NEW YORK: An Introduction to Bankruptcy Litigation

The year 2025 is off to a precarious start. The first half of 2025 has already seen volatility in the equity and bond markets. Corporations are uncertain how to proceed in this environment, with many not giving guidance for future growth and pulling back on deploying capital. There has been talk of a recession in 2025 or 2026 with varying degrees of certainty. Simply put, the market, and more precisely the restructuring space, finds itself in uncertain times and facing concerns about a downturn.

A confluence of factors portend increased restructuring activity in the near future. First, the cost of debt remains elevated relative to recent norms and shows no signs of abating. When the Federal Reserve began increasing interest rates in 2022 to combat the post-COVID surge in inflation, many assumed that it would not be long before we returned to the near-zero interest rate environment that typified the credit markets in the wake of the financial crisis. But the Federal Reserve has dashed those expectations, signaling that it plans to take a cautious approach to future rate cuts. Meanwhile, yields on U.S. government treasuries have surged, with the yield on the U.S. ten-year approaching 5% last month—the highest it has been since 2007. Higher borrowing costs will put strain on corporates that need access to credit and make refinancing more difficult as maturities approach.

Second, rising geopolitical tensions and the prospect of a global trade war that would disrupt supply chains is also weighing on companies and investors. While the Trump administration has reached bilateral deals with some of the U.S.’s leading trade partners, these deals have tended to result in higher tariffs for U.S. businesses and consumers, and they have done little to quell the uncertainty fostered by recurring changes in tariff policies. Businesses have accordingly been left to grapple with unforeseen changes in their cost structures, while investors and lenders similarly have needed to recalibrate whether and how to deploy their capital.

Third, the explosion of the private credit industry in recent years has fueled a wave of sponsor-led acquisitions that have pushed leverage to new heights. With corporate defaults still at relatively low rates relative to historic norms, sponsors and lenders alike have developed greater risk tolerance, and as such have shown comfort with imposing substantial leverage on more challenged borrowers. And as traditional lenders subject to greater regulatory oversight have stepped back from more speculative-grade credit, private credit has stepped in to fill the void, supplying nearly limitless financing to borrowers. Much of this credit, however, has been extended under debt documents with minimal covenant protection. These “covenant light” financial instruments have given borrowers and their equity sponsors greater flexibility in addressing capital structure challenges, while restricting the ability of lenders to declare defaults and exercise remedies.

Against this backdrop, 2025 has already seen an increase in defaults and chapter 11 filings. And even when a Chapter 11 bankruptcy has been avoided, that has often been the result of aggressive liability management measures that themselves provide fodder for litigation. For example, there has been a marked increase in so-called “drop-down” financings, whereby a borrower will move a substantial portion of its asset base into an unrestricted subsidiary—thereby releasing those assets from liens and guarantees that attach to entities within the restricted group—and pledging the unrestricted subsidