Structured Deferral: The Promises and Limits of Liability Management Exercises

Introduction

Insolvency law has cycled through punitive, pro-creditor, and debtor-friendly models, reflecting a "legislative cycling" that balances competing interests to attract business.

Within this history, the Liability Management Exercise (LME) entered as a contract-driven restructuring mechanism outside the formal architecture of Chapter 11 in the mid-2010s in the United States, presumably as part of the aftermath of the 2008 Global Financial Crisis (GFC). Early actions that are today characterized as LME structures predate the GFC: in Caesars Entertainment, for instance, the earliest transactions scrutinized upon the Chapter 11 filing dated to 2007. This note reviews the LME’s current position and its purported advantage over traditional bankruptcy, by comparing post-completion outcomes of LMEs against Chapter 11 processes, where research has shown that the former has had success in less than a tenth of its attempts whereas the latter has seen success in more than half of its attempts.

I. LMEs in the world of Insolvency

Some critics view the LME as a mere rebranding of earlier debtor-creditor negotiation mechanisms. The foundational core of an LME lies and in the art of contract interpretation. The shift in capital structures of companies in the 1980s from equity financing to debt financing and from traditional bilateral loan borrowings to syndicated loan structures was the seedling for LME. While some practitioners attribute LME viability to lighter covenants in the loan documents, LMEs continue to see the of use creative interpretations and creditor-on-creditor violence, in essence, structuring adverse scenarios amidst creditors to ensure greater runway for the debtor’s repayment, through aggressive up tiers and dropdowns to bypass the increasingly tighter covenants.  In practice, certain courts with strict contract interpretation and understanding of complex corporate and financial structures have been preferred over others. The prevalence of LMEs has also transcended boundaries, seeing extensive application in the United Kingdom and Europe, many of whom were largely implicated by credit documents governed by New York law. However, no jurisdiction has yet enacted special legislation to regulate LMEs.

II. LMEs, Chapter 11, and the Problem of Repeat Distress

A primary distinction between out-of-court and in-court reorganization processes is the ability to structurally reorganize itself under court supervision, further supplemented with the benefits of moratorium and collective action. Often, companies that are otherwise sound but for certain onerous trade agreements or employee arrangements choose to file Chapter 11 to elect for performance/termination of contracts during insolvency and to renegotiate terms. On the contrary, out-of-court structures do not provide such benefits and further, are unlikely to be successful where there are serious governance or organizational concerns. Therefore, a choice between these mechanisms would need a preliminary consideration of these factors. In this regard, it is also useful to analyze the success of a Chapter 11 versus an LME. Although widely varying in its core objective, it would not amount to a comparison of dissimilar processes, but rather a comparison of potential consecutive process. In an ideal world, the company with the most potential would first approach an LME, a less viable company would approach Chapter 11, and so on toward liquidation. The data however does not reflect this.

Edward Altman coined “Chapter 22” for companies that refile for Chapter 11 after a purportedly successful initial reorganization. Altman also analyzed the likelihood of companies exiting Chapter 11 and thereafter, needing to refile. In a 2014 study covering the period between 1984 and 2013, approximately 272 companies had filed Chapter 11 more than once. Accounting for these refilings as failures of the first proceeding, only 55% of companies were truly successful in their initial Chapter 11. Multiple reasons have been cited for this result, including the baseline viability of the business and change in external circumstances. Although the Chapter 11 process was presumed to correct operational concerns, such concerns remained a significant factor for refiling. The Spirit Airlines “Chapter 22” filing is illustrative in this regard, the airline emerged from Chapter 11 in 2025 having equitized approximately $800 million in debt, only to refile within 190 days, citing fuel costs, intensified competition and a strained business model, and has since ceased operations entirely.

In contrast, only 7% of companies avoided formal bankruptcy within three years of an LME, with the majority refiling within the first year. While all of the reasons attributable to a re-filing in Chapter 11 apply herein as well, the factor of continued corporate governance and operational failures loom large. Essentially, where the capital structure remains the same or is additionally levered and operational changes may or may not have been mandated via covenants, there is little incentive and even if not, further minimal breathing space for an entity to amplify its cash flow and revenue to an extent that de-levers the company. The baseline viability of the business plays the most integral role in both contexts, but the LME's structural failure to deleverage compounds that vulnerability considerably.

Historically, out-of-court procedures were chosen to avoid bankruptcy costs. Today, however, high professional fees for LMEs often rival those of formal proceedings, undermining this cost advantage.

While this does not preclude the possibility of successful LMEs, it does however require extensive diligence and feasibility tests prior to engagement. Failure to evaluate all considerations prior to engaging in an LME, while could be fatal to a company, in the traditional standard of necessitating filing, could also attract extensive scrutiny during and post-bankruptcy as to the bona fides of such transaction. In the “Chapter 22” context, Altman proposes applying the Z-score test for credit scoring of emerging market firms, upon the newly emerged entity after Chapter 11 to test business viability and refiling likelihood. However, an integral component of the Z-score formula is the market value of equity as a measure of the company’s financial cushion, and a post-LME company cannot present actual data to this end, given there is no significant change to the capital structure, underscoring once more the structural limitation of the LME as a durable mechanism.

III. Future of LMEs

Significant LME developments over the last decade have prompted corresponding evolution in contract terms. No outright prohibition has emerged and is unlikely to, given the potential restriction on all pre-filing negotiation. Market players have sought to include efficient LME-blockers in credit documents, often equally met with more creative new structures.  Courts are shifting toward a 'substance-over-form' analysis (STG Logistics), scrutinizing the bona fides of transactions previously shielded by technical contract compliance. These developments collectively mirror the trajectory that ultimately suppressed the hostile takeover scene in the 1980s, and whether the LME is approaching a similar inflection point is the central question for the restructuring practice.

The LME entered insolvency practice as a mechanism to beat bankruptcy. The data suggests it more commonly defers it, often destroying value by stripping collateral and complicating future financing, making liquidation inevitable. The LME's runway, for most companies, is not long enough, and the insolvency regime, moving through the same processes of contract, court considerations and regulation, is closing in.

Oviya Nila Muralidharan is an LLM (International Business Regulation, Litigation and Arbitration) graduate from the NYU School of Law, where she served as a Graduate Editor for the Journal of Law and Business. She is a dual qualified lawyer, in India and England & Wales. Prior to commencing her LLM, she was an Associate in the Disputes Resolution practice at large law firm in India. She graduated with a BA LLB (Hons.) degree from the Tamil Nadu Dr. Ambedkar Law University in 2020.