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David Nazar In corporate finance, creditor-on-creditor violence is becoming a concern, especially in distressed debt situations. Appartently, the aggressive tactics employed by certain creditors to improve their position at the expense of others within the same debt structure can disrupt traditional expectations of equal treatment among creditors and have profound implications for debt markets.
David Nazar, a specialist in Europan corporate credit, says that creditor-on-creditor violence is "a civil war amongst creditors for a subset of creditors to get a better outcome than other groups of creditors who start in the same position as them. There will be different recoveries after creditor-on-creditor violence for creditors at the same level of seniority in the credit structure. And even in the same instruments. The weapons of this war are credit documentation and insolvency processes, and those devices are used to transfer recovery from one group to another in distress credit situations."
London-based Ironshield Capital Management is a specialist absolute return investment manager founded in 2007, focusing on European credit markets. Founder and CIO David Nazar, and Ishar Sawhney, senior credit analyst from the US, recently gave an insightful webinar on the topic on Opalesque.
Creditor-on-creditor violence is a phenomenon where creditors use legal mechanisms to gain better debt recovery outcomes at the expense of other creditors, even those in similar positions.
To do so, they use several tactics such as uptearing (moving into senior debt positions), selective creditor engagement, and exploiting credit documentation and insolvency process technicalities.
According to Ishar Sawhney, the trend originated in the US and is now spreading to Europe. 2024 marked a significant year for this practice, especially after interpretations of the EU's 2019 restructuring directive which lowered voting thresholds for restructuring, facilitating these tactics.
Market Dynamics facilitated this phenomenon, such as rising interest rates and debt maturities (2026-2028) which are creating default risks. 47% of lower-rated European high-yield debt matures in the next three years and there is potential for increased restructuring and defaults, especially in 2025.
The managers think that creditor-on-creditor violence will eventually become as prevalent in Europe as it is in the US, even though Europe has historically differentiated from the US in that it has stronger director duties, higher voting thresholds in credit documentation, and more collaborative restructuring approaches.
But all in all, the practice challenges the traditional pari passu principle of equal creditor treatment and introduces significant uncertainty in credit markets.
This phenomenon does not affect any particular industry or sector, says Nazar, as it is primarily about credit documentation and insolvency law. "One aspect is that the more losses that creditors have taken, the more likely they are to be violent and try and get a better recovery that way. And of course, that can be linked to certain sectors and industries where operating performance has declined industry-wide."
Specialist investors know several ways to assess the likelihood of creditor-on-creditor violence before investing in a distressed situation, which he explains.
You can watch this the whole webinar, Creditor-on-Creditor Violence: New Dynamics in Distressed Debt, here:
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