(Bloomberg) -- Uniti Group Inc. is dangling the prospect of lower payments for Windstream Holdings Inc. on the disputed lease that helped trigger its bankruptcy in return for getting some surplus Windstream assets, according to people with knowledge of the matter.

Talks are underway, with Uniti envisioning a mutually beneficial transaction that includes a way to make up for the revenue it would lose if it reduces Windstream’s $650 million annual payments, the people said. Shares of Uniti jumped as much as 8.6%.

Concessions could include transferring fiber network assets that Windstream isn’t using to Uniti, which could then lease those lines to a third party, said the people, who asked not to be identified discussing confidential negotiations. A deal might also include an upfront payment by Uniti for the transferred assets or extending the lease beyond its 2030 expiration, according to the people.

Clues to how big a price break Uniti could grant can be found in the terms of its own credit agreement. Uniti could cut lease payments by $100 million to $150 million before it would violate a requirement to keep its secured leverage ratio under 5 times debt to a measure of earnings.

That’s the middle of the value Windstream previously placed on its unused “dark fiber” assets that it was trying to sell before it went bankrupt. Last November, Chief Financial Officer Robert Gunderman estimated those were worth $100 million to $200 million.

Credit Limits

Leverage restrictions in other parts of Uniti’s credit agreements and waivers on those limits from creditors might also affect the outcome. The company has warned that outright rejection of the lease by Windstream, while unlikely, could cast doubt on its own solvency.

A representative for Windstream said the company declined to comment. A Uniti investor relations representative didn’t immediately respond to a request for comment. Shares of Uniti gained 20 cents to $9.26 at 4 p.m. in New York and traded as high as $9.84.

The fate of Windstream’s lease has been a central question hanging over the restructuring. Uniti was spun off in a 2015 deal that gave it ownership of Windstream’s network assets. Windstream then leased the network back from Uniti to provide service to Windstream’s 1.4 million rural residential and small business customers in 18 states.

Aurelius Capital Management LP, the hedge fund run by Mark Brodsky, contended that the sale-and-leasback violated terms of Windstream’s debt, and the resulting default plunged Windstream into bankruptcy.

Now Windstream is trying to renegotiate the lease, saying the deal for the copper-wire network is overpriced in an age when customers want high-speed internet service on fiber-optic lines. It’s possible the two companies could agree on a reduction of the lease beyond the limits spelled out by Uniti’s covenants if lenders believe the deal would lead to a better outcome and grant a waiver, according to Bloomberg Intelligence analyst Phil Brendel.

Read More: Uniti Says Windstream Required to Continue Making Payments

Complicating matters is that unsecured bondholders want Windstream to completely stop monthly lease payments of about $54 million because they say it’s not a true landlord-tenant lease -- it’s just a financing arrangement -- and thus doesn’t enjoy any special status under bankruptcy law. The value of those payments should be kept for creditors, they contend.

The more senior first-lien note holders have sided with the company, saying they should be the ones to bring any claims against Windstream if talks with Uniti fail. A hearing is scheduled for July 26.

In the financial chess match of bankruptcy negotiations, the threat of seeing the lease recharacterized as a financing arrangement may strengthen Windstream’s hand. Uniti gets the bulk of its revenue from the Windstream lease and has warned investors that its own financial stability would be in jeopardy if the lease is rejected. Windstream said in May that rejection and recharacterization are both on the table.

Mutual Needs

“The unsecured noteholders’ recent motion to recharacterize the Uniti master lease as a financing sets forth plausible arguments that could give Windstream leverage in lease talks,” Bloomberg Intelligence analyst Negisa Balluku wrote in a recent note.

Any settlement between Windstream and Uniti is unlikely to include an outright rejection of the lease by Windstream, given its relative importance to both parties. Windstream needs access to the network assets owned by Uniti to operate its business, and Uniti gets nearly 70% of its revenue from the lease. Uniti also needs to maintain a certain percentage of its revenue from real estate in order to hold onto its tax status as a real estate investment trust.

What’s more, Windstream is a “carrier of last resort” in certain markets where it uses Uniti assets to provide service. Windstream would need approval from state and federal regulators if it tries to reject the lease and stop providing service in those areas -- “a more rigorous standard of review than standard business judgment, given potential public interest concerns,” Balluku said.

Windstream has until Sept. 23 to accept or reject the lease. By then, according to the unsecured creditors, it will have paid out nearly $400 million from the estate that belongs to them.

“The bizarre turn here is that many on the Windstream executive team and board orchestrated the sale-leaseback transaction, and are now threatening to recharacterize it as a secured financing,” said Brendel at Bloomberg Intelligence. “Uniti may consider the threat as it is being posed more of a bluff, but they still may settle at a small discount to end litigation that questions its existence and asset ownership.”

To contact the reporter on this story: Allison McNeely in New York at amcneely@bloomberg.net

To contact the editors responsible for this story: Rick Green at rgreen18@bloomberg.net, Nicole Bullock

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