A transformation is underway in how distressed companies and their creditors negotiate financial restructurings. Liability Management Exercises — commonly known as LMEs — have emerged as a dominant tool for companies seeking to extend liquidity runways without formal bankruptcy proceedings. For middle market dealmakers, understanding these techniques has become essential, as their proliferation reshapes creditor rights, sponsor strategies and the economics of stressed and distressed credit.
“LME activity as a percentage of total defaults and LME volume has increased notably in the last few years,” observes WTW’s October 2025 analysis. “The LME boom kicked off with the rise in interest rates during 2022 and the subsequent struggles of floating rate borrowers in addressing interest payment headwinds.”¹
Understanding the Mechanics: Drop-Downs and Uptiers
LMEs encompass a range of transactions, but two structures have attracted the most attention — and controversy. “The types of LMEs attracting the most attention are drop-down (shifting assets outside of the credit group) and uptier (shifting existing debt into new, super senior tranches of debt) transactions,” explains Cassels.²
Drop-Down Transactions: In a drop-down, “the borrower uses ‘basket capacity’ under its existing covenants to transfer collateral out of the credit group to an ‘unrestricted subsidiary,'” explains Norton Rose Fulbright.³ The transferred assets are then free to secure new senior indebtedness, effectively subordinating existing creditors who retain claims only on the remaining asset base. Notably, these transactions may not require majority creditor consent because they can be executed within existing documentation flexibility.
Uptier Transactions: “In contrast, uptier transactions do not require moving collateral,” notes Quinn Emanuel’s January 2025 analysis. “Instead, the issuer typically acquires the necessary consents from participating lenders in order to amend the governing debt documents to permit the issuance of new notes with a superior claim on the collateral.”⁴ Participating creditors exchange existing debt for new, senior positions while non-participating creditors find themselves subordinated — often dramatically.
The Litigation Landscape: Serta, Wesco, and Evolving Case Law
LMEs have generated substantial litigation as excluded creditors challenge transactions they view as violating their contractual rights. The Serta Simmons case became a landmark: “On December 31, 2024, the U.S. Court of Appeals for the Fifth Circuit issued its decision on Serta, ruling that the company’s debt exchange did not qualify as an open market purchase,” reports Lincoln International.⁵
Yet on the same day, “the New York Supreme Court’s First Appellate Division issued a separate decision ratifying an uptier transaction effectuated by Mitel Networks,” where debt documents did not include the “open market purchase” qualifier that proved decisive in Serta. These divergent outcomes underscore the critical importance of specific documentation language.⁶
The recovery impact can be severe. According to Fitch data cited by WTW, “in 2024, companies that defaulted and previously engaged in an LME had lower recovery rates for first-lien debt by approximately 57%, relative to issuers who did not conduct an LME.”⁷
Private Credit’s Different Dynamic
Notably, LMEs have been largely absent from the private credit market. “The absence of LMEs in the private credit market is unsurprising to industry participants,” observes Lincoln International. “Private credit documents are significantly more restrictive than BSLs in terms of the loose provisions that allow LMEs. Equally important, lender groups in private credit are not only small, but comprised of lenders who maintain close relationships with sponsors in each credit and with one another.”⁸
This relationship dynamic creates different incentives. “These relationships often deter lenders from taking adverse actions against others in the group. As a result, negotiations to ‘kick the can down the road’ can often be completed without resorting to aggressive transactions.”⁹
Ecosystem Implications
For Private Equity Sponsors: “A few years ago, most sponsors would have avoided LME transactions altogether,” Lincoln International notes. “Today, even the most conservative sponsors are considering these transactions as part of their playbooks for managing stressed balance sheets.”¹⁰ Understanding LME mechanics enables sponsors to preserve equity value in stressed situations while managing lender relationships strategically.
For Lenders: Cooperation agreements have emerged as a defensive tool. “As creditor disputes become more common amid rising LMEs, cooperation agreements have reemerged as a useful tool for debt investors,” notes Loomis Sayles. “These agreements formalize collaboration among creditors, preventing any single group from securing preferential terms at the expense of others.”¹¹
For Legal Advisors: LME exposure begins at documentation drafting. Law firms are increasingly focused on “LME ‘blocking’ provisions” in new credit agreements, though the market remains split on their adoption. Understanding which provisions provide meaningful protection versus those that can be circumvented has become critical expertise.
For Investment Bankers: LME advisory has become a specialized practice area. Understanding which transactions are achievable under specific documentation, which creditors might participate or object, and how to structure maximum flexibility requires deep technical expertise that commands premium advisory fees.
For Turnaround Advisors: “Whether it is due to sponsors’ fatigue over supporting these companies for the last four years, concern about investing good money after bad when there is no longer equity value, or the unavailability of capital due to the fund’s life cycle, there have been some cracks starting to form in the relationships between private sponsors and direct lenders,” reports Lincoln International.¹² Turnaround advisors must navigate these dynamics while advocating for their clients’ positions.
Looking Ahead
LMEs appear to be a permanent feature of the credit landscape. “LMEs seem to be here to stay,” concludes Lincoln International. “An economic recession might reduce lenders’ willingness to underwrite these deals or make a liquidity shortfall too large for LMEs to be effective. Even in such a hypothetical, both participating lenders and companies retain strong incentives to implement LME solutions.”¹³
For middle market participants, the imperative is clear: understanding LME mechanics, litigation risks, and defensive strategies has moved from optional expertise to essential knowledge for navigating today’s credit environment.
Sources
¹ WTW, “Liability Management Exercises (LMEs): The ‘quiet default’ that is reshaping credit markets,” October 2025: https://www.wtwco.com/en-us/insights/2025/10/liability-management-exercises-lmes-the-quiet-default-that-is-reshaping-credit-markets
² Cassels, “A Liability Management Prime-r,” January 2025: https://cassels.com/insights/a-liability-management-prime-r/
³ Norton Rose Fulbright, “Liability management transactions: providing new capital and laying the groundwork to cramdown of those left behind”: https://www.nortonrosefulbright.com/en/knowledge/publications/e245aa48/liability-management-transactions
⁴ Quinn Emanuel, “Lead Article: Liability Management Exercises: What They Are and What They Mean for Market Participants,” January 2025: https://www.quinnemanuel.com/the-firm/publications/lead-article-liability-management-exercises-what-they-are-and-what-they-mean-for-market-participants/
⁵ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
⁶ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
⁷ WTW, “Liability Management Exercises,” October 2025: https://www.wtwco.com/en-us/insights/2025/10/liability-management-exercises-lmes-the-quiet-default-that-is-reshaping-credit-markets
⁸ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
⁹ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
¹⁰ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
¹¹ Loomis Sayles, “Liability Management Exercises: Looking Beyond the Headlines”: https://blog.loomissayles.com/liability-management-exercises-looking-beyond-the-headlines
¹² Business Wire / Lincoln International, “The Lincoln Private Market Index Records Another Quarter of Growth in Q2,” August 2025: https://www.businesswire.com/news/home/20250812373268/en/
¹³ Lincoln International, “LME Predictions and Strategies,” August 2025: https://www.lincolninternational.com/perspectives/articles/lme-predictions-and-strategies/
