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, and thereby extend distressed firms’ runways to recover and take off. If true, these benefits 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 a way to avoid bankruptcy. Second, the winning participants typically take higher-priority debt rather than stabilizing equity, further undermining already overindebted structures. High debt levels and low credit ratings persist. The added capital complexity can prod the firm toward default and a potentially 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. When dealmakers redistribute value, they have less incentive to focus on stabilizing the firm’s finances and improving its operations.

We present evidence supporting all four claims—nearly definitive for the first two, substantial although not ruling out alternatives for the second two. The evidence overall points to coercive recapitalizations’ potential to lock capital in poor investments for too long. From a lawyer’s perspective, that could raise troubling fiduciary-duty questions. From a market-wide perspective, inefficient deals and misallocated capital could eventually favor more effective contracts and deals. Rent seeking to grab value from other investors can persist despite its costs, but not always.