While corporate restructuring is a domain that business leaders and finance executives generally prefer to avoid, some recent developments in this area have underscored the need for better understanding it.

It may seem counterintuitive, but the reality is that management teams — both in highly leveraged or struggling companies and perfectly healthy ones — can operate more effectively and even shift the balance of power in negotiations by equipping themselves with a deep understanding of the complexities of corporate restructuring.

The utilization of liability management transactions (LMTs), sometimes also referred to as Liability Management Exercises, in particular, including the use of private credit in some recent restructurings, and the potential role of artificial intelligence could permanently change the game of negotiating credit agreements.

Liability Management Transactions

Some view an LMT as a cunning tactic for borrowing corporations to relieve their debt burdens by exploiting the loopholes of credit documentation. A borrower can often execute an LMT via parallel agreements (side deals) with certain lenders, much to the chagrin and expense of the other lenders.

The primary categories of LMTs are as follows:

‘The Double-Dip’

In a double-dip transaction, certain lenders end up having two claims in the event of a default on the same debt. This is functionally executed by:

• The parent company (P) that is the principal borrower in a credit facility causes an unrestricted [i] subsidiary (US) to issue (e., sell) debt to a third party (Lender) that is guaranteed [i] by a restricted subsidiary (RS) [ii].
• This guarantee serves as the first claim for Lender in a potential default/bankruptcy. In the event of P’s bankruptcy, and subsequent liquidation, this guarantee gives Lender a claim on the recovery proceeds
• US then loans the proceeds of this debt to P (or other subsidiaries) in exchange for a receivable.
• The receivable from P is pledged by US to the Lender, and serves as the second claim by Lender on the recovery proceeds if P liquidates.
• If P later files for bankruptcy, US’s Lender will be protected by RS’s guarantee and US’s receivable from P. Practically, however, Lender’s recovery is usually capped at the par value of the debt due to a legal principle called the single satisfaction rule [iii].

The objective of a double-dip is for Lender to bolster its claim in a potential bankruptcy of the corporate enterprise. Without the transaction, and assuming such Lender pari passu with another senior lender, it would receive 50% of the collateral in a liquidation. By executing the double-dip, Lender would receive 2/3rd of the collateral proceeds due to two claims.

Dropdown

In a dropdown, existing lenders of the borrower become subordinated to senior debt issued by an unrestricted subsidiary. This is accomplished by the borrower/parent utilizing certain provisions within the credit agreement (e.g., investment, asset sale, or other restricted payment baskets) to transfer collateral from restricted subsidiaries to unrestricted subsidiaries not bound by the covenants of the existing credit agreement. This transferred collateral is then used to issue structurally senior debt at the unrestricted subsidiary, thereby allowing the borrower (the corporate enterprise, that is) to raise additional capital through its unrestricted subsidiary without encumbering additional assets.

Uptiering

An uptiering transaction enables a borrower to raise senior debt without actually transferring any collateral. This is generally executed by the borrower amending its leveraged loan agreement, most commonly the credit agreement which is usually broadly syndicated. Depending on the size of the loan, the number of lenders in the syndicate could range from a couple to 20+. Amending the credit agreement that governs such facilities usually requires consent from syndicate member lenders with aggregate commitments more than 50% of the principal amount of the loan. Moreover, in this type of LMT, a borrower negotiates consents with certain existing lenders to amend its credit agreement to permit raising senior debt and invites participating lenders to exchange their existing debt for this new senior debt. This, in turn, subordinates the non-participating existing lenders.

Prominent LMTs

J. Crew

One of the most notorious LMTs in recent years was a dropdown executed by J. Crew in 2017.

The apparel retailer transferred intellectual property from restricted subsidiaries to unrestricted subsidiaries to reduce its debt by $340 million without pledging any new collateral, having additional encumbrance on existing assets. J. Crew accomplished this by utilizing three investment baskets permitted in the credit agreement:

1. Investment in unrestricted subsidiaries up to the higher of $100 million or 3.25% of total assets,
2. Investment in certain restricted subsidiaries up to the higher of $150 million or 4% of total assets, and
3. Investments by certain restricted subsidiaries in unrestricted subsidiaries financed with proceeds of investments in these restricted subsidiaries.

