‘Creditor-on-creditor violence’ restructurings fail to stave off default
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Troubled companies that seek to avoid costly US bankruptcy proceedings by striking controversial deals with creditors overwhelmingly default within three years, new research shows, raising questions about whether the processes do more harm than good.
Liability management exercises — otherwise known as “non-pro rata” refinancings or “creditor-on-creditor violence” — such as the one completed by US retailer Saks Global in June, have increasingly usurped formal Chapter 11 proceedings for distressed US companies.
The transactions typically involve a company striking a deal with a majority of creditors, who agree to put in new money in exchange for an increased chance of getting repaid what they are owed.
The deals prove contentious as they cut out a minority of creditors whose debt is pushed down the order for repayment, often rendering it worthless.
Research by Mark Roe of Harvard Law School and Vasile Rotaru of the University of Oxford shows that more than 80 per cent of 89 LME transactions executed in recent years defaulted on their debts within 36 months, including many resorting to a formal bankruptcy.
The academics argue that those bankruptcies should have been pursued in the first instance, with the business and its employees harmed by the underlying problems not being proactively fixed, even if that meant creditors and shareholders took an upfront hit.
“[T]he ‘avoid bankruptcy’ rationale crashes into a brute fact: half of the purportedly successful LMEs end up in bankruptcy anyway, and those bankruptcies tend to be longer and more contentious than for non-LME filers,” Roe and Rotaru write in a forthcoming paper.
The rise of LMEs had been driven by covenant-lite debt sold since the financial crisis, which contains few investor protections to guard against asset-stripping, the academics said.
A second factor behind the increase is that companies are increasingly owned by private equity firms, which are emboldened to pursue aggressive financial engineering to keep troubled investments out of bankruptcy court, where judges reset a company’s valuation lower and wipe out junior debtholders and equity holders.
Saks raised $600mn of rescued debt in June but seven months later was forced into bankruptcy because of a lack of cash.
A number of lawyers and bankers have become increasingly uncomfortable with deals that kick the can down the road, although they acknowledged they had benefited from the high fees for repeat assignments.
“I’m not saying most LME’s aren’t worth a shot, but the fact that they don’t solve long-term issues in many cases is just fundamentally bad, and the cost is borne by creditors in the direct financial sense and by companies in terms of effects on people, long-term enterprise value, etc,” said one longtime restructuring lawyer.
Out-of-court refinancings and exchanges allow equity to stay alive in the hopes of a turnaround, even if functionally it remains worthless.
In some instances, the strategy has worked. In 2018 retailer PetSmart, backed by BC Partners, separated its online unit, Chewy. The manoeuvre left Chewy outside the reach of creditors. Chewy subsequently went public and reached a market cap of $40bn, allowing all of PetSmart’s broader debt to be repaid at par.
More recently, the likes of Carvana and EchoStar, each listed but with significant founder stakes, executed LMEs and gained enough breathing room to turn around their operations. Those two companies later added more than $100bn of market value and their debt rallied to 100 cents on the dollar.
But those proved to be exceptional cases. Most companies who choose an LME deal end up adding temporary liquidity and extended maturities. However, the cash infusion comes in the form of new net debt and higher interest service that often proves unsustainable.
Some advisers argue that LMEs are an attractive free option to restructure outside of Chapter 11 bankruptcy proceedings, the latter of which entails strict procedures and high costs.
“When a company uses an LME to buy time to allow the business to recover, and the business does recover, that’s a clear good for all parties,” said John Sobolewski, a partner at law firm Latham & Watkins where he leads their LME practice.
Sobolewski had led a LME in 2024 for telco Lumen Technologies, whose more than $20bn debt seemed unsustainable with pending maturities looming.
The transaction ultimately added to the company’s debt and interest expense. However, Lumen changed its strategy to position itself as a critical player in AI infrastructure and its share price surged from about $1 to more than $8.
Securities filings showed that Lumen paid more than $400mn in expenses to get refinancing and bond exchanges done, charges that resemble formal Chapter 11 proceedings.
The law firms and investment banks that structure LME transactions are coming under increasing scrutiny about their roles in successive refinancings.
Altice USA, the cable and broadband provider, in a recent lawsuit against top private capital firms blamed advisers for fomenting tensions in distressed debt markets in order to maximise their deal fees.
“It can be two fees instead of one,” said one former private equity executive who now is a consultant to distressed companies.
“And for the lawyers, the prospect of expensive litigation in a complicated Chapter 11, post-LME, is great for fees.”
Messy restructurings have led to worse outcomes for secured claimants in distressed situations.
Moody’s data shows that senior loans issued between 2008 and 2022 recovered on average 75 cents on the dollar. But the combination of “covenant-lite” debt and complex restructurings led to that recovery average dropping to just 57 cents after 2022.
As for Saks, the creditors who extended the 2025 summer financing have seen their paper shrivel to under nickels on the dollar, with those bondholders asked to fund the company’s bankruptcy.
Separately, Amazon, which put $475mn of equity into Saks, has in bankruptcy court filings accused the company of “mismanagement, improper governance, and disregard of corporate separateness” and of violating the retailer’s rights in the 2025 LME transaction that raised $600mn.
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