Creditor-on-Creditor Violence: How Liability Management Exercises Became the New Bankruptcy

On December 31, 2024, two appellate courts issued decisions that crystallized the current state of corporate restructuring in America. In In re Serta Simmons Bedding, L.L.C., 125 F.4th 555 (5th Cir. Dec. 31, 2024), the court invalidated an uptier exchange based on its credit agreement language. The same day, in Ocean Trails CLO VII v. MLN Topco Ltd., 2024 N.Y. Slip Op. 06660 (App. Div. 1st Dep't Dec. 31, 2024), a different court upheld a nearly identical transaction interpreting subtly different contract language. Small differences in hundreds of pages of credit documents drove opposite outcomes in billion-dollar disputes.

These decisions matter because liability management exercises have fundamentally transformed corporate restructuring.  According to Oaktree Capital Management’s Q4 2024 report “The LME Wave,” over 50% of corporate defaults now occur through Liability Management Exercises (LMEs) rather than traditional Chapter 11 bankruptcy.  Yet many companies executing LMEs still file bankruptcy subsequently, suggesting these transactions often delay rather than prevent insolvency.  For business leaders—whether running leveraged companies, investing in leveraged loans, or serving on corporate boards—understanding LME structures, litigation outcomes, and creditor dynamics has become essential.

How Liability Management Exercises Became the Dominant Restructuring Tool

The rise of LMEs can be traced back to three market transformations.  First, covenant-lite loans grew from roughly 1% of the leveraged loan market in 2000 to over 90% by 2021, replacing quarterly maintenance covenants with incurrence covenants tested only when taking specific actions.  This gave borrowers extraordinary flexibility.  Simultaneously, institutional ownership replaced relationship banking, with collateralized loan obligations now holding 60-65% of leveraged loans, creating a diffuse creditor base that struggles to coordinate.  Finally, credit agreement drafters inadvertently created exploitation opportunities through flexible investment baskets, undefined terms, and sacred rights provisions that failed to address modern restructuring techniques.

J. Crew’s dropdown transaction in 2016 and 2017 established the template. The company transferred valuable intellectual property to an unrestricted subsidiary by stacking multiple investment baskets, then used that IP to collateralize new financing outside existing lender protections. The transaction spawned “J. Crew blockers” in subsequent deals.  However, market data shows only about 9% of recent loans contain comprehensive dropdown protections, compared to roughly 70% containing uptier blockers—suggesting the market learned to defend against uptier exchanges but left dropdown vulnerabilities largely unaddressed.

The uptier exchange emerged as the dominant structure in 2020.  Boardriders and Serta Simmons demonstrated how majority lender coalitions could create super-priority debt and subordinate non-participants.  The mechanics are designed to exploit a gap: whereas amendments affecting principal, interest, maturity, and collateral release require unanimous consent, lien subordination historically did not.  The market responded with anti-subordination provisions jumping from roughly 10% of new deals to 70% post-2020, but the installed base of existing loans remains vulnerable.  The pattern is clear: exploitation becomes standard playbook, protective provisions evolve, new structures follow.

The Transaction Playbook: How Value Gets Redistributed

These market conditions enabled two main transaction structures, uptier exchanges and dropdown transactions, that now dominate liability management exercises with many other creative offshoots.

Uptier exchanges allow borrowers to work with lenders holding sufficient debt—typically at least 50.1% (“Required Lenders”)—to create new priority tranches that subordinate existing ones.  Participating lenders exchange existing debt for “second-out” priority (terms for converting existing debt into new priority positions) while providing “first-out” new money (first-out debt is first in line for repayment from the company’s assets).  Exit consents—amendments that departing lenders approve as they leave—strip protections from legacy debt: wider covenants, removed events of default, and amended no-action clauses (provisions preventing individual lenders from suing without meeting minimum thresholds) to inhibit litigation.  In the Travelport transaction, subordinated lender recovery estimates dropped from 75% to 0% according to S&P.  In some transactions, this new priority debt can exceed $1 billion, fundamentally reshaping the capital structure.

Dropdown transactions transfer collateral assets from the restricted credit group to entities outside lender protections, automatically releasing liens.  Investment basket capacity enables these transfers: credit agreements permit dedicated unrestricted subsidiary investments, general investment baskets, and “builder” baskets that accumulate based on financial performance.  Companies have stacked multiple baskets to designate entire profitable business segments as unrestricted.  For example, Envision Healthcare transferred its valuable ambulatory business outside the credit group.  J. Crew blockers focused narrowly on intellectual property but left other assets unprotected.

