LCM XXII Ltd. v. Serta Simmons Bedding, LLC

Background

The plaintiffs—LCM XXII Ltd., LCM XXIII Ltd., LCM XXIV Ltd., LCM XXV Ltd., LCM 26 Ltd., LCM 27 Ltd., and LCM 28 Ltd.—held approximately $7.4 million of Serta Simmons Bedding, LLC’s first-lien loans. Under the First Lien Term Loan Agreement, first-lien lenders generally shared payments proportionally. The agreement usually allowed amendments with approval from lenders holding more than half of the loans, but required consent from each lender directly and adversely affected by changes to certain specified rights.

In June 2020, Serta entered into a transaction that provided $200 million in new financing and exchanged participating lenders’ first- and second-lien loans for new debt with payment priority ahead of the plaintiffs’ first-lien loans. The transaction also included amendments permitting the new priority debt, authorizing a related intercreditor agreement, and removing a provision that treated subordination of the first-lien debt as an event of default.

The plaintiffs alleged that the transaction breached the agreement, that Serta improperly amended the agreement without their consent, and that Serta violated the implied covenant of good faith and fair dealing by using the agreement to subordinate the plaintiffs’ debt. Serta moved to dismiss under Federal Rule of Civil Procedure 12(b)(6), arguing that the agreement expressly permitted the transaction, that majority approval was sufficient, and that the plaintiffs had not alleged legally sufficient damages.

Contract-breach theories

The court held that the term “open market purchase” in Section 9.05(g) was ambiguous in the agreement’s context. Serta argued that the transaction was an open-market purchase because it resulted from negotiations between willing buyers and sellers. The plaintiffs argued that the transaction was privately negotiated with selected lenders and did not reflect terms set by an open market. Because the agreement did not define the phrase and both interpretations were plausible, the court could not decide at the motion-to-dismiss stage that the agreement clearly authorized the transaction.

The court therefore held that the plaintiffs plausibly alleged a breach of Section 9.05 based on a loan repurchase that was not conducted in the open market. The court did not accept the plaintiffs’ separate argument that Serta’s amendments required consent from every affected lender. It concluded that the agreement’s proportional-payment protections applied to payments among lenders in the same class and did not protect against subordination to a new, higher-priority class of debt. The court also concluded that removing subordination as an event of default did not reduce a voting percentage protected by the agreement. Those amendments could therefore be approved by a majority of lenders under the agreement.

The court rejected the plaintiffs’ argument that the transaction violated the agreement’s waterfall provision or released substantially all collateral or guarantee value. The waterfall provision was subject to applicable intercreditor agreements, and the agreement authorized the amended intercreditor arrangement. The court also found that the plaintiffs adequately alleged damages because they claimed that the transaction reduced the value of their loans and rights relative to what they would have been worth without the alleged breach. The agreement’s no-action clause did not bar the suit because the plaintiffs sought damages and injunctive relief rather than enforcement of collateral or a loan guaranty.

Implied covenant and injunctive relief

The court allowed the plaintiffs’ claim for breach of the implied covenant of good faith and fair dealing to proceed as an alternative theory. The implied covenant generally requires contracting parties not to undermine the other party’s benefit from the agreement. The court found that the plaintiffs plausibly alleged that Serta secretly negotiated with selected creditors, changed the agreement to permit higher-priority debt, and used its contractual amendment power to subordinate the plaintiffs’ loans. The claim was not improperly duplicative at this stage because it depended on whether the transaction and amendments were ultimately found consistent with the agreement’s express terms.

The court also allowed the plaintiffs to continue seeking a permanent injunction. Although an injunction is a remedy rather than an independent claim, the court declined to dismiss the request merely because the plaintiffs had listed it separately.

Disposition

The court denied Serta’s motion to dismiss. The order left the plaintiffs’ claims pending; it did not finally decide whether Serta breached the agreement or the implied covenant. Serta was ordered to answer the complaint by April 20, 2022, and the parties were directed to submit a joint status letter and proposed case-management plan by May 4, 2022.