In the low interest rate environment that followed the Great Recession, a fanatical demand for high-yield investments provided private equity firms an opportunity. Newfound borrower leverage facilitated credit documents with few creditor safeguards and various loopholes. Borrowers subject to these “sponsor-favorable” terms now had options in times of financial distress. More specifically, they had the option to strike first.
Utilization of coercive exchanges began in earnest around 2015 and has since flourished. Unmonitored portfolio companies experiencing financial distress now regularly rely on questionable interpretations of ambiguous contractual provisions to surreptitiously move assets away from creditors’ collateral baskets and subordinate lenders. These unprecedented acts of financial war are pure, self-interested behavior designed to seize and redistribute value. Creditors in this multiplayer prisoner’s dilemma have two choices: (i) cooperate with its creditor group and attempt to prevail by securing a majority coalition, or (ii) defect and work with the borrower who promises to share some of the spoils of victory.
Scholars have thoroughly detailed private equity’s plan of attack. But what is missing is an exploration of creditor countermeasures to these new coercive exchanges. This Essay attempts to conceptualize the decision to coordinate and analyze the benefits and costs of cooperation. Further, this Essay explores the prevalent terms and basic design of cooperation agreements based on my unique review of a number of private disputes.
The possibility of opportunistic behavior casts a long shadow in these battles of financial titans. The benefits of a coordinated response are clear, but there still exist many obstacles, including threats of free riding. And borrowers have myriad weapons in their arsenal to splinter adversary groups. In choosing between cooperation and defection, creditors know there may be no honor among thieves.
“The first principle of Economics is that every agent is actuated only by self-interest. [But invariably an agent must choose to act] without, or with, the consent of others affected by his actions. In [a] wide sense, the first species of actions may be called war; the second contract.”
Samir D. Parikh, Creditors Strike Back: The Return of the Cooperation Agreement, 73 Duke Law Journal Online 1-33 (2023)