Workouts Without Witnesses: How Liability Management Exercises Have Quietly Reordered the Capital Structure—and What Institutional Investors Must Demand Before the Next Uptier

In the past five years, the single most consequential transformation in American corporate restructuring has occurred without a courtroom, without a creditors' committee, and—most acutely for equity holders—without the disclosure architecture that has historically attended financial distress. Liability management exercises, or "LMEs," have not merely complemented Chapter 11; they have begun to displace it. According to data compiled by Moody's and Barclays Research for Oaktree Capital Management's fourth-quarter 2024 publication "The LME Wave," more than fifty percent of corporate defaults now occur through LMEs rather than traditional Chapter 11 proceedings.¹ Practitioners have given the phenomenon a blunter name: "creditor-on-creditor violence."²

The empirical record on outcomes is no longer in dispute. In a February 2026 study published through the Harvard Law School Bankruptcy Roundtable, Professor Mark Roe of Harvard Law School and Vasile Rotaru of Harvard Law School and the University of Oxford examined a hand-collected dataset of eighty-nine coercive, non-pro-rata LMEs and reached findings that should arrest the attention of every equity holder in a stressed or distressed issuer. Within two years of executing an LME, only twenty-two percent of borrowers had avoided both bankruptcy and re-default; among the subset of firms with at least two years of post-LME history, fifty-six percent had already filed for bankruptcy.³ Industry data summarized by Quinn Emanuel Urquhart & Sullivan LLP suggests that only approximately fourteen percent of companies executing LMEs successfully avoid a subsequent bankruptcy filing.⁴ When LME borrowers do ultimately file, they spend, on average, two to three times longer in bankruptcy than non-LME prepacks or private-equity-backed debtors.⁵

The picture that emerges is not of a softer alternative to Chapter 11. It is of a deferral mechanism whose dominant outcome is a more expensive, longer-running version of the very process it was designed to avoid.

Why This Matters to the Equity Holder

For the institutional investor reading the 10-K—whose fiduciary obligations begin where the credit markets' end—the rise of LMEs is not merely an inside-baseball restructuring story. When a company executes an LME, the next chapter of its operating history is being rewritten in the credit documentation rather than in the income statement. The equity holder, whose information rights are governed by securities law rather than indenture terms, is frequently the last party at the table to understand what has just happened.

Buxton Helmsley does not adopt a partisan view on the merits of any particular liability management exercise. The point of forensic interest is different: the disclosure asymmetry between the credit market and the equity market in stressed and distressed situations has grown to the point that the equity holder's traditional toolkit—the 10-K debt footnote, the going-concern assessment, the MD&A liquidity discussion—is no longer sufficient to detect or evaluate the most consequential restructuring decisions a board may face.

How We Got Here

The structural conditions enabling the LME wave are well understood within the credit markets. Covenant-lite loans, which constituted approximately one percent of the leveraged loan market in 2000, exceeded ninety percent by 2021—a transformation that effectively eliminated the quarterly maintenance covenants that historically forced borrowers into the restructuring table on a defined timetable.⁶ In their place, incurrence covenants—triggered only by specific corporate actions—created a far more flexible documentary regime, one that sophisticated borrowers and their sponsors quickly learned to exploit.

Two structures have come to dominate. The "drop-down," pioneered by J. Crew in 2016 and 2017, allows a borrower to transfer collateral—typically intellectual property or operating subsidiaries—out of the credit group and into an unrestricted subsidiary, where it can be pledged to support new senior indebtedness.⁷ The "uptier," exemplified by the Serta Simmons exchange in 2020, does not require moving collateral; it leverages the consent of a majority of existing lenders to amend the credit documents to permit the issuance of new debt with superior priority to the pre-existing debt of non-participating lenders. Participating creditors are typically invited to exchange their existing debt for the new senior tranches, dramatically subordinating those left out.⁸

What unites both structures is a single operating assumption: within the four corners of the credit documentation, and with the consent of only a majority of existing lenders, the borrower can elevate one creditor group at the expense of another, without judicial supervision. Transactions are negotiated in confidence, with steering committees of large lenders receiving non-public information under confidentiality agreements weeks before any public announcement. By the time the transaction is disclosed to the broader market—including to equity holders—the capital structure has already been reordered.