J. Crew utilized baskets (i) and (ii) to transfer $250 million of intellectual property assets (which had already been pledged to the existing $1.5 billion term loan facility) to an unrestricted subsidiary. This unrestricted subsidiary licensed the use of intellectual property back to J. Crew, raised senior notes secured by these intellectual property assets, and exchanged them at a discount for the existing unsecured PIK notes with impending maturity. The lenders of the existing term loan facility lost their claim on $250 million of collateral, had to share their claims with lenders of the new senior notes issued by the unrestricted subsidiary in a potential liquidation, and let J. Crew use term loan proceeds to pay licensing fees for the use of intellectual property.

Revlon

Revlon attempted a similar drop-down transaction more recently but with a higher degree of panache.

In 2016, Revlon executed a $1.8 billion term loan facility that allowed for additional revolving loans and was secured partly by intellectual property. In 2019, as its financial performance declined, credit ratings suffered, and leverage piled up, Revlon approached the term loan lenders seeking to transfer intellectual property collateral to an unrestricted subsidiary in order to raise fresh capital outside the purview of the credit agreement.

Unsurprisingly, lenders with aggregate commitments exceeding 50% of the total facility rejected, but several others did consent. Revlon borrowed an additional $65 million in revolving loans from these consenting lenders which was the exact amount necessary to increase the aggregate holdings of the consenting lenders above 50%. Their votes were now enough to allow the transfer of intellectual property to the beauty brands subsidiary, which was unrestricted and raised a super senior facility funded by the consenting lenders with rolled-up commitments of the $1.8 billion term loan facility and $880 million of new money. Its existing lenders, who were thus subordinated to the super senior facility, challenged it in court, but the case was ultimately dismissed. (Case No. 22-10760 at United States Bankruptcy Court Southern District of New York)

Serta

An even more recent uptiering transaction with an unhealthy dose of twists and turns was executed by Serta. In 2020, Serta caused certain of its lenders to exchange $1.2 billion of existing loans (of a total facility of $1.95 billion) for $1.075 billion of new super-priority debt. This was accomplished by relying on the ‘open market purchases’ condition in its credit agreement.

The credit agreement contained customary provisions about the pro rata treatment of similarly situated lenders and prohibited amendments to the pro rata clause without the consent of all impacted lenders. One exception to the prohibition was for open market purchases. An open market purchase is where the borrower purchases loans from lenders who elect to sell their loans; this effectively enables participating lenders to receive consideration on a non-pro-rata basis.

The transaction was challenged in bankruptcy court by non-participating lenders, who argued violation of pro-rata distribution and good faith clauses in the credit documents. While the bankruptcy court ruled in favor of Serta, agreeing with it on the utilization of the open market purchases principle, the Fifth Circuit subsequently reversed the bankruptcy court’s ruling, providing some hope going forward for non-participating lenders on the short end of the LMT stick. (Case No. 23-20181(5th Dec.31, 2024) at the U.S. Court of Appeals for the Fifth Circuit).

In the last few years, lenders and management teams have been more cognizant of LMT related discord. As a result, credit documents in syndicated deals have tended to be much tighter, with less room for conflicting interpretations of covenants.

Private Credit

Going forward, a potential decline in LMTs could also be attributed to the contemporaneous blossoming of private credit. The largest segment of private credit is ‘direct lending’ which, as the name suggests, often involves a non-bank lender directly loaning capital to borrowers.

Since direct lending usually involves a single lender, the borrower cannot privately negotiate on a selective basis with other lenders, which is often the case in broadly syndicated loans. Moreover, non-bank lenders that make direct loans are often players who are not afraid of engaging in shareholder activism and other tactics that can incentivize a borrower to prefer to avoid conflict.

Lastly, direct loans are customized to the borrower’s circumstances, and an LMT might eventually place the borrower (especially if the borrowing entity’s operations are of significant size and scale, or if the loan amount is meaningful) in a worse-off situation from capital structure and cash flow standpoints, all things considered. These underlying attributes of direct lending suggest an organic mitigation of LMTs in the years to come.

In response to the 2008 financial crisis, as traditional banks had to cut back on lending due to increased regulatory scrutiny, risk aversion, and higher capital adequacy requirements, private credit sensed an opportunity to target underserved borrowers and expanded aggressively. According to a recent Bloomberg report, private credit had grown to $1.5 trillion globally (at the end of June 2024) – a meteoric rise for a sector in its infancy less than 20 years ago, with more than half of this volume in the form of direct lending and more than 2/3rds if we also include distressed debt. ( see Bloomberg article titled “Private Credit is the Hot New Thing on Wall Street. But What Is It?” published on February 19, 2025).

