Stay Decision and Rejects that Challenging Noteholders’ Appeal would be Likely to Succeed
The Challenging Noteholders then appealed the Initial Stay Decision to the District Court,11 arguing that (1) the plain language of the Application of Proceeds Sacred Right required unanimous consent to subordinate the 10.5% Notes Lien to the 10.875% Notes Lien; and (2) the Bankruptcy Court Opinion improperly relied on the Bankruptcy Court’s determination of “custom and usage” in the industry.
On appeal, the District Court weighed the (1) likelihood of success on the merits; (2) irreparable harm absent a stay; (3) balancing of the harms in deciding whether to stay the proceedings; and (4) public interest.12 The first prong – “likelihood of success” – is a relatively low standard for movants to meet: the Challenging Noteholders only had to provide evidence that they had a “better than negligible” chance to win on the merits of the appeal for this prong to weigh in favor of a stay. Notwithstanding the low bar, the District Court found that the Challenging Noteholders failed to meet this prong and ultimately failed to carry their burden to stay the appeal.
1. District Court Found the Plain Language did not Require Unanimous Consent to Prime the 10.5% Notes
The Challenging Noteholders, on the one hand, and the Debtors and Ad Hoc Noteholder Group, on the other, disputed how broadly or narrowly to read the purview of the Application of Proceeds Sacred Right. The Challenging Noteholders principally contended that the plain language of the Application of Proceeds Sacred Right prohibited the issuance of the 10.875% Notes absent unanimous consent because it affected the “application of proceeds of Collateral that adversely affected” the 10.5% Noteholders and applied to subordination.
The Challenging Noteholders argued that the term “dealing with the application of proceeds of Collateral” in the Application of Proceeds Sacred Right should be interpreted broadly, as amending the 10.5% Notes Indenture to permit the senior 10.875% Lien, and thereby requiring all proceeds from Collateral to repay the 10.875% Notes prior to any proceeds being received by the 10.5% Noteholders would alter the order that Collateral proceeds are distributed.13 Thus the Challenging Noteholders contended that the Application of Proceeds Sacred Right required all 10.5% Noteholders to consent. For support, the Challenging Noteholders cited the Trimark decision, where the court, in denying a motion to dismiss a complaint regarding an uptiering transaction broadly similar to that contemplated by the 10.5% Subordinated Indenture, acknowledged that one “reasonably way” to read an “application of proceeds” of collateral provision is as a prohibition on subordination – to prohibit the parties from “placing any tranche of debt above Plaintiffs’ place in the waterfall, even if the order of distribution” is not affected. Trimark, 2021 WL 3671541, at *12.
In response, the Debtors and the Ad Hoc Noteholder Group, responding jointly, contended that the Application of Proceeds Sacred Right should be interpreted narrowly, and given that the subordination of the 10.5% Notes Lien to the 10.875% Lien did not by its terms modify the application of proceeds of Collateral among the 10.5% Noteholders or between the lenders under the ABL facility and the 10.5% Noteholders under the 2019 Intercreditor Agreement, the 10.5% Supplemental Indenture only required majority consent of the 10.5% Noteholders. For support, the Debtors and Ad Hoc Noteholder Group countered the reliance on Trimark by referring to the Serta decision, where the court held that “sacred rights” with respect to a pro rata sharing of payments provision are not implicated in an uptier transaction as such transaction did not modify “payment rights within the same class of lenders — which remain fully intact.” Serta, 2022 WL 953109 at *10. Because subordination protection was not an enumerated “sacred right,” the changes in Serta required only a majority of the lenders’ approval. Id. The Debtors and Ad Hoc Noteholder Group argued the same was true in TPC. The Bankruptcy Court Opinion agreed and cited Serta favorably for the proposition that such a similar sacred rights provision would “naturally apply to distributions within a class,” and not prohibit subordination of an entire class to another, different class.14
The District Court also agreed with the Debtors and Ad Hoc Noteholder Group’s interpretation, finding “little support” for the Challenging Noteholders’ position that the Application of Proceeds Sacred Right could be read to prohibit subordination absent unanimous consent and echoed the court in Serta that courts should reject broad interpretation of sacred rights provisions as anti-subordination provisions and instead limit unanimous consent requirements to only those sacred rights specifically enumerated.15 Sophisticated parties represented by sophisticated counsel know how to draft an anti-subordination provision, and neither the 10.5% Notes Indenture nor the 2019 Intercreditor Agreement expressly or impliedly prohibited subordination. Contrary to the arguments of the Challenging Noteholders, the District Court found that the Application of Proceeds Sacred Right, unambiguously applied only to amendments that would change the distribution of proceeds among the existing 10.5% Notes. In addressing the Challenging Noteholders’ reliance on Trimark, the District Court pointed out that the court’s decision in that case involved a denial of a motion to dismiss because of a plausible reading of the “sacred rights” provision, but that the case settled before the court ever reached a definitive construction of the language at issue.
