Credit Bidding Gone Awry: Town Sports’ Prepetition Lenders Sue Each Other
Fallout continues from the November 2020 bankruptcy sale of Town Sports’ assets to a new entity backed, in part, by an ad hoc group of Town Sports’ prepetition lenders. A separate group of prepetition lenders who did not participate in the sale filed suit in May against the ad hoc group and the administrative agent for the lender syndicate, alleging that ad hoc group’s actions had rendered the non-participating group’s secured loans “essentially worthless.”[1] The case, which is still in its early stages, demonstrates the importance of properly documenting a multi-party transaction and also provides another recent example of “lender on lender” violence.
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Town Sports, the owner and operator of health and fitness clubs throughout the United States, filed for bankruptcy in September 2020 as a result of the COVID-19 pandemic and related government shut down orders (Town Sports’ litigation with the New York Attorney General in connection with its bankruptcy case was discussed in prior posts available here and here). Several years before the filing, a syndicate of lenders had provided Town Sports with a senior secured credit facility. Following Town Sports’ bankruptcy filing, an ad hoc group from among this syndicate proposed to team up with Tacit Capital in a joint transaction to purchase the assets and operations of Town Sports out of bankruptcy: Tacit agreed to pay $47.5 million in cash for 80% equity in the “NewCo” entity that would hold the Town Sports assets; the ad hoc group of lenders agreed the lender syndicate would credit bid $80 million of the pre-petition secured indebtedness in exchange for 20% equity; and Newco would issue $35 million in new debt to the ad hoc group and the other prepetition syndicate lenders. Town Sports’ bankruptcy court approved the sale in November 2020.
Shortly thereafter, however, difficulties arose. First, Tacit backed out of the transaction, transferring its rights to Peak Credit LLC. Second, the ad hoc group accused Peak of not providing the full $47.5 million in capital needed to fund the new company, post-closing, and of not authorizing the new company to issue the required $35 million in additional debt. Based on this, the ad hoc group sought to withhold its $80 million credit bid and moved on an emergency basis to enjoin the sale they had designed. The debtors and unsecured creditors’ committee objected, noting that the terms of the sale had already been approved and that, if the ad hoc group had issues with Peak Credit, as its co-purchaser, those issues should be worked out directly between the ad hoc group and Peak Credit. The bankruptcy court agreed and denied the ad hoc group’s motion to enjoin the sale on November 30, 2020. The sale closed the same day.
Several months later, on May 25, 2021, two lenders that had been part of the prepetition syndicate, but which had not joined the ad hoc group of lenders that had negotiated the bankruptcy sale, sued the ad hoc group, alleging that the group’s actions breached the prepetition credit agreement and rendered all of the prepetition loans “essentially worthless.” The lenders also sued the administrative agent for breach of the prepetition credit agreement alleging the agent failed to stop the ad hoc group’s actions.
As an initial matter, the dissenting lenders claimed that the ad hoc group did not have the right to credit bid since they only constituted “Required Lenders” under the governing credit agreement and a commitment to credit bid required the consent of all lenders. The lenders also alleged that the ad hoc group had “failed to obtain any binding and enforceable commitments from Tacit or NewCo regarding the new debt instruments or the $47.5 million capital infusion in NewCo,” with the “only support” for the purported agreement between the ad hoc group and Tacit being “an email exchange between the parties referencing bracketed numbers.” The lender plaintiffs allege that the ad hoc group’s breach of the prepetition credit agreement combined with the ad hoc group’s failure to obtain binding agreements from Tacit cost the lenders tens of millions of dollars because the lenders were forced to exchange $80 million of prepetition loans for a 20% equity stake in NewCo that, without the full amount of Tacit’s originally-promised $47.5 million equity infusion, was worth only $45,000 as of December 29, 2020.
On July 19, 2021, the ad hoc group filed a letter with the United States District Court for the Southern District of New York in which it requested a pre-motion conference and argued that the lenders’ complaint has a number of fatal defects. The ad hoc group argues that the breach of contract claims relate to agreements and issues already heard and resolved by the Delaware bankruptcy court in connection with the Town Sports bankruptcy case. Because of that, the ad hoc group argues that the lenders’ claims are barred by issue and claim preclusion. Further, the ad hoc group argues that, in any event, venue should be transferred to the Delaware bankruptcy court because the lenders are represented there and have appeared in every stage of the Town Sports bankruptcy case.
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The Town Sports litigation suggests the potential hazards in pursuing a deal in bankruptcy when commitments and deal mechanics are not fully documented. In approving the proposed sale, the bankruptcy court approved and enforced the original deal between the ad hoc group, Tacit and Town Sports. However, assuming the lender plaintiffs’ claims are proven, the ad hoc group was left without recourse against Tacit (and Peak Credit as Tacit’s successor) because the ad hoc group failed to give itself the ability to walk away from the deal if the other parties could not meet their obligations (e.g., by expressly tying its credit bid obligations at closing to the funding of Tacit’s equity contribution). The case also provides another example of so-called “lender on lender violence” with borrowers teaming up with some, but not all lenders, in the same credit facility to get a deal done — and groups of lenders then attacking one another when things go wrong. It is a case that bears watching for further developments.
[1] Compl. p. 4 ¶ 7 [Adv. Dkt. No. 1].