The Equity Holder's Blind Spot

For the institutional investor in the borrower's common stock, the most troubling feature of the LME regime is what is not disclosed. SEC reporting requirements obligate registrants to disclose material developments, but the threshold definitions for materiality, the timing of disclosure obligations, and the technical accounting treatment of debt modifications all leave significant room for delay and discretion.

Under ASC 470-50, a debt modification is accounted for either as a modification (with the original instrument continuing to be recognized) or as an extinguishment (with the original instrument derecognized and the new instrument recorded at fair value), depending on whether the present value of cash flows under the new debt differs by at least ten percent from the present value of remaining cash flows under the original debt.⁹ The classification has substantial implications for reported interest expense, for gains or losses recognized in earnings, and for the accuracy of going-concern assessments. Yet the technical analysis underlying the classification is rarely disclosed in detail. The equity holder is left with a footnote summary that obscures the very judgments most relevant to evaluating the company's runway.

Going-concern disclosure is equally constrained. ASU 2014-15 places the going-concern determination squarely on management, with the auditor's separate obligation under PCAOB Auditing Standard 2415 operating as a backstop that fires too late, if at all.¹⁰ A successful LME—one that extends maturities or injects new money—is treated by both management and auditor as evidence that going-concern doubt has been mitigated. Yet the Harvard empirical record demonstrates that the relapse risk embedded in any LME is substantial, and the auditing and disclosure literature has not yet caught up to that finding.

The Litigation Backdrop

The litigation arising from LMEs has revealed both their fragility and the unsettled state of the law that governs them. On December 31, 2024, two appellate courts issued opposite rulings on materially similar uptier transactions. In In re Serta Simmons Bedding, L.L.C., the United States Court of Appeals for the Fifth Circuit held that Serta's uptier exchange did not qualify as an "open market purchase" under the credit agreement and therefore violated the agreement's pro-rata sharing requirements, reversing and vacating in part the bankruptcy court's plan confirmation order.¹¹ The same day, in Ocean Trails CLO VII v. MLN Topco Ltd., the New York Appellate Division, First Department, upheld a nearly identical Mitel Networks uptier where the credit agreement permitted a "purchase" without the "open market" qualifier.¹² Two-word differences in hundreds of pages of credit documentation drove opposite outcomes in billion-dollar disputes. Notably, neither LME ultimately spared its borrower from Chapter 11—Serta filed in January 2023, and Mitel filed in a pre-negotiated case on March 10, 2025, just over two months after the First Department upheld its uptier.

The Wesco/Incora litigation underscores how unsettled the legal terrain remains. In an oral ruling on July 10, 2024 (formalized in a written report and recommendation on January 17, 2025), Judge Marvin Isgur of the United States Bankruptcy Court for the Southern District of Texas concluded that Incora's multi-step uptier "had the effect of" releasing liens under a "falling dominoes" theory of multi-step transactions, even though no single step did so in isolation.¹³ On December 8, 2025, however, Chief Judge Randy Crane of the United States District Court for the Southern District of Texas reversed, rejecting the falling-dominoes framework, declining to find implied "sacred rights" beyond those expressly negotiated, and holding that each amendment must be tested for indenture compliance independently at the time it was executed.¹⁴ For the equity holder, the lesson is not that the courts have closed the LME loophole, but that they are deeply divided on whether to do so.

