Introduction
In its New Year's Eve decision in Serta Simmons Bedding, the Fifth Circuit underscored the importance of drafting debt documents with clarity and precision and cautioned against borrowers' reliance on ambiguous language to effectuate the popular uptier exchange transaction being utilized by debtors across the country to restructure their debt. Since its issuance, this decision has been the subject of many articles discussing its potential impact on the future of liability management exercises (LMEs).
Receiving somewhat less attention is the Fifth Circuit's refusal to apply the judicially created principle of equitable mootness with respect to the bankruptcy court's order confirming a plan containing broad indemnities for the uptier exchange participants. The Fifth Circuit's criticism of the equitable mootness doctrine is not particularly surprising if one examines Fifth Circuit jurisprudence over the past decade, but the court's sharp criticism of the doctrine nevertheless serves as a useful reminder of the doctrine's limitations in preventing appellate review of certain transactions.
The Serta Decision
Plagued with liquidity issues stemming from the COVID-19 pandemic, Serta Simmons Bedding ("Serta") entered into an uptier agreement with certain of its lenders holding first-lien and second-lien debt (the "Participating Lenders"). The Participating Lenders provided new money financing and exchanged existing debt for new super-priority debt. The applicable credit agreement contained a typical pro rata sharing provision prohibiting Serta from paying its obligations to certain, but not all, of its lenders. Serta and the Participating Lenders took the position that the uptier transaction was permitted under the credit agreement's "open market purchase" exception to the pro rata sharing provision. Recognizing the inherent risk of the transaction, Serta agreed to indemnify the Participating Lenders for any and all losses incurred in connection with their participation. Serta ultimately filed for bankruptcy in January 2023 and filed (i) an adversary proceeding seeking approval of the uptier exchange and (ii) a plan that provided for an indemnity covering the Participating Lenders.The bankruptcy court validated the uptier transaction and confirmed the plan, including the indemnity.1 Thereafter, the lenders excluded from the uptier transaction (the "Objecting Lenders") appealed (i) the validity of the uptier transaction and (ii)the propriety of the indemnities granted to the Participating Lenders under the plan.
The Fifth Circuit reversed the bankruptcy court's decision, finding the uptier transaction was not a permissible "open market purchase" under the credit agreement.In reaching that conclusion, the Fifth Circuit rejected Serta's and the Participating Lenders' argument that the doctrine of equitable mootness barred the court's review of the plan confirmation order, calling the doctrine a "judicial anomaly" that is a "scalpel, rather than an axe" to be applied with "caution" to direct appeals from a bankruptcy court.2
The circuit court analyzed the three factors considered when determining whether to apply equitable mootness: (i) whether a stay of the confirmation order was obtained by the Objecting Lenders; (ii)whether the plan was substantially consummated; and (iii) whether the relief requested - excising the indemnity provisions at issue from the plan confirmation order - would affect the rights of parties not before the court or the success of the plan.3 The court quickly dispensed with the first two factors, acknowledging that while the Objecting Lenders failed to obtain a stay and the plan was substantially consummated, "this court has still exercised appellate review when only the third factor weighed against equitable mootness."4 The court found that the third factor did just that: excising the indemnity from the confirmation order would not necessarily harm any third parties not before the court; rather, it would impact only Serta and the Participating Lenders, the former of which would benefit from the excision, while the latter would not. Both Serta and the Participating Lenders were present before the court.5Nor would excising the indemnity threaten the success of the plan, the court found; in fact, Serta would benefit from the excision and "face an easier future without a massive liability hanging over its head."6
The court was similarly unsympathetic to the Participating Lenders' claim that doing away with their indemnity...
