Inside the Legal Arms Race: Creditor-on-Creditor Violence is Reshaping Corporate Finance

Financial Times expert Sujit Indap explains how covenant-light loans enable aggressive restructuring tactics, legal fee explosions, and the breakdown of traditional lending relationships in modern corporate finance.

Discover why lawyers are earning $30 million annually creating new ways for lenders to fight each other, and how this "blood sport" is transforming distressed debt markets.

Key Takeaways

• Creditor-on-creditor violence occurs when lenders with theoretically equal rights fight each other using legal technicalities and majority control tactics
• Covenant-light loans now represent 90% of the leveraged loan market, up from 30% in 2014, enabling more aggressive borrower behavior
• Legal innovations like "uptier exchanges" and "drop downs" allow majority lenders to strip collateral from minority holders through complex restructuring maneuvers
• Private credit was supposed to eliminate these conflicts through smaller, collaborative lending groups but now experiences similar violence due to rapid market growth
• Legal fees have exploded with lawyers charging $2,500 per hour and some deals generating $100 million in professional fees alone
• Social norms preventing aggressive behavior have eroded as repeat player concerns diminish in the massive, impersonal leveraged loan market
• Courts play crucial roles in outcomes, with legal strategies designed around specific judges and jurisdictions to maximize favorable rulings
• Apollo exemplifies private equity firms expanding into credit markets, using regulatory arbitrage to build trillion-dollar alternative asset management businesses

Timeline Overview

• 00:00–12:30 — Creditor Violence Introduction: Definition of creditor-on-creditor violence concept, covenant-light loan evolution from 30% to 90% market share, and theoretical equality versus practical inequality among lenders
• 12:30–25:15 — Legal Mechanics and Techniques: Explanation of uptier exchanges, drop downs, super priority structures, and how majority lenders can disadvantage minority holders through complex restructuring transactions
• 25:15–38:00 — Private Credit Promise and Reality: How private credit was supposed to solve violence through smaller lending groups, social dynamics, and collaborative relationships, but has begun experiencing similar conflicts
• 38:00–50:45 — Document Standardization Breakdown: Arms race among law firms to exploit loose covenant language, creative transaction structuring, and the shift from standardized templates to customized aggressive tactics
• 50:45–63:30 — Court System Gaming and Strategy: Judge shopping between state, federal, and bankruptcy courts, legal choreography planning, and the Serta Simmons case study of competing restructuring proposals
• 63:30–76:15 — Social Norms and Behavioral Changes: Erosion of repeat player constraints, good faith covenant breaches, cooperation agreements, and pro-rata transaction attempts to restore fairness
• 76:15–89:00 — Professional Fee Explosion: Legal costs reaching $2,500 per hour, law firm talent wars, $100 million deal fees, and impact on investment returns driving client pushback
• 89:00–102:15 — Market Structure Evolution: Leveraged lending guidance failures, bank regulation arbitrage, non-bank market growth, and complexity of modern capital structures in bankruptcy
• 102:15–END — Apollo Case Study: Private equity expansion into credit markets, regulatory arbitrage opportunities, trillion-dollar asset management growth, and broader alternative investment industry transformation

The Mechanics of Modern Creditor Warfare

Creditor-on-creditor violence represents a fundamental shift from traditional lending relationships where all lenders holding the same security theoretically enjoyed equal treatment. Sujit Indap illustrates this breakdown through a simple scenario: three lenders each holding portions of a first lien term loan who discover that despite identical contractual language, majority holders can systematically disadvantage minority participants.

The core mechanism involves leveraging majority control to direct restructuring benefits disproportionately. When companies face liquidity challenges, they typically approach existing lenders for new capital rather than filing bankruptcy, which would likely wipe out private equity sponsors. However, the company distributes available value—what Indap calls "cookies"—selectively rather than proportionally.

Instead of splitting $100 million in restructuring value equally among all lenders, majority holders can capture the entire amount while leaving minority lenders behind. The company remains indifferent to this distribution since total value remains constant, but the concentrated benefits create powerful coalition incentives for large lenders.

This dynamic fundamentally undermines the pari passu principle that theoretically governs equal securities. Lenders holding identical instruments with identical language discover their practical rights depend entirely on their relative size and ability to form controlling coalitions rather than contractual protections.

The violence escalates through increasingly complex priority structures. "Super priority" debt sits above existing first lien obligations, but creative lawyers have developed "super super priority" and "1.5 lien" instruments that create multiple gradations between traditional senior and subordinate positions.

These innovations create what Indap describes as "Frankenstein capital structures" where bankruptcy courts struggle to untangle competing claims among supposedly senior lenders. Each restructuring adds new layers of complexity that future reorganizations must navigate, creating cascading legal and administrative costs.

The Covenant-Light Revolution and Its Consequences

The explosive growth of covenant-light loans from 30% of the leveraged loan market in 2014 to approximately 90% today represents one of the most significant structural changes in corporate finance. This transformation has fundamentally altered the balance of power between borrowers and lenders by eliminating traditional protective restrictions.