These rulings have prompted a documentation arms race—"J. Crew blockers," "Serta blockers," and other prophylactic provisions are now standard in next-generation credit agreements—but their efficacy is not yet fully tested in court, and the LME market has adapted by structuring transactions to be inclusive but unequal: most lenders participate, but early-organizing or well-connected lenders receive better economics in exchange for organizing the group.¹⁵

The Governance Question

The governance dimensions of LMEs are less developed in the public discourse than the documentary and litigation dimensions, and they are where the forensic equity investor should focus most intently. Under Delaware law, the directors of a solvent corporation owe their fiduciary duties to the corporation and its stockholders, not to its creditors; only upon actual insolvency do creditors gain standing to sue derivatively for breaches of fiduciary duty.¹⁶ The result is that an LME executed by a solvent but distressed borrower is governed by a fiduciary framework oriented toward shareholders—and yet, in many cases, the transaction is structured in ways that elevate certain creditor groups at the implicit expense of the common shareholders' residual claims on the enterprise.

The use of independent directors in such transactions is widespread but uneven. In sponsor-backed borrowers, where the equity sponsor often has a direct relationship with participating lenders, independent directors with separate counsel are nearly universal. But independence is a continuum, and the effectiveness of an independent director's review depends on the rigor of the process, the quality of the solvency analysis obtained, and the directors' willingness to reject a transaction that the sponsor or management has endorsed. For the public-company equity investor, the proxy statement and the related-party-transaction disclosure are the primary windows into this process, and those disclosures are frequently sparse.

What Institutional Investors Must Demand

In light of these dynamics, Buxton Helmsley believes that any institutional equity investor in a portfolio company with stressed credit metrics, near-term maturity walls, or sponsor-backed capital structures should approach the company's disclosures with a specific set of demands that go beyond what SEC rules and FASB pronouncements require at minimum.

First, the 10-K debt footnote should disclose, with specificity, the consent thresholds required for material amendments to the company's credit agreements and indentures—including the thresholds applicable to lien subordination, collateral release, and the issuance of senior priming debt—and should describe any amendment to those thresholds in the prior fiscal year.

Second, where the company has executed any debt modification within the prior twenty-four months, the ASC 470-50 analysis underlying the modification-versus-extinguishment classification should be summarized, with the key inputs—the change in present value of cash flows, the discount rate used, and the treatment of any new tranches—disclosed at a level of granularity sufficient to permit independent evaluation.

Third, the going-concern discussion in the MD&A should address the company's exposure to LME risk. Where the company has covenant-lite credit documentation, the discussion should describe the consent thresholds for uptiers and drop-downs and the company's view on whether such transactions are reasonably foreseeable in light of the near-term maturity schedule.

Fourth, where the company has executed any uptier or drop-down transaction, the proxy statement should disclose the role of the board's independent directors in approving the transaction, the qualifications and independence of any solvency-opinion provider, and any related-party connections between the equity sponsor and the participating lenders.

Fifth, and most fundamentally, the audit committee should engage with the company's independent registered public accounting firm regarding the consistency of the company's debt-modification accounting with the broader pattern of LME activity in its industry, and should obtain documented audit comfort that the going-concern assessment reflects the relapse risk embedded in the empirical literature.

Conclusion

The LME phenomenon is, at its core, a story about how disclosure obligations have not kept pace with documentary innovation. The credit markets have developed a sophisticated playbook for restructuring without judicial supervision, but the equity markets are still relying on disclosure frameworks designed for a world in which distressed borrowers either filed for bankruptcy or executed pro-rata workouts. The result is a structural information asymmetry that disadvantages the institutional equity holder whose fiduciary obligations demand a level of analytical rigor that the issuer's filings, as currently constructed, do not support.

The Harvard empirical record makes the stakes plain. An LME is not, on average, a successful workout; it is a longer, costlier path to the same destination, with the deferral premium paid by equity holders and non-participating creditors rather than by the participating creditors and sponsors who structure the transaction. Recent appellate decisions may slow the most aggressive variants, but they have also revealed how unsettled the doctrine remains—and the underlying drivers—covenant-lite documentation, sponsor-driven balance sheets, and the cost and execution risk of formal Chapter 11—are not going away. The institutional equity investor who treats the 10-K debt footnote with the same forensic rigor as the income statement, and who insists on the disclosures outlined above, will be better positioned to identify the borrowers whose runways are shorter than they appear—and to act before the doors close.