The District Court ventured further, and adopted the Bankruptcy Court’s reasoning that in order to make sense, the amendment provisions of the 10.5% Notes Indenture should be analyzed in light of a “hierarchy of consent.” Specifically, as the consent of only a two-thirds majority of the 10.5% Noteholders was required to release the 10.5% Lien on all or substantially all of the Collateral, it would be anomalous to hold that the subordination of the 10.5% Lien to the 10.875% Lien, an action less drastic that a release of the 10.5% Lien, would require unanimous consent.16
2. The Bankruptcy Court’s Reliance on Custom and Usage was not a Reversible Error
The Challenging Noteholders also contended that the Bankruptcy Court’s reliance on “the customs, practices, usages and terminology as generally understood in the particular trade or business” to interpret the sacred rights provision of the 10.5% Notes Indenture, rather than relying solely on the plain text of the 10.5% Notes Indenture constituted reversible error. The Bankruptcy Court Opinion’s reliance on the customs and usage in the industry came out of its attempts to distinguish the TPC case from the Trimark decision. In TPC, the Bankruptcy Court Opinion acknowledged that Trimark was “certainly right that both constructions of the language at issue were plausible based on the language in isolation.” However, the Bankruptcy Court noted Trimark only considered the words in “isolation” and did not employ “tools of construction, beyond the words themselves.”17 The Bankruptcy Court discussed that New York law provides that contractual language must be understood through the lens of “the customs, practices, usages and terminology as generally understood in the particular trade or business.” The Bankruptcy Court went on to note that express anti-subordination clauses in the context of an indenture are sufficiently commonplace that, under the customs and usages that are common in the trade, “a provision providing for ratable distribution (in the absence of an express anti-subordination clause) would more naturally apply to distributions within a class, and not prohibit subordination of an entire class to another, different class.” 18
In any event, the District Court found that the Bankruptcy Court Opinion turned more on the “the structural one about ‘hierarchy of consents’” regarding voting thresholds, rather than the “custom and usage” argument. Thus, to the extent the Bankruptcy Court Opinion relied on the “custom and usage” it was not dispositive and thus not reversible error.19
Therefore, the District Court similarly found that Challenging Noteholders failed to make a significantly better than negligible showing that they are likely to succeed on the merits of the appeal.
3. Remaining Factors for a Stay Pending Appeal and Request for Expedited Hearing
The District Court went on to weigh the remaining factors. On whether the Challenging Noteholders faced irreparable harm, the District Court acknowledge that if the proposed DIP Financing were to be approved on a final basis, Section 364(e) of the Bankruptcy Code would essentially lock-in the roll up of the applicable portion of the 10.875% Notes, making it “extremely difficult” for the Challenging Noteholders to be made whole even if such Challenging Noteholders eventually won on appeal. However, when balancing the harms, the District Court found that the DIP Financing would provide a path to emergence to the chapter 11 cases, where no other viable path exists, such that the balance of the harms weighed in favor of denying the stay.20 The District Court found “public interest” was not a material consideration.
As a result, the District Court ultimately found the balance of equities, including the underlying merits, weighed in favor of denying staying to appeal. The District Court also denied the Challenging Noteholders’ request for an expedited hearing schedule for the underlying substantive objection to the Bankruptcy Court Opinion.
D. Aftermath of Priming Fight
On July 22, 2022, the Debtors filed a motion to approve their disclosure statement and solicit a Chapter 11 plan in which the 10.875% Notes will recover in full, while the 10.5% Notes would be impaired under the plan and receive approximately $350 million in cash, takeback paper, equity in the reorganized company, and equity and debt subscription rights.21 Additionally, after the District Court Opinion, on July 29, 2022, Judge Goldblatt approved the Debtors’ DIP Financing, including the proposed roll up of the 10.875% Notes.22 While the Bankruptcy Court Opinion, the District Court Opinion and the Bankruptcy Court’s subsequent approval of the DIP Financing signified that the Challenging Noteholders will have a low likelihood of success, the Challenging Noteholders may continue their appeal to the U.S. Court of Appeals for the Third Circuit, or lodge a confirmation objection that continues to attack their treatment under the plan. However, the August 2, 2022 DIP Order includes language that provides that the 10.875% Noteholders may make “express reliance upon the protections offered by [Section] 364(e) of the Bankruptcy Code,” meaning that no subsequent order can affect the validity of the debt so long as the financing was advanced in good faith.23 Therefore, with the roll-up of the 10.875% Notes all but impossible to overturn, the Challenging Noteholders’ appeal, if pursued, may prove futile.
Protective Language Negotiated in Documents: Had the 10.5% Notes Indenture contained express language that required unanimous consent for subordination of the 10.5% Lien, the transactions contemplated by the 10.5% Supplemental Indenture would not have been able to take effect absent satisfaction of such threshold. As noted above, contracting parties certainly have the ability to include express subordination protection as a sacred right rather than as a change that by implication only requires a majority vote, and the Bankruptcy Court found that express anti-subordination clauses in the context of an indenture are “commonplace”24. By way of example, the 10.875% Notes Indenture protects the 10.875% Noteholders from being subordinated absent supermajority consent (which could be modified if desired when drafting the document to require unanimous consent rather than two-thirds consent):25
- “Notwithstanding the foregoing in this Section 9.02, no amendment, supplement or waiver to the Indenture or any other Note Document shall subordinate the Lien securing the Notes Obligations to any other Lien (and the Trustee shall not enter into any intercreditor agreement providing for such subordination) without the consent of the holders of at least 66-2/3% in aggregate principal amount of the Notes then outstanding.”