Most of the capital in private credit originates from financial institutions (pension funds, insurance companies, etc.) and affluent individuals with long-term investment horizons. Such lenders have the luxury of holding their loans through volatile periods until maturity (in stark contrast to broadly syndicated loans (BSLs) and being able to provide capital to borrowers with weaker credit. In exchange for paying slightly higher interest, borrowers not only have less onerous reporting obligations (since private debt does not trade), but they also receive customized solutions as well as more flexible terms.

The very nature of direct lending and the structure of private loans fits perfectly with the capital requirements of financially distressed companies that can focus on turning around operations instead of worrying about the entire loan syndicate and related haggling — a harbinger of liability management transactions. Private credit funds have been aggressively hiring professionals with bankruptcy and restructuring experience [iv] — further underscoring the ability of these funds to proficiently navigate and profit off any potential restructuring within and outside their portfolios.

The Road Ahead

As it pertains to corporate restructuring, no two negotiations or workouts are alike. The reorganization plan in every restructuring is often a solution that addresses most of the agenda items of every stakeholder. In order to get to such solution, debtor and its advisors have to constantly weigh the ever-evolving priorities of most critical constituents of the estate and strive to present a plan that satisfies most parties. In such dynamic environment of corporate restructuring, LMTs have muddied the waters by promoting yet another set of private negotiations. The gamesmanship, litigation, and everchanging value preservation tactics have already led to higher courts ruling in favor of non-participating lenders.

Since Wall Street wizards are nothing but creative, any decline in LMTs could very well yield other maneuvers to abruptly alter capital structures. It remains to be seen, for example, how artificial intelligence (AI) may play a role in all this, but borrowers have already been leveraging it to improve their forecasting processes. This could be extended to preemptively flag potential distressed situations, and sophisticated AI models could assist a company in restructuring to refine its plan of reorganization prior to a confirmation hearing by predicting product or service performance based on analyses of simulated data. AI could also assist in the restructuring process by using machine learning to replace manual labor associated with court filings, as well as to analyze comprehensive datasets to identify fraudulent activity. [v]

One additional ‘pulled from the headlines’ stumbling block to redefining capital structures is the eventual application of tariffs by trade partner nations. At the time of writing this article, a Chuck E. Cheese financial deal had been delayed due to market swings and tariff discussions. Hopefully the financing environment stabilizes in time for the company to replace the $660 million debt due in May 2026. Similarly, the retailer At Home is in the market to raise a loan to address declining cash reserves but needs a financing window to open up soon or otherwise faces a looming default. More than $50 billion of corporate debt is due in 2026 and $120 billion is due in 2027.

[Editors’ Note: We think you’ll also like “Uptier Transactions and Other Lender-on-Lender Violence: The Potential for More Litigation and Disputes on the Horizon.”]

This article was originally published on April 21, 2025.

©2025. DailyDAC^TM, LLC. This article is subject to the disclaimers found here.

Footnotes

[i] Assumes permissibility and capacity for such guarantees under relevant covenants including Permitted Debt, Permitted Liens, Investments, etc. 

[ii] A ‘restricted’ subsidiary refers to one that is bound to requirements contained in the corporate enterprise’s existing credit agreement. A restricted subsidiary is also typically a guarantor of the obligations of the parent under the credit agreement. If lenders do their job correctly, most of the value of a corporate enterprise resides in the primary borrower and its restricted subsidiaries. The term ‘corporate enterprise’ is used to denote all of the legal entities that comprise a single business. Most publicly traded companies, for instance, are comprised of numerous legal entities. 

[iii] A common law principle that a claimant should only recover once for a particular loss thereby preventing overcompensation for the same loss. 

[iv] See The Wall Street Journal, “Private-Credit Firms Expand Restructuring Teams Amid Bankruptcy Surge,” March 12, 2025. 

[v] See “A Story of Two Holy Grails: How Artificial Intelligence Will Change the Design and Use of Corporate Insolvency Law,” The University of Chicago Law Review: noting that experts are also exploring the possibility of utilizing AI to predict court decisions and make the contracting process more efficient.