Liability management transactions have gained popularity in recent years. Part of the growth is attributable to the high-interest rate environment, which has caused borrowing costs for companies to rise. Liability management transactions, or LMTs, simply refer to certain types of transactions that restructure the liabilities on a company’s balance sheet.

LMTs cover a wide range of transactions that enable corporate borrowers to rework their capital structures and manage their liabilities without undergoing formal restructuring or bankruptcy proceedings. The goal is usually to help the company deleverage, generate additional liquidity, or prolong maturity dates on outstanding debt. Popular types of LMTs include what are commonly referred to as J. Crew, Chewy, and Serta transactions.

One category of LMTs is known as a “J. Crew” transaction. A J. Crew transaction is an example of an asset dropdrown transaction. An asset dropdown involves the transfer of valuable assets to a subsidiary that is not a loan party, thus putting the assets outside the reach of creditors. The non-loan party subsidiary, also referred to as an unrestricted subsidiary, can then use those assets are collateral in order to incur new debt financing.

It is important to structure a “J. Crew” transaction properly, as such an asset transfer can be challenged as a fraudulent conveyance. In particular, it is critical that the asset transfer be structured in compliance with the borrower’s existing credit agreements and other debt documents. For example, the value of the assets that the borrower transfers to the unrestricted subsidiary cannot exceed the borrower’s available capacity under the terms of its debt documents. In the specific J. Crew case in 2016, the company transferred valuable IP assets to an unrestricted subsidiary. That unrestricted subsidiary subsequently used those assets as collateral to support the issuance of new secured debt.

Another category of LMTs is known as a “Chewy” transaction, named after a situation involving the pet food and product companies PetSmart and Chewy. A Chewy transaction is another example of an asset dropdown transaction. It also involves the concept of transferring valuable assets to unrestricted or excluded subsidiaries. Such a transfer can result in the release of the excluded subsidiary’s obligations to guarantee or pledge collateral.

In 2017, PetSmart acquired the pet e-commerce supplier Chewy for approximately $3 billion. As a result of the shift in consumer preference from physical retail stores to online shopping, PetSmart’s performance had been declining in the years leading up to the acquisition. The financing of the acquisition involved adding $2 billion to PetSmart’s existing debt load, through the issuance of new secured and unsecured debt. In addition, Chewy guaranteed PetSmart’s existing debt and pledged some of its assets to secure PetSmart’s secured debt. In 2018, PetSmart transferred a portion of its equity interests in Chewy to an unrestricted subsidiary. As a result, Chewy was no longer a wholly-owned subsidiary of PetSmart and the subsidiary was released from its guarantee and pledged collateral obligations.

Another popular type of LMTs is referred to as a “Serta” transaction. A Serta transaction is an example of an uptiering priming transaction. Uptiering priming transactions result in the creation of a new tier of secured debt that is senior in priority to the borrower’s existing secured debt. The incurrence of this new class of super-priority debt will be approved by a majority of creditors and involves amending existing debt documents. As a result, the existing secured debt held by the minority, non-participating creditors is effectively subordinated.