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Opinion CLOs
As the US courts become more involved, the number of aggressive LMEs should decrease
by Dagmara Michalczuk
Dagmara Michalczuk
Co-chief investment officer
Tetragon Credit Partners
Loan and CLO investors would be better served by working together
Over the past decade, the US loan market has witnessed a troubling rise in adversarial liability management exercises (LMEs), creating cracks in the traditional foundations of corporate lending. In particular, strategies like ‘up-tier exchanges’ and other forms of unequal treatment of pari-passu lenders in restructurings have led to vastly different recoveries for same-class lenders. The use of such tactics has raised fundamental questions about the fairness and transparency of restructuring processes, and the value of so-called lender ‘sacred rights’ — increasing market uncertainty.
While certain CLO managers assumed that their scale would generally ensure participation on the ‘winning’ side of non-pro rata LMEs, other aggrieved lenders have increasingly sought redress through the courts. Recent rulings in Serta Simmons and ConvergeOne mark a notable shift away from the normalisation of unequal treatment and so-called lender-on-lender violence. These decisions carry important implications not only for future LMEs but for all CLO investors — particularly equity holders, which ultimately bear the costs of LME-related credit losses and the ensuing litigation.
Courts strike down ‘private’ deals
In Serta Simmons, the US Court of Appeals for the Fifth Circuit ruled on 31 December 2024 that the company’s 2020 up-tier priming transaction violated the credit agreement’s rateable treatment provisions and did not qualify as an “open market purchase”. The court found that the new super-priority loans were selectively offered and privately negotiated rather than exposed to true market testing. It also struck down the indemnity previously granted by the company to the “participating lenders”, holding that it violated the bankruptcy code’s equal-treatment requirements. The decision marked a clear rebuke of aggressive liability management strategies that advantaged certain creditors at the expense of others.
In ConvergeOne, on 3 April 2024, a group representing 81% of the company’s first and second lien lenders signed a restructuring support agreement (RSA), one day before the company filed for Chapter 11 in the Southern District of Texas.
The deal wiped out roughly USD 1.6bn of debt and included an equity offering that gave certain majority lenders the exclusive right to backstop the offering at a steep discount. Although the bankruptcy plan was initially approved, minority lenders challenged the outcome, arguing they had been unfairly excluded. On 25 September 2025, the District Court agreed, ruling that the selective allocation of backstop and participation rights violated the bankruptcy code’s equal-treatment requirements. Citing the Serta decision, the court emphasised that any such rights must be offered to all lenders in the same class or opened to a competitive market-based process.
Increasing judicial scrutiny
I believe these decisions collectively mark a shift in how US courts assess unequal treatment of same-class lenders in liability management exercises and bankruptcy proceedings, signalling greater judicial scrutiny of such transactions. They reinforce the long-standing principles of equal treatment and market-based testing that have underpinned corporate lending for decades. In my view, they also heighten the risk of future litigation by excluded or disadvantaged minority lenders, while weakening the liability protections previously relied upon by the advantaged majority participants.
These heightened execution and liability risks may ultimately reduce the prevalence of aggressive non–pro rata LMEs and help narrow recovery disparities among lenders. In the meantime, however, the associated principal losses and litigation costs continue to fall largely on CLO equity investors. Any short-term wins achieved by majority lenders through non–pro rata restructurings may prove fleeting, as appellate rulings could unwind those advantages and require repayment of any ill-gotten gains.
In the long run, both loan and CLO investors would be better served by working together to strengthen credit agreement protections and deal structures, rather than competing in what too often becomes a self-defeating race to be the smallest loser under the guise of being on the ‘winning’ side.
