Explainer

What is a liability management exercise?

A liability management exercise (LME) is an out-of-court transaction, or series of transactions, that reshapes a stressed company’s capital structure using flexibility in its existing debt documents. Companies use them to raise liquidity, push out maturities or capture discount on debt trading below par, without a bankruptcy or insolvency filing.

What sets LMEs apart from an ordinary refinancing is that they often treat creditors of the same class differently. Lenders who take part can gain priority, collateral or guarantees that lenders who stay out do not. The market calls this “creditor-on-creditor violence”.

The main structures

• Drop-down: assets move to a subsidiary outside the existing creditors’ reach, which raises new debt against them.
• Uptier: a majority of lenders amends the documents to create a priority tranche and exchanges into it.
• Pari plus: new debt shares equally in the existing collateral and also gets extra support from outside it.
• Double-dip: new lenders hold two claims against the same credit support.
• Hunter-gatherer: an investor buys discounted debt in the market, then exchanges it with the company for senior secured debt.
• Distressed exchange: an exchange made to avoid default, which rating agencies treat as a selective default.

How they are done

Some LMEs need no creditor consent at all and use capacity already in the documents. The book calls these Deal Away LMEs. Others need a majority of creditors to amend the documents; the book calls these Consensual LMEs.

How lenders respond

After each new structure, lenders write a covenant to stop it: the J.Crew blocker, Serta blocker, Chewy blocker and others. They also organise in advance through cooperation agreements.

Where they happen

Most LMEs, and most of the litigation over them, are in the United States. They now appear in English and European deals, often through intercreditor agreements, and in Canadian borrowers’ US-market debt.