The creativity does not stop there.  Beyond uptiers and dropdowns, sophisticated advisors continue developing new structures that exploit document gaps:

• New money purchases into creditor classes: Investors buy enough debt to control amendment votes, then approve transactions benefiting themselves at other creditors’ expense
• Double-dip structures: A subsidiary borrows money with parent guarantees (first claim), then lends that money to the parent and pledges the IOU back to the lender (second claim)—creating two recovery paths from one loan
• Priming lien structures: Creative covenant interpretation elevates certain debt above previously equal-priority obligations
• Amendment and extension transactions: Borrowers bifurcate lender groups by offering some lenders extended maturities with different economics, splitting the class
• Selective consent payments: Borrowers manipulate “most favored nation” provisions through carefully structured payment terms that technically comply but create economic pressure

 

The pattern is consistent: transaction structures evolve faster than protective provisions can be embedded in new deals.  For those drafting credit agreements, specific prohibitions get circumvented through new structures, while principles-based protections that prohibit subordination or value transfers “directly or indirectly” fare better but have disappeared in the era of “cov-lite” loans.

The Systematic Sorting: Who Wins and Who Loses

LME transactions divide creditors into distinct tiers. Understanding transaction mechanics is only half the picture—the other half is understanding who gets invited to participate in structuring these deals. Steering committees comprising the largest lenders negotiate directly with borrowers and receive the best economics: new money fees, backstop commitments, and the most favorable terms for converting existing debt into new priority positions.  Ad hoc participants achieve some protection but on less advantageous terms.  Non-participating lenders hold subordinated legacy debt with recovery prospects that can deteriorate from investment-grade to near-zero overnight.

Information asymmetry drives outcomes.  Steering committees receive non-public information under confidentiality agreements and negotiate term sheets weeks before public announcement.  Ad hoc groups form through self-identification—creditors finding each other through bilateral contacts or advisor outreach.  Smaller investors often learn about transactions only when publicly announced, by which time key economic terms are set.  This dynamic has driven creditors to seek collective defenses.

Cooperation agreements have emerged as the primary defensive mechanism, with more than ten formations reported in the first half of 2024 alone according to Reorg.  These binding agreements require creditors to work together, vote collectively on group-approved proposals, and reject non-approved offers.  Transfer restrictions ensure members can only sell positions to other participants or purchasers who sign joinders.  In the Altice France transaction, over 90% of term lenders joined the cooperation agreement, creating formidable collective leverage.  However, these agreements favor early participants, with materially different economics for initial parties versus those who join later, and some recent agreements now limit subsequent participation entirely.

Family offices represent a case study in structural disadvantage.  Family offices merit particular attention because they represent a growing portion of leveraged loan buyers yet lack the institutional infrastructure to protect themselves.  Position sizes are typically too small for steering committee access—committees typically form around lenders holding $50 million or more.  They maintain limited restructuring expertise compared to dedicated distressed teams at large institutional investors.  Decision-making moves more slowly: whereas major institutional restructuring groups commit capital in days, family offices may need weeks for investment committee approval.  They have fewer relationships with restructuring advisors who facilitate group formation.  Legal fees for active participation can exceed $50,000 to $100,000, difficult to justify ex ante but minimal compared to subordination losses.

Most critically, family offices learn about transactions too late.  Steering committees operate under confidentiality for weeks.  By public announcement, the family office investor must decide within days whether to participate in a transaction whose terms were negotiated without their input.  The lesson extends beyond family offices: any creditor without scale, relationships, and dedicated expertise faces systematic disadvantage.  Specialized litigation counsel can provide partial offset to these resource disadvantages, creating the possibility of challenging disadvantageous terms or negotiating better treatment. It is particularly important for family office investors to retain special litigation counsel early in the process if they perceive stress in one of their investments.

Independent Directors: When Process Protects Against Claims

Although creditor positioning determines who wins and loses economically, companies face a different challenge: managing liability risk from the transaction itself.  Companies appoint independent directors when conflicts exist with equity sponsors—nearly universal in PE-sponsored LMEs.  Delaware law provides the framework: directors of solvent companies owe duties to shareholders, not creditors, even in the “zone of insolvency.” Only upon actual insolvency do creditors gain standing for derivative claims.

Process provides protection.  True independence means directors with no financial ties to the sponsor or management, separate legal and financial advisors hired by the committee (not company management), and actual authority to approve or reject the transaction rather than merely recommend.  J. Crew’s dropdown succeeded partly because independent directors with complete discretion retained independent consultants for solvency opinions.  The resulting factual record withstood scrutiny and substantially undermined subsequent fraudulent transfer claims—allegations that a company transferred assets or incurred debt while insolvent, potentially allowing courts to unwind transactions.  Conversely, in SportCo Holdings, all directors were PE sponsor or company employees—the court denied dismissal of duty of loyalty claims.  Friedman v. Wellspring Capital Mgmt., LLC (In re SportCo Holdings, Inc.), No. 20-50554, 2021 WL 4823513 (Bankr. D. Del. Oct. 14, 2021)

Why Contract Language Determines Everything

Process protections only matter if the underlying transaction complies with the credit agreement.  And that determination turns entirely on contract language.  The Serta Simmons and Mitel Networks decisions demonstrate how minutiae drive billion-dollar outcomes.  In Serta, the credit agreement permitted non-pro rata assignments “through open market purchases.” The Fifth Circuit held “open market purchase” requires purchase on the secondary market for syndicated loans—privately negotiated debt exchanges do not qualify.  It allowed excluded lenders to have a “strong case” for breach.  The Mitel credit agreement permitted “purchase” without the “open market” qualifier.  The New York Appellate Division found refinancing can constitute a “purchase.” Transaction upheld.  Two-word difference, opposite outcomes.

