Apollo’s Debt-Lawsuit Defeat to Reshape Wall Street Risk Models

When Apollo Global Management Inc. and its allies sued struggling mattress maker Serta Simmons Bedding for giving an unfair advantage to creditors providing fresh cash, many on Wall Street snickered.

Apollo has earned a reputation over the years for cutting distressed-debt deals that hurt existing creditors, and some bankers delighted in the role reversal. But when the private equity giant and partners including Angelo Gordon & Co. lost the lawsuit, the snickering stopped.

The ruling could turn the Serta Simmons transaction into a playbook for restructuring debt that undermines a central tenet of credit markets and hands distressed borrowers a source of leverage over lenders, just as the pandemic sparks a surge in showdowns between the two sides.

For all the perceived ugliness in Apollo and Angelo Gordon’s distressed deal-making approach, it differs in one big way from the Serta Simmons transaction. They generally give all existing creditors the option to take part in any new loan and, as a result, skip to the front of the repayment line alongside them if the borrower falls into bankruptcy. That’s been the market convention. The Serta Simmons financing, which it got from firms including Eaton Vance Corp. and Invesco Ltd., gave only some investors that opportunity.

And so if creditors can now be pushed down the repayment pecking order without notice and have no recourse to fight back, they will be forced to reassess risk -- and potentially demand higher interest rates -- when granting loans and buying certain kinds of bonds.

The Serta Simmons deal was “particularly aggressive,” said Elisabeth de Fontenay, a professor at Duke University School of Law and a former corporate lawyer. “You could absolutely see it being a big problem for credit markets.”

A spokesperson for Serta Simmons said the company is confident the financing it chose was the best option available, and it is now focusing on its turnaround efforts. The mattress maker said in court filings that it fully followed the terms of its prior lending agreements, and that Apollo doesn’t even have the legal right to own its loans. A New York state court evidently agreed with Serta Simmons’s arguments earlier this month when it denied the Apollo and Angelo Gordon group’s initial efforts to block the financing.

‘Substantial Damages’

Representatives for Apollo, Angelo Gordon and Gamut Capital Management LP, another plaintiff, declined to comment. But the firms said when the ruling went against them that they will continue to pursue claims for “substantial damages.”

Fights like these are growing increasingly common, and acrimonious, as the Covid-19 pandemic saps revenues for companies around the world, giving them less money to make debt payments and often forcing them to renegotiate the terms of their borrowings. At the end of June, there was nearly $200 billion of distressed debt outstanding.

For years, investors desperate for yield have been accepting weaker and weaker protections in their lending agreements. That’s giving lenders less negotiating power now.

“The underlying powder keg is there: All the documents are out there allowing for a ton of flexibility,” said Judah Gross, director of leveraged finance at Fitch Ratings, and a former restructuring lawyer. “The execution of this deal is merely the spark.”

Falling Loans

The impact of the Serta Simmons transaction is already etched in the mattress company’s loan prices, with the new one quoted at about 95 cents to 100 cents on the dollar. The existing loan, which previously had the first claim on assets, is quoted at just around 24 cents to 29 cents, according to traders.

Serta Simmons, based in Doraville, Georgia and owned by private equity firm Advent International Corp., last year began working with law firm Weil, Gotshal & Manges LLP and investment bank Evercore Inc. on restructuring its debt. The mattress market had grown increasingly competitive, draining the company’s profit, and the pandemic only made matters worse. Advent declined to comment.

In March Serta Simmons’s board authorized a committee to consider ways to refinance, and it soon started soliciting proposals from both existing and new lenders. Angelo Gordon, which holds about $281 million of the company’s debt, and Apollo, which in March bought $192 million of Serta Simmons’s approximately $2 billion of loans that had a first claim, started working together on their proposal according to people with knowledge of the matter.

The group’s plan would have moved intellectual property to a subsidiary, out of the reach of other lenders. The company’s adviser, Evercore, suggested such a move in the company’s request for financing proposals, according to a person with knowledge of the matter.

Serta Simmons spoke to holders of 85% of its existing loans about possible transactions, according to a separate person with knowledge of the matter. The deal it was discussing with Eaton Vance and Invesco allowed the lenders to jump to the front of the line of creditors in any bankruptcy, ahead of other existing loan holders, in exchange for giving the company $200 million of additional debt funding.

Representatives for Eaton Vance and Invesco declined to comment.

Apollo Blacklisted?

The mattress maker says it didn’t need to seek approval from other investors under its lending agreements, and said in previous court filings that any injunction to block the deal would damage financing prospects for distressed companies. The financing package it rejected from Apollo, Angelo Gordon and Gamut Capital would have hurt other lenders by moving assets into a new subsidiary that lenders wouldn’t have claims to in bankruptcy, the company said in court filings.

In a sign of how contentious the litigation was, Serta Simmons said that Apollo doesn’t have a legal right to own its loans, because the investment firm is on the mattress company’s “blacklist.” Apollo was only able to sneak past the list by buying through a deceptively-named affiliate, the company said.

Blacklisting, where some investors are forbidden from buying a company’s loans, is an accepted practice in the leveraged loan market. Apollo countered that it never hid its involvement behind an affiliate company, and was told by Serta Simmons’s administrative agent for the credit agreement that it wasn’t on any blacklist.

Apollo, Angelo Gordon and Gamut tried to block the transaction from happening and got a temporary restraining order against it, which a New York state judge subsequently lifted. Now the investors are considering their next steps.

“It will be interesting to see how this plays out,” said Valerie Potenza, who analyzes debt documents for Xtract Research. “Given the current economic conditions, we’ll likely see these provisions invoked more.”

©2020 Bloomberg L.P.

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