Covenant-light structures provide companies and their private equity sponsors extraordinary flexibility to restructure assets, raise new capital, and modify terms without traditional lender approval processes. This flexibility proves particularly valuable during financial stress when companies need rapid access to new funding sources.

However, this flexibility comes at the expense of lender protection and recovery rates. Historical leverage loan recovery rates of 80-90% reflected substantial loss absorption from subordinate securities like high-yield bonds. Modern loan-only capital structures eliminate this cushion, creating higher risk profiles for supposedly senior debt holders.

The market's evolution toward covenant-light structures reflects supply and demand dynamics where borrowers can easily replace restrictive lenders with more accommodating alternatives. Individual lenders attempting to negotiate tighter terms simply get bypassed by competitors willing to accept looser documentation.

This creates a race-to-the-bottom dynamic where market-wide standards deteriorate despite individual lender preferences for stronger protections. The collective action problem prevents effective resistance to increasingly borrower-friendly terms even when most lenders would prefer tighter covenants.

The regulatory response through leverage lending guidance proved ineffective due to regulatory arbitrage. Banks subject to lending restrictions were replaced by non-bank lenders, private credit funds, and institutions like Jefferies that escaped regulatory oversight, allowing covenant deterioration to continue unabated.

Legal Innovation and the Arms Race

The legal profession has responded to covenant-light structures by developing increasingly sophisticated techniques to exploit document ambiguities and create new sources of competitive advantage. Law firms now operate "laboratories" where attorneys design complex transaction structures that combine multiple unusual elements to achieve desired outcomes.

The "uptier exchange" represents one prominent innovation where existing lenders exchange their current positions for new securities with enhanced priority and different terms. This technique requires a series of coordinated steps that individually might seem innocuous but collectively achieve dramatic collateral reallocation.

"Drop down" transactions involve moving valuable assets from the borrowing entity to subsidiary structures where existing lenders cannot reach them. Apollo and Angelo Gordon famously competed with uptier exchange proponents using drop down techniques in the Serta Simmons restructuring, demonstrating alternative approaches to similar objectives.

The "double dip" and other exotic structures create even more complex arrangements where single assets can theoretically secure multiple sets of obligations through intricate corporate structures and cross-guarantees. These innovations require extensive legal choreography to implement successfully.

Legal strategies now encompass entire transaction lifecycles from initial documentation through ultimate litigation outcomes. Attorneys design documents with specific court jurisdictions in mind, anticipating how different judges might interpret contested language and structuring transactions to maximize favorable venue possibilities.

This arms race has transformed legal practice from standardized template work to highly customized strategic planning. Individual transactions require unprecedented legal complexity as attorneys attempt to anticipate and counter opposing strategies while exploiting newly discovered document vulnerabilities.

Private Credit's Broken Promise

Private credit markets were supposed to eliminate creditor-on-creditor violence through smaller, more collaborative lending groups that maintained personal relationships and repeat player dynamics. The theory suggested that intimate negotiations among three to five lenders would prevent the adversarial dynamics plaguing widely syndicated markets.

The social dynamics argument held that private equity sponsors wouldn't antagonize small groups of relationship lenders since future financing needs would depend on maintaining positive relationships. Unlike anonymous institutional investors in massive syndications, private credit lenders could effectively discipline bad behavior through future deal exclusion.

However, private credit markets have begun experiencing their own creditor violence as the sector has grown rapidly and institutionalized. The Plural Sight case, while relatively mild compared to leveraged loan conflicts, demonstrated that even private credit relationships can break down when financial pressures intensify.

The fundamental issue involves scale and institutionalization. As private credit markets have grown to rival traditional leveraged lending, the personal relationships and repeat player dynamics that supposedly prevented aggressive behavior have weakened significantly.

Moreover, the same legal techniques developed for syndicated markets prove applicable to private credit structures. Law firms readily adapt uptier exchanges, drop downs, and other innovations to smaller lending groups when economic incentives align with aggressive restructuring strategies.

The cooperation agreements now emerging in private credit represent explicit attempts to recreate the collaborative dynamics that were supposed to exist naturally. These contracts require all lenders to negotiate collectively rather than allowing sponsors to divide coalitions, acknowledging that informal social pressures proved insufficient.

Court System Gaming and Strategic Litigation

The judicial system has become an integral component of creditor-on-creditor violence strategies, with legal teams designing entire transaction structures around anticipated court outcomes and specific judge preferences. This judicial gaming represents a sophisticated evolution beyond simple document interpretation toward comprehensive strategic planning.

Most leverage loan documentation uses New York state law, but actual litigation can occur in New York state courts, federal courts interpreting New York law, or bankruptcy courts with their own specialized procedures and powers. Each venue offers different procedural advantages and timeline expectations that influence strategic choices.

The Serta Simmons case exemplifies this judicial complexity. Competing lender groups proposed alternative restructuring approaches—an uptier exchange versus a drop down—with each believing their technique offered better legal positioning. The company essentially conducted an auction between competing legal strategies.

