By Professor Vincent S.J. Buccola (University of Chicago Law School) and Professor Greg Nini (LeBow College of Business at Drexel University)
Since 2016, several companies have executed recapitalizations that allowed the distressed borrower to access liquidity while circumventing a traditional bankruptcy proceeding. In two controversial strategies – the dropdown and the uptier – the borrower issues new debt with priority over existing first-lien loans. While borrowers benefit from these liability management transactions, dismayed lenders have contested their legitimacy in court and sought stronger contractual protections to prevent them. In “The Loan Market Response to Dropdown and Uptier Transactions,” we examine empirically the extent to which loan contracts have changed to limit future transactions.
Both dropdown and uptier transactions enable borrowers to subordinate existing lenders. A dropdown involves transferring collateral to an unrestricted subsidiary – an entity not bound by the loan’s covenants – and using this collateral to secure new senior debt. In an uptier transaction, by contrast, the borrower amends its loan agreements to allow issuance of new super-senior debt, offering select lenders a chance to swap their existing loans for the new debt while leaving others subordinated. From a borrower’s perspective, dropdowns and uptiers are close substitutes for traditional bankruptcy financing, allowing companies to raise capital without court oversight.
Permitting borrowers to issue priming debt need not be inherently suboptimal. In Chapter 11, courts often allow debtors to obtain super-priority loans, so allowing such flexibility outside of bankruptcy may be sensible. Unrestricted subsidiaries, for example, facilitate a dropdown but can also be used for strategic restructuring beyond priming debt, such as separating high-growth subsidiaries from a borrower’s core business. The efficiency of permitting such strategies depends on the balance between borrower flexibility and lender protection.
A comprehensive review of over 600 leveraged loan agreements from 2016 to 2022 reveals two distinct trends. First, outright prohibitions on unrestricted subsidiaries remain rare, though lenders have increasingly inserted so-called “IP blockers,” which prevent the transfer of IP collateral that has been common in many prior transactions. Second, following the 2020 Serta Simmons uptier transaction, lender protections increased dramatically. Prior to 2020, only 40% of loans restricted uptiers, often inadvertently. By mid-2022, 85% of new loans explicitly blocked uptiers, with 70% requiring unanimous lender consent for subordination.
The swift evolution of loan contracts following the Serta Simmons transaction shows that the loan market can quickly adapt to innovations that challenge existing norms. In the case of uptiers, the change in contract terms reveals that contracting parties view unfavorably the ability to opportunistically renegotiate with a subset of lenders to reassign the priority of existing collateral. Conversely, typical contract terms continue to allow dropdowns under specific conditions, suggesting that borrower flexibility remains valuable in some contexts. This dynamic reflects the broader trade-off in corporate finance: balancing access to capital for distressed companies with creditor safeguards against opportunistic debt restructurings.
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