Increased Comfort in Uptier and Priming Transactions: Both the Bankruptcy Court and the District Court reaffirmed the court’s holding in Serta that pro rata sharing provisions are not disguised anti-subordination provisions and that in order for subordination to require unanimous consent, it needs to be specifically enumerated as a sacred right. Likewise, both the Bankruptcy Court and the District Court noted that the Trimark did not reach a definitive construction that pro rata distribution provisions provide protection against subordination. The Bankruptcy Court and the District Court also seemed sympathetic to the reality that for a borrower facing liquidity constraints, there are valid reasons why existing lenders would agree to subordinate their liens to another series of debt. Consequently, the TPC decisions should provide more comfort to issuers and lenders looking to consummate an uptiering financing that unless the amendment terms of any existing first lien indebtedness clearly provide that subordinating such indebtedness requires unanimous consent, such indebtedness may be subordinated with a majority vote of the holders of such indebtedness.
In addition, it should be noted that while a super-majority right to release collateral is more frequently included in indentures rather than in syndicated credit agreements, the “hierarchy of consent” analysis advanced by the Bankruptcy Court and blessed by the District Court would still be applicable to credit agreements or indentures that require unanimous rather than super-majority consent to release a lien on all or substantially all collateral. Under this line of reasoning, if the release of a lien on all or substantially all collateral requires unanimous consent, then it makes sense that a subordination of a lien on collateral, which is less severe of an event than a release, would require a lower consent threshold; in many debt instruments, this would imply the consent threshold for subordination would be majority consent.
Timing of a Lender Challenge: Affected lenders may want to consider filing a declaratory relief action prior to a company’s potential bankruptcy filing. The District Court Opinion, in denying the expedited hearing, noted when weighing the balance of the harm that denying the stay was in the estate’s best interest because $8 million to $10 million was being spent on professional fees every month. When a debtor enters bankruptcy with either DIP Financing or a plan that adheres to the priority scheme that resulted from a controversial priming transaction, there is momentum behind the court approving such a transaction. Filing a complaint immediately after a transaction, such as the case in Trimark, could result in a more level playing field for lenders left on the wrong side of such a transaction, rather than being the squeaky wheel in a bankruptcy case where time and resources are limited.
Capitalized terms in the Executive Summary shall have the meanings ascribed to them below.
An “anti-subordination” provision prohibits additional debt from being layered on top of existing debt absent the consent of a certain amount of lenders holding such debt. Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp. (“TriMark”), 2021 WL 3671541 (Sup. Ct. N.Y. Cty. Aug. 19, 2021) (finding that similar “application of proceeds” of collateral language in a sacred rights provision could plausibly be read more broadly as an anti-subordination provision).
LCM XXII Ltd. V. Serta Simmons Bedding LLC, 21 Civ. 3987, 2022 WL 953109, at *10 (S.D.N.Y. Mar. 29, 2022) (finding that anti-subordination provisions must be express and that a similar uptier transaction did not implicate the “payment rights within the same class of lenders—which remain fully intact”).
District Court Opinion, at *2.
Id. (emphasis in original).
Id. at *3.
Id. at *3.
Bankruptcy Court Opinion, at *12.
District Court Opinion, at *4.
The Challenging Noteholders also requested that the District Court expedite the substantive appeal of the Bankruptcy Court Opinion, which the District Court denied.
Id. at *5.
Id. at *6.
Bankruptcy Court Opinion, at *11 n.75.
District Court Opinion, at *8 (citing Serta, 2022 WL 953109 at *9-10).
Id. at *9.
Bankruptcy Court Opinion, at *11.
Id. at *11.
District Court Opinion, at *10.
Id. at *10-*13.
Debtors’ Motion for Entry of an Order (I) Approving Disclosure Statement, (II) Fixing Voting Record Date, (III) Approving Solicitation Materials and Procedures for Distribution Thereof, (IV) Approving Forms of Ballots and Establishing Procedures for Plan Voting, (V) Scheduling Hearing and Establishing Notice and Objection Procedures in Respect of Confirmation of Plan, and (VI) Granting Related Relief. In re TPC Grp. Inc., (Bankr. D. Del. 2022) [D.I. 490].
Final Order (I) Authorizing the Debtors to (A) Obtain Senior Secured Priming Superpriority Postpetition Financing and (B) Use Cash Collateral, (II) Granting Liens and Providing Claims with Superpriority Administrative Expense Status, (III) Granting Adequate Protection to Prepetition Secured Parties; (IV) Modifying the Automatic Stay; and (V) Granting Related Relief. In re TPC Grp. Inc., (Bankr. D. Del. 2022) [D.I. 566].
Id. at H.h.i.
Bankruptcy Court Opinion, at *11.
District Court Opinion, at *9.