Capital & Financing

Liability Management Exercises

How a majority of lenders can subordinate the minority, how assets leave a collateral pool without a breach, and what the courts have said about it so far, which is less than the market assumed and is still changing.

  • Expert
  • 13 min total
  • 13 chapters

What decision this helps you make: Whether to participate in, defend against, or execute a liability management transaction, and which document terms would have prevented the one you are looking at.

What this topic is

A liability management exercise is an out-of-court transaction that reorders a borrower's capital structure using capacity that already exists in its credit documents. The three principal structures are the drop-down, which moves assets to a subsidiary outside the credit group and raises new debt against them; the uptier, in which a majority of lenders exchange into new priority debt that subordinates the non-participating minority; and the double-dip, which gives new-money lenders two claims against the same estate.

Why it matters

Distressed exchanges have accounted for a majority of leveraged loan defaults in recent years, and liability management is how most of them were executed. For a lender, the risk is no longer only that the borrower fails. It is that the lenders alongside you agree to a transaction that leaves you behind. Nothing in a classic intercreditor agreement or covenant package addresses that. For a borrower, these transactions can be the only realistic alternative to a filing, and they carry legal, rating and reputational consequences that have to be weighed honestly.

Who should learn it

Credit investors and direct lenders who need to know what their documents permit, sponsors and CFOs considering a restructuring outside court, and advisers assessing whether a transaction will hold up.

What you will understand

  • The mechanics of drop-downs, uptiers and double-dips, step by step
  • What courts have decided to date, where they have divided, and what remains open
  • The specific document terms that prevent each structure
  • How to assess a transaction you are being offered, or defending against, in real time

Prerequisites

Common misconception

"Our documents have a J.Crew blocker, so we are protected." A J.Crew blocker prevents one route: transferring material assets to an unrestricted subsidiary. It does nothing about an uptier exchange, in which no assets move at all and a majority of your own class simply agrees to be repaid ahead of you. It does nothing about a double-dip, which uses intercompany loan and guarantee capacity. And blockers that name specific entity types are routinely circumvented by routes they did not name. Protection against liability management is not a checkbox; it is a set of provisions across the definitions, the payments article and the amendment article, and it has to be assessed as a whole.