When Serta ultimately filed bankruptcy, the winning lender group sought bankruptcy court validation of their transaction, leveraging the court's speed and specialized expertise to finalize their advantage over state court litigation. The Houston bankruptcy court's rapid approval sealed the transaction before appellate review could occur.

Strategic forum shopping extends beyond simple venue selection to timing coordination. State and federal courts move slowly while bankruptcy courts operate rapidly, creating opportunities to structure transactions that leverage these speed differentials to create fait accompli situations.

The choreography involves anticipating opponent responses and designing sequences that maximize favorable procedural positioning. Legal teams literally game out chess-like move sequences to optimize their position regardless of underlying legal merits, transforming litigation from dispute resolution into strategic warfare.

The Professional Fee Explosion

The legal arms race has generated unprecedented fee inflation that now meaningfully impacts investment returns and deal economics. Individual lawyers command $2,500 per hour rates while moving between firms like professional athletes, seeking higher compensation for specialized creditor violence expertise.

Law firm talent wars reflect the concentrated value of attorneys who understand complex restructuring techniques and can successfully navigate adversarial negotiations. These specialists can command $20-30 million annual compensation packages, representing dramatic increases from traditional law firm partnership economics.

The WeWork bankruptcy generated approximately $100 million in professional fees for what Indap describes as a "relatively small company," demonstrating how legal complexity can consume substantial portions of enterprise value. These costs directly reduce recoveries for all stakeholders regardless of litigation outcomes.

Transparency requirements in bankruptcy proceedings reveal fee structures that would otherwise remain confidential, shocking investors who discover how much of their returns flows to professional service providers rather than underlying business performance.

Investment funds increasingly focus on limiting professional service costs as a distinct portfolio management challenge. The fees have grown sufficiently large that they materially affect fund returns, forcing investors to consider legal budget management alongside traditional investment analysis.

Success fees for "standard" restructuring work can reach $50 million for individual engagements, representing substantial wealth transfers from investors to professional service providers. These costs create incentives for advisors to encourage aggressive strategies that generate higher fees regardless of client benefits.

Market Structure Evolution and Apollo's Expansion

Apollo exemplifies the broader transformation of alternative asset management, where firms originally focused on leveraged buyouts have expanded into credit markets that offer greater scalability and fee generation opportunities. This evolution reflects both regulatory arbitrage and natural market development.

Traditional private equity faces inherent scale limitations since firms can only acquire and manage finite numbers of portfolio companies. Credit markets offer virtually unlimited expansion possibilities as banks retreat from complex lending due to post-financial crisis regulatory constraints.

Apollo's heritage in credit markets, tracing back to Drexel Burnham Lambert, positioned the firm to capitalize on banking sector consolidation and regulatory restrictions. Their expertise in complex negotiations, valuation, and creative structuring translates effectively from equity to debt investments.

The regulatory arbitrage component involves non-bank lenders operating with greater flexibility than traditional banks subject to leverage lending guidance and other restrictions. This regulatory differential creates competitive advantages for firms like Apollo in complex restructuring situations.

Credit market expansion enables trillion-dollar asset management scale that would be impossible through equity-only strategies. The broader addressable market allows firms to deploy more capital across more transactions while generating management fees on larger asset bases.

This transformation has systemic implications as alternative asset managers increasingly replace traditional banks in corporate financing relationships. The shift concentrates financial expertise among fewer, larger institutions while potentially reducing system-wide diversification and stability mechanisms.

Common Questions

Q: What exactly constitutes creditor-on-creditor violence in corporate finance?
A: Violence occurs when lenders holding theoretically equal securities use legal technicalities and majority control to disadvantage minority holders in restructuring situations, despite identical contractual rights.

Q: How did covenant-light loans enable more aggressive creditor behavior?
A: Covenant-light structures eliminate traditional lender protections, giving borrowers and sponsors flexibility to restructure assets and raise capital without approval processes that previously prevented aggressive tactics.

Q: Why hasn't private credit solved creditor violence problems as originally promised?
A: Private credit markets have grown and institutionalized rapidly, weakening the personal relationships and repeat player dynamics that were supposed to prevent aggressive behavior in smaller lending groups.

Q: How do legal fees impact investment returns in distressed debt situations?
A: Professional fees have exploded to levels where individual lawyers earn $2,500 per hour and single deals generate $100 million in legal costs, materially reducing investor recoveries.

Q: What role do courts play in creditor-on-creditor violence outcomes?
A: Legal teams design entire strategies around specific judges and jurisdictions, using forum shopping and timing coordination to maximize procedural advantages regardless of underlying legal merits.

The creditor-on-creditor violence phenomenon reveals how financial innovation, regulatory changes, and legal creativity can fundamentally transform market relationships in ways that individual participants cannot effectively resist. The resulting system prioritizes legal sophistication over traditional investment analysis while generating substantial costs that reduce returns for all stakeholders.

Understanding these dynamics becomes essential for anyone participating in leveraged finance markets, whether as investors, borrowers, or advisors navigating an increasingly complex and adversarial landscape.