Distressed Debt Legal Insights

Welcome back to Distressed Debt Legal Insights, Ropes & Gray’s source of timely insights for professionals navigating the complex world of liability management and special situations finance. In this issue we will provide a summary of certain aspects of the noteholder litigation in Wesco that culminated in the recent district court decision approving the 2022 uptier transaction and reversing the bankruptcy court’s decision.

The Original Transaction

On March 28, 2022, Wesco effectuated an uptier exchange with an ad hoc group of secured noteholders including Pimco and Silver Point. Prior to the exchange, the ad hoc group held 71% of Wesco’s 2024 secured notes but only 62% of the 2026 secured notes (which was less than the required two-thirds supermajority threshold needed to release the liens securing the 2026 secured notes). A separate group of noteholders of the 2026 secured notes, including Golden Gate Capital, JP Morgan and BlackRock (the “Minority Group”), held over one-third of the 2026 secured notes and thus had a sufficient amount to block the release of liens.

The uptier was achieved in two steps. First, using the ad hoc group’s simple majority position, Wesco and the ad hoc group amended the 2026 secured notes indenture to permit the issuance of $250 million of additional 2026 secured notes to the ad hoc group for cash, which gave that group over two-thirds of the total amount of 2026 secured notes. Second, Wesco and the ad hoc group amended both series of secured notes to release collateral and exchanged their now-unsecured notes into new, first lien 2026 secured notes. The Minority Group was left with unsecured notes and behind the uptiered notes.

Minority Group Sues

The Minority Group sued on Oct. 31, 2022, in New York state court. It argued that the transactions should be viewed as a single integrated transaction in which the liens securing the 2026 secured notes were released without the required two-thirds supermajority consent. The Minority Group also argued that the first step (of issuing more debt under the 2026 secured notes indenture) had the “effect of” releasing all of the liens securing the 2026 secured notes, which required two-thirds supermajority consent, because it was one step in a predetermined series of steps that would result in the lien stripping.

Wesco and the ad hoc group argued that, in part, the purpose of the first step was to raise needed liquidity for the company, and that the two steps should be viewed as distinct transactions.

Bankruptcy Court Process and Report

On June 1, 2023, Wesco filed for chapter 11 in the Southern District of Texas. A six-month trial began on Jan. 25, 2024 to determine whether the uptier transaction complied with the 2026 secured notes indenture (among other related issues).

On July 10, 2024, in an interlocutory oral ruling, the bankruptcy court ruled that the uptier transaction breached the 2026 secured notes indenture. It found that the supplemental indenture that authorized the issuance of the additional $250 million of secured notes was not permitted because, in light of how each of the steps were tied together, it “had the effect of releasing all or substantially all of the collateral” without the required two-thirds majority. A simple majority could have amended the 2026 secured notes indenture to permit the issuance of additional secured notes, the bankruptcy court said, unless the amendment had the effect of releasing all or substantially all of the liens.

The bankruptcy court further agreed with the Minority Group that the transaction was structured such that after the relevant supplemental indenture was executed, the entire transaction would be self-implementing without any further actions, “like dominoes.” The new money provided by the ad hoc group was contingent on the exchange taking place immediately thereafter, which meant that the supplemental indenture permitting the additional notes had the “irrevocable effect” of releasing the liens without meeting the required two-thirds majority consent threshold.

District Court Ruling

The litigation moved to the district court for the Southern District of Texas. At a status conference on Sept. 11, U.S. District Judge Randy Crane indicated that he planned to reverse the bankruptcy court’s decision. He did so in an order dated Dec. 8.

In its order, the district court emphasized that the indentures were drafted, negotiated and agreed to by “sophisticated parties who chose their language carefully.” It continued that “if the parties had wanted to bargain for additional sacred rights that would have allowed minority holders to prevent the 2022 [uptier] Transaction, they could have done so, but they did not.”

The district court held that under the plain language of the 2026 secured notes indenture, only a simple majority vote was needed to authorize the issuance of $250 million of additional notes. To conclude that the issuance of additional notes had the effect of releasing all the liens “would flout the ordinary meaning of ‘effect’” and “threaten serious uncertainty.” It found that the “effect of” language in the two-thirds supermajority provision applied only to amendments that directly released liens, not to amendments that might, through subsequent steps, enable such a release. The court declined to read in any implied “sacred rights” or minority vetoes beyond the 2026 secured notes indenture’s plain language.

The transactions therefore did comply with the 2026 secured notes indenture, as each supplemental indenture had the consent of the required percentage of noteholders.

Why This Matters

Those who disagreed with the bankruptcy court’s “dominoes” reasoning have been vindicated by the district court’s “plain meaning of the text” interpretation of the indenture. The district court’s decision reinforces the primacy of contractual language in debt instruments and provides a roadmap for structuring liability management transactions within the four corners of debt documents. The case stands as a reminder that parties seeking to protect against adverse outcomes must do so at the drafting stage. The court’s refusal to infer additional minority protections or to collapse multi-step transactions into a single “effect” for consent purposes will be of particular interest to market participants.