This past year was marked by extraordinary deal activity. Record breaking M&A activity drove record breaking private credit activity. Private equity M&A activity was at a substantial high, with over 8,500 deals worth $2.1 trillion, a 60% increase over 2020. Not surprisingly, in this environment, defaults were at all-time lows. The Proskauer Private Credit Default tracker showed an active default rate of approximately 1% at the end of 2021, compared to 3.6% in 2020.

There is a common misconception that lender liability is a thing of the past. However, a recent decision provides a warning to lenders that they can be held liable and face substantial damages if they exercise excessive control over a debtor’s business affairs.

There is a common misconception that lender liability is a thing of the past. However, a recent decision provides a warning to lenders that they can be held liable and face substantial damages if they exercise excessive control over a debtor’s business affairs.

In an opinion that mostly flew under the radar in 2021, Judge Christopher Sontchi from the Bankruptcy Court for the District of Delaware (the “Court”) found investment firm Yucaipa American Alliance Fund I, L.P. and Yucaipa American Alliance (Parallel) Fund I, L.P.

In an opinion that mostly flew under the radar in 2021, Judge Christopher Sontchi from the Bankruptcy Court for the District of Delaware (the “Court”) found a private equity sponsor (the “Sponsor”)¹ liable (and, in some cases, not liable) under various contractual and tort theories in connection with actions the Sponsor took or did not take in its failed efforts to stave off a potential bankruptcy filing of its portfolio company, Allied Systems Holdings, Inc., now known as ASHINC Corporation (“Allied” or the “Company

Overview

Despite the Supreme Court’s rejection of a structured dismissal in 2017,[1] there is a growing trend of bankruptcy courts approving structured dismissals of chapter 11 cases following a successful sale of a debtor’s assets under Section 363 of the Bankruptcy Code.

The Executive Summary provided a short version of the facts. The next few paragraphs provide a longer version, or you can skip to the next section.

Executive Summary

The primary investment thesis of a private credit lender is simple — get the loan repaid at maturity. Private credit lenders do not make loans as a means to acquire their borrower’s business. There are circumstances, however, where private credit lenders must be prepared to take ownership when the borrower is distressed and there is no realistic prospect of near-term loan repayment. Becoming the owner of a borrower’s business may very well be the loan recovery option of last resort.