Creditor-on-creditor violence heats up as lenders weaponise co-ops

The distressed-debt fights known as “creditor-on-creditor violence” are escalating, as majority lender groups deploy more coercive tactics and excluded creditors increasingly fight back in court.

There is a constant evolution in this part of the market, Chris Gartman, a partner in Hughes Hubbard’s Corporate Reorganization & Bankruptcy group, said as borrowers and their private equity sponsors keep looking for new tools to avoid bankruptcy. But Gartman says those using liability management exercises (LME) often end up in bankruptcy anyway.

Indeed, a study from the University of Oxford this year found that more than 80 per cent of 89 LME transactions that took place in recent years defaulted on their debts within 36 months, with many going into formal bankruptcy.

And a recent Moody’s note found that where there had been a fight between creditors, the lenders that lost ended up recovering just 14 cents on the dollar versus a recovery of 57 cents for senior lenders to a company that went into bankruptcy without an LME transaction.

The sharpest escalation is in cooperation agreements, pacts binding lenders to act as a bloc. Doug Mintz, a restructuring partner at Cadwalader, said the pendulum has “swung toward the majority groups pushing more aggressively through the use of coercive co-ops to bring those that are excluded to heel quicker and more efficiently than before”.

For example, co-ops admit second or third-tier creditors but introduce a carve-out on fees and expenses that seeks to reimburse the steering committee for doing the heavy lifting. An outer-ring member, Mintz said, is “consenting to the steering committee packing any and all value it wants to into those fees” and “if they sign they’re throwing their lot entirely in with the majority”.

Another development, Gartman said, is litigating strategically by buying in only after the LME has closed.

“Some of these lenders are buying in after the liability management transaction has been done, and then litigating,” he said.

The standard argument against such litigation is that the funds bought in knowingly – as is the case in Trinseo, reportedly. Minority lenders are challenging the company’s LME in 2023, but in a motion filed in June, the defendants have claimed that the leader of the minority lender group, CastleKnight, purchased its position with full notice of “the very contractual provisions and transactions it now seeks to nullify”.

Gartman said that more cases are proceeding past the motion-to-dismiss stage, and bankruptcy courts are increasingly appointing examiners to probe these transactions.

“You need to make sure that you’re tracking everything. The deal documents, the litigation element, the courts and the judges that are issuing those decisions,” Gartman said.

Mintz noted that for excluded lenders, those who push back – with a strategy and good counsel – “tend to get greater recoveries than those who just take whatever the steering committee hands them”.

Elsewhere, Gartman sees an increasing shift to pro-rata transactions.

“That means that most or all the lenders are participating in the LME,” he added. “A lot of the litigation that has been pursued to date has been about non-pro-rata deals because we’re talking about deals that were done several years ago that are now being challenged. But I think that there’s less of an appetite for mass litigation so there is more of a shift.”