Sacred rights provisions require unanimous consent for key amendments: principal, interest, maturity, collateral release.  Historically, lien subordination did not require unanimous consent.  Strong anti-subordination provisions now prohibit amendments that “subordinate, or have the effect of subordinating” liens without affected lender consent. Weak provisions prohibit subordination “unless all lenders are offered ratable participation”—allowing circumvention through selective solicitation.

The phrase “have the effect of” proved critical in Wesco/Incora.  Participating noteholders issued additional notes (simple majority), creating the required vote threshold by first issuing new debt to friendly parties, then used the manufactured supermajority to release liens.  Judge Isgur ruled the first amendment “had the effect of” releasing liens even though indirect.  The phrase captured the multi-step transaction, invalidating it.  Courts increasingly collapse multi-step transactions rather than blessing each step separately.

The takeaway is clear, precision in contract drafting determines outcomes.  Courts give minimal weight to policy, industry practice, or fairness once applying plain-meaning interpretation.  Given this unpredictability, parties increasingly recognize that litigation risk must be managed from day one.

Litigation Across the Transaction Lifecycle

The role of litigation counsel extends far beyond courtroom advocacy.  Value is created at multiple touchpoints.

Document analysis before negotiations is critical.  Courts apply “plain meaning” interpretation and reject deference to market conventions.  Litigation counsel assesses how courts will likely interpret provisions—distinct from transactional counsel’s understanding of market practice.  At origination, this means drafting provisions that actually prevent modern structures: true anti-subordination language, anti-stacking limitations, defined terms like “open market purchase,” and voting mechanics preventing manufactured supermajorities.

Pre-transaction strategy for companies focuses on controlling the narrative and building defensive records.  J. Crew filed a declaratory judgment action—a lawsuit seeking court confirmation that actions comply with contracts—immediately after closing.  This controlled venue, timing, and narrative framing.  According to market reports, 88% of term loan holders ultimately agreed to settlement.  Independent special committee documentation creates the factual record essential for defending fraudulent transfer and implied covenant claims.

Creating leverage for excluded creditors requires speed.  In TriMark USA LLC (New York Supreme Court), excluded lenders’ litigation settled with non-participants exchanging debt dollar-for-dollar at par—complete recovery.  See Audax Credit Opportunities Offshore Ltd. v. TMK Hawk Parent, Corp., 72 Misc. 3d 1218(A) (Sup. Ct. N.Y. Cnty. 2021). In Boardriders, excluded lenders ultimately received full repayment when Authentic Brands acquired the company during litigation.  See ICG Global Loan Fund 1 DAC v. Boardriders, Inc., Index No. 655175/2020 (Sup. Ct. N.Y. Cnty. Oct. 17, 2022). The litigation created settlement leverage translating into better economics than original offers.  Critical barriers exist: no-action clauses prevent individual lawsuits without administrative agent consent or minimum debt thresholds, often 25% or more. Speed matters because transactions close within days of term sheet circulation.

Quinn Emanuel’s Special Situations Group brings experience representing the full spectrum: companies executing transactions, participating lenders protecting positions, excluded creditors challenging treatment, and independent directors navigating fiduciary obligations.  The firm’s approach combines rigorous document analysis with litigation strategy from the outset, recognizing that LME transactions are negotiated with litigation risk in clear view.

An Evolving Landscape

Liability management exercises now represent the majority of significant corporate defaults. Yet the success rate tells a sobering story: industry data suggests that approximately 14% of companies executing LMEs successfully avoid subsequent bankruptcy filing. These transactions often delay rather than resolve fundamental business challenges.

The sophistication arms race continues: transaction structures evolve faster than protective provisions can be embedded in new credit agreements. Information and resource asymmetries that advantage large institutional investors over smaller creditors are structural features, not accidents.  And as Serta and Mitel demonstrate, outcomes turn on contract language minutiae that only become clear through litigation.

The timeline matters critically.  By the time term sheets circulate to the broader creditor base, steering committees have negotiated basic structure under confidentiality and positions are hardening.  For all stakeholders—companies structuring deals, lenders protecting positions, excluded creditors challenging treatment, independent directors managing fiduciary risk—early engagement with specialized litigation counsel has become essential infrastructure.  The sophistication required spans both transactional mechanics and litigation strategy.  In this environment, that combined expertise is not a luxury.  It is the cost of participation.