Lenders seeking to challenge controversial, often punitive, liability management transactions scored a recent win in Boardriders. The transaction at issue, a priming uptier exchange transaction favoring certain participating lenders at the expense of non-participating lenders, has been the focus of recent federal and state court litigation in Serta and TriMark, respectively. The Boardriders’ court denied defendants’ motion to dismiss, holding that plaintiffs’ contractual and good faith and fair dealing claims could proceed against the participating lenders and the company. Although litigation in Boardriders is far from over (in fact, it has really just begun), the trio of Serta, TriMark, and Boardriders demonstrate that non-pro rata priming debt transactions are risky and could result in viable damages claims against defendants.
In Boardriders the court found that a group of non-consenting lenders (the “Non-Consenting Lenders”) whose interest had been subordinated through an uptier exchange transaction, pled sufficient facts in their October 2020 complaint to survive a motion to dismiss on claims against (i) Oaktree Capital Management LLC, who served as the sponsor and, through its affiliated funds, as lenders (“Oaktree”), (ii) syndicate lenders that participated in the transaction (the “Participating Lenders”), and (iii) Boardriders, Inc. (the “Company,” collectively with Oaktree and the Participating Lenders, the “Defendants”). The gravamen of those claims were that Defendants:
- breached the “sacred rights” pro rata sharing provisions under Sections 4.01 and 12.06 of the Credit Agreement, which provide that all lenders are entitled to equal treatment with respect to payment and that these equal treatment provisions cannot be amended without unanimous consent; and
- violated the implied covenant of good faith and fair dealing under New York law through actions taken during the transaction to freeze out the Non-Consenting Lenders.
Separately, the court dismissed a claim for tortious interference asserted against Oaktree on the grounds that Oaktree sufficiently asserted an economic interest affirmative defense.
As background, the Non-Consenting Lenders, the Participating Lenders, and Oaktree collectively held $450 million in first lien debt governed by the Company’s April 2018 syndicated credit agreement (the “Credit Agreement”). A series of amendments to the Credit Agreement, requiring only majority approval, stripped away affirmative and negative covenants that protected the Non-Consenting Lenders’ rights (including an amendment to Section 9 of the Credit Agreement that prohibited the Company from “incurring new debt…”); and eliminated the requirement in the Credit Agreement that any intercreditor agreement entered into must be junior to, or pari passu with, the first lien debt, that collectively allowed the first lien term loans to be subordinated. Furthermore, the Defendants modified a “no-action” provision in an attempt to inhibit the Non-Consenting Lenders from later challenging the transaction.
Immediately after these amendments, the Company conducted a debt-for-debt exchange of the first lien debt held by Oaktree and the Participating Lenders for new, superiority term loans through “open market purchase agreements” that resulted in the Non-Consenting Lenders’ approximately $85 million in first lien term loans to fall to last in line for payment. Moreover, the Defendants allegedly froze out the Non-Consenting Lenders from participating in the process.
Boardriders may serve as a check on parties considering aggressive lender-on-lender liability management transactions. Key takeaways include:
- Boardriders adopted an “entire contract” approach to whether pro rata sharing provision are violated, rather than a “narrow,” provision-only reading: The biggest takeaway from Boardriders is the court’s finding that while no express violation of the Non-Consenting Lenders’ rights to pro rata distribution occurred, actions taken by the Defendants that had the effect of harming pro rata recoveries without unanimous lender consent may breach the pro rata “sacred rights” provision in the Credit Agreement.
The Defendants contended that the multi-step transaction did not explicitly violate the Credit Agreement, because each action taken, on its own (e.g., subordinating liens, removing affirmative and negative covenants, and altering the intercreditor language) did not require unanimous consent.
Because the court was only evaluating the transaction at the motion to dismiss stage, the court reviewed whether the Credit Agreement “utterly refute[d]” the Non-Consenting Lenders’ claims that the amendments to the Credit Agreement implicated the pro rata distribution sacred right. The court found that while the pro rata provisions did not expressly prohibit the Defendants’ actions, the court rejected the Defendants’ “narrow” reading that has been adopted recently in the TPC decision. The court found that accepting the Defendants’ argument would essentially vitiate the equal repayment provisions and be contrary to the court’s obligation to consider the context of the entire contract, rather than particular words in isolation.
The court’s ruling in this regard is in line with Trimark, which acknowledged that a “pro rata” sharing provision could be broadly read to encompass more than just express amendments of such provision.
- Open question as to how courts apply the “open market” exception: Section 2.15 of the Credit Agreement included an “open market” exception that excused the Company from making ratable pro rata distributions to lenders when the company repurchased loans through an “open market” purchase. There have been a number of recent transactions, including in Serta, that utilize the open markets exception as a tool to conduct a debt-for-debt exchange to raise capital (i.e. “purchasing” debt from select lenders through the “open market” and in turn reissuing new, priming debt to those same lenders).
Here, as part of the debt-for-debt exchange, the Company entered into private agreements with Oaktree and the Participating Lenders, pursuant to which the Company agreed to satisfy its obligations on $321 million of term loans at par in exchange for an equal amount of the new, super-priority debt, which Defendants executed through “open market purchase agreements.”
