Liability Management's Limited Runway: Corporate Restructuring Today

Coercive, non-pro rata debt restructurings, often driven by private equity sponsors, have become a major force for fixing distressed companies. They are promoted—by stressed companies, their owners, their advisors, and favored creditors—as the best way to avoid bankruptcy and reduce financial stress by extending distressed firms’ runways to recover and take off. If true, it would explain their growing frequency. But the post-deal results contradict proponents’ positive claims.

First, a majority of coercively restructured firms end up filing for bankruptcy anyway—a letdown for a maneuver mainly justified as avoiding bankruptcy. Second, the winning participants typically take higher-priority debt rather than stabilizing equity, thereby further undermining already overindebted structures. High debt levels and low credit ratings persist. The added capital complexity prods the firm toward default and a potentially a thornier bankruptcy. Third, efficiency justifications commonly offered—like avoiding bankruptcy’s expense—are doubtful. Coercive debt restructurings are themselves expensive, and many restructured firms end up in bankruptcy anyway, yielding two costly deals. Fourth, coercive restructurings are as consistent with redistributing value from disfavored creditors to owners and favored creditors as with efficient restructuring.

We present evidence supporting all four claims. As such, coercive recapitalizations may lock capital in less-than-worthwhile investments for longer than is efficient. From a lawyer’s perspective, that could raise troubling fiduciary-duty questions. From a market-wide perspective, inefficient recapitalizations and capital misallocation could eventually favor more effective contractual terms and deals. Rent-seeking to grab value from other investors can persist despite its costs, but not always.