Oaktree Capital Management and Wind Point Partners portfolio company STG Logistics has become the latest test case for how far sponsors and majority lenders can push drop-downs, uptiers, and double dips.
Arguments in litigation related to the company’s 2024 liability management exercise are hitting on a handful of key LME strategies, and an upcoming motion-to-dismiss ruling might change the approach used in future out-of-court restructurings.
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In March 2022, STG acquired the intermodal division of XPO Logistics, financed with $725 million of broadly syndicated debt.
After a brief honeymoon period, the deal went south thanks to an unfortunate mix of strikes, labor shortages, and deterioration of the freight market.
By May 2024, liquidity issues forced STG to negotiate a seven quarter holiday for its financial covenant in exchange for agreeing to additional lender protections—the Fifth Amendment to the credit agreement—meant to prevent non-pro rata transfers to unrestrictied subsidiaries.
With no improvement by August 2024, a group of lenders quietly negotiated an extensive liability management exercise with the company.
The transaction included a Sixth Amendment to the credit agreement which stripped the lender protections added months earlier, as well as most covenants.
It also created a new unrestricted subsidiary and transfered into it the company’s less-than-truckload business and STG Distribution unit — “substantially all” of the company’s assets, according to plaintiffs.
The deal included $137 million of first lien first out new money provided to the subsidiary by participating lenders, who received a non-pro rata repayment of their existing debt holdings at a premium to the trading price, close to the face value of the loans.
STG then lent the new money from the unrestricted subsidiary to the parent (the borrowing entity under the credit agreement), which allowed participating lenders to benefit from a double dip structure (receiving two claims on existing collateral by combining a guarantee by the parent company and a secured intercompany loan from the subsidiary, strengthening their position in a potential recovery at the expense of non-participating lenders).
Those non‑participating lenders were separately offered a less favorable exchange into first lien second out and first lien third out debt at a mix of 40 cents and 30 cents on the dollar, respectively, of their legacy term loan holdings.
In Janury, two holdout lenders, Axos Financial and Siemens Financial Services, sued STG, agent Antares Capital, and participating lenders in New York State Supreme Court.
Their complaint called the deal a “bad-faith scheme” that violated their “bargained-for rights as holders of STG loans and significantly diminished the loans’ value,” labeling the structure “particularly egregious.”
Referencing the Fifth Amendment, the filing alleged that “STG never intended to abide by those negotiated protections,” and asserted the agreement was part of “a bad-faith effort to provide the company temporary financial runway while STG fully intended to strip and disregard those newly-granted lender protections as needed to further restructure its debt on better terms than those for which it had actually bargained.”
Axos and Siemens point to language in the credit agreement known as a Serta blocker, in reference to Serta Simmons’ controversial 2020 uptier, which requires that affected lenders consent to any amendments that “could change or have the effect of changing the priority or pro rata treatment of any payments, Liens, proceeds of Collateral or reductions in Commitments,” or for any amendments which could subordinate existing liens.
In other words, a subset of lenders can’t exchange their existing debt for higher priority debt to push excluded lenders down the stack without the consent of those excluded lenders, which is precisely what the plaintiffs say STG did to them.
STG, however, says that’s not true.
The company and its sponsors argue that they never actually changed the repayment waterfall or lien priorities under the credit agreement — the waterfall and lien priorities were changed, but, says STG, because this reshuffling all happened at the newly-formed unrestricted subsidiary, it believes the credit agreement restrictions don’t apply.
The argument all comes down to the meaning of the “effect of” language and the difference, if any, between structural seniority (what happened here) and actual lien or payment subordination.
Another key point of contention is the path the company took to execute the non-pro rata dropdown and pari-plus exchange in the first place.
STG’s credit agreement required any debt buybacks be funded with “internally generated” cash.
The plaintiffs say that intercompany loans, or the new money provided by the unrestrictied subsidary to the parent, are clearly not the same as cash from operations, and therefore should not have been available to use for the non-pro rata debt repurchases that benefitted the participating lender group.
Not so fast, say Oaktree and Wind Point, who argue that intercompany loans are “by their nature, internally generated because the funds come from within the company.”
Their position: if “internally generated” meant “internally generated from operations,” the credit agreement would have said so.
The case’s oral arguments were held in August and Judge Anar Patel’s ruling on a motion to dismiss is expected in the coming months. Whatever the decision, expect it to inform how future liability management exercises are handled.
As for the defendants, it’s possible they’ll still come out ahead even with the ongoing dispute.
“It seems the benefits of non-pro rata treatment are sufficient for many lenders to take the litigation risk,” said David Prager, co-leader of the bankruptcy and restructuring practice at advisory firm Brattle, speaking to Bloomberg shortly after the plaintiffs filed.
“If all you need to do is fix your funded debt, this trade-off might make sense — the cost of litigation may be lower than the cost of a bankruptcy.”