The Non-Consenting Lenders raised a series of arguments as to why the “open market” exception should not apply, including that the transfer was not market-tested, no third-party advisor or broker was hired to canvass the market, and that the Company did not purchase the loans at “market value” because Participating Lenders and Oaktree’s loans were exchanged at par despite trading at a 40-50% discount to par at the time of the transaction.
The court acknowledged that the Defendants had a viable argument that the open market condition does not include an express condition that an open market purchase be “open and offered to all lenders.” As “open purchase” was undefined in the Credit Agreement, the court found that the contractual language was reasonably susceptible to more than one interpretation, and thus ambiguous. The court therefore found that a factual issue as to whether the “open market” exception applied, and accordingly declined to dismiss the breach of contract claims on that basis.
- Freezing out certain creditors may be found to be a violation of “good faith” covenant: Under New York law, all contracts imply a covenant of good faith and fair dealing in the course of performance, which pledges that “neither party shall do anything which will have the effect of destroying or injuring the right of the other party to receive the fruits of the contract.” The court found that certain facts in the complaint, including that the Defendants carried out the transaction in secret, abused their ability to amend the Credit Agreement, implemented the no-action provision, and eliminated affirmative/negative covenants, were sufficient to show that Defendants deprived the Non-Consenting Lenders of the benefit of their bargain under the Credit Agreement. Boardriders serves as a lesson that lenders should proceed with caution prior to participating in an exchange that is not offered collectively (or pro rata) to other lenders, particularly when ostracized lenders express a willingness to be part of the deal.
- “Economic Interest” defense provides protection for sponsor from tortious interference claims: The court dismissed the tortious interference claim against Oaktree. Oaktree successfully raised an “economic interest” defense by demonstrating it acted to protect its own legal and financial stake in the business. The court found that the facts were not sufficient to show that Oaktree acted with malice, fraud, or illegality to overcome the economic interest defense. Specifically, the court noted that “shutting down avenues of communication” with the Non-Consenting Lenders does not rise to the level of malice or illegality.
- Court found amended no-action provision unenforceable: In amending the Credit Agreement, the Defendants attempted to remove minority lenders’ right to sue altogether by modifying the “no-action” provision. The original no-action provision would have permitted the Non-Consenting Lenders to pursue their claims. The amended provision required the consent of the administrative agent for the Non-Consenting Lenders to take action. The court found that Non-Consenting Lenders sufficiently alleged that the no-action provision was amended in “bad faith” to prevent Non-Consenting Lenders from suing to enforce their rights under the Credit Agreement and that their right to bring this action is not barred by the pre-amended version of the no-action provision. This conclusion was in line with the Trimark and TPC decisions on similar no-action amendments, suggesting that standing arguments cannot be used to knock out creditors who seek to challenge such transactions.
 ICG Global Loan Fund 1 DAC v. Boardriders, Inc., No. 655175/2020, 2022 WL 10085886 (N.Y. Sup. Ct. Oct. 17, 2022) (“Boardriders”).
 LCM XXII Ltd. V. Serta Simmons Bedding LLC, 21 Civ. 3987, 2022 WL 953109, at *9, *15 (S.D.N.Y. Mar. 29, 2022) (“Serta”) (denying motion to dismiss with respect to breach of contract claims for defendants’ violation of the open-market provision and breach of the implied covenant of good faith and fair dealing claims).
 Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., 2021 WL 3671541, at *13 (Sup. Ct. N.Y. Cty. Aug. 16, 2021) (“Trimark”) (denying motion to dismiss with respect to breach of contract claims, but dismissing implied covenant of good faith and fair dealing claims).
 After the Trimark decision, the company entered into a follow on transaction to assuage the challenging creditors. TriMark USA Announces Resolution of Litigation with its Lenders, Press Release, (Jan. 7, 2022 4:40 PM), available at https://www.prnewswire.com/news-releases/trimark-usa-announces-resolution-of-litigation-with-its-lenders-301456561.html.
 In re TPC Grp. Inc., No. 22-10493 (CTG), 2022 WL 2498751 (Bankr. D. Del. July 6, 2022) (“TPC”) (rejecting a broad interpretation of a pro-rata sharing provision as an anti-subordination provision and limiting unanimous consent requirements to only those sacred rights specifically enumerated).
 Serta, at *7 (finding that that an open market purchase exception was sufficiently ambiguous under the applicable agreement to deny a motion to dismiss).
 511 W. 232nd Owners Corp. v Jennifer Realty Co., 98 NY2d 144, 153 (2002).
 See White Plains Coat & Apron Co., Inc. v Cintas Corp., 8 NY3d 422, 426 (2007).
 Trimark, at *9 (finding no-action amendment unenforceable because it was “never agreed to by the parties to the Original Agreement, [and] do not serve the ‘salutary purpose’ that generally supports enforceability”).
 TPC, at *8 (finding that “case law expresses a strong skepticism towards reading a no-action clause to preclude the enforcement of rights that an agreement expressly grants to individual holders”).