Referenced Sources:

¹ Oaktree Capital Management, "Oaktree Credit Quarterly 4Q2024: The LME Wave," at Figure 3 (citing Moody's and Barclays Research, as of August 2024), available at https://www.oaktreecapital.com/insights/insight-commentary/market-commentary/oaktree-credit-quarterly-4q2024-the-lme-wave.

² Quinn Emanuel Urquhart & Sullivan LLP, "Creditor-on-Creditor Violence: How Liability Management Exercises Became the New Bankruptcy," Business Litigation Reports, January 1, 2026.

³ Mark Roe & Vasile Rotaru, "Liability Management's Limited Runway: Corporate Restructuring Today," Harvard Law School Bankruptcy Roundtable, February 24, 2026, available at https://bankruptcyroundtable.law.harvard.edu/2026/02/24/liability-managements-limited-runway-corporate-restructuring-today/.

⁴ Quinn Emanuel Urquhart & Sullivan LLP, "Creditor-on-Creditor Violence: How Liability Management Exercises Became the New Bankruptcy," Business Litigation Reports, January 1, 2026.

⁵ Roe & Rotaru, supra note 3.

⁶ Quinn Emanuel Urquhart & Sullivan LLP, "Creditor-on-Creditor Violence: How Liability Management Exercises Became the New Bankruptcy," Business Litigation Reports, January 1, 2026.

⁷ Id.

⁸ Quinn Emanuel Urquhart & Sullivan LLP, "Lead Article: Liability Management Exercises: What They Are and What They Mean for Market Participants," January 15, 2025.

⁹ Financial Accounting Standards Board, Accounting Standards Codification, Topic 470-50 ("Debt — Modifications and Extinguishments"); see FASB ASC 470-50-40-10 (ten-percent cash flow test for substantial modification).

¹⁰ Financial Accounting Standards Board, Accounting Standards Update No. 2014-15, "Presentation of Financial Statements—Going Concern (Subtopic 205-40)" (August 2014); Public Company Accounting Oversight Board, Auditing Standard 2415, "Consideration of an Entity's Ability to Continue as a Going Concern."

¹¹ In re Serta Simmons Bedding, L.L.C., 125 F.4th 555 (5th Cir. Dec. 31, 2024), as amended (Jan. 21, 2025), revised and superseded (Feb. 14, 2025), reh'g denied (Feb. 18, 2025).

¹² Ocean Trails CLO VII v. MLN Topco Ltd., 2024 N.Y. Slip Op. 06660 (App. Div. 1st Dep't Dec. 31, 2024).

¹³ Wesco Aircraft Holdings, Inc. v. SSD Investments Ltd. (In re Wesco Aircraft Holdings, Inc.), Adv. Proc. No. 23-03091 (Bankr. S.D. Tex.) (oral ruling of Judge Marvin Isgur on July 10, 2024; written report and recommendation issued January 17, 2025); see also Cleary Gottlieb Steen & Hamilton LLP, "Bankruptcy Court Finds Incora's Uptier Exchange is a Bust," July 2024.

¹⁴ Wesco Aircraft Holdings, Inc. v. SSD Investments Ltd., No. 4:25-CV-202, 2025 WL 3514358 (S.D. Tex. Dec. 8, 2025) (Crane, C.J.); see also Cleary Gottlieb Steen & Hamilton LLP, "District Court Reverses Bankruptcy Court in Wesco/Incora LME; Finds No Domino Effect in 2022 Uptier Transaction," January 8, 2026; Cadwalader, Wickersham & Taft LLP, "Not All Things Are Sacred: District Court Finds Wesco Aircraft Uptier Transaction Is Lawful," January 7, 2026.

¹⁵ Robert W. Miller, "From Hostile Restructurings to Managed Inequality: How Liability Management Exercises Have Evolved," Oxford Business Law Blog, February 12, 2026.

¹⁶ Quinn Emanuel Urquhart & Sullivan LLP, "Creditor-on-Creditor Violence: How Liability Management Exercises Became the New Bankruptcy," Business Litigation Reports, January 1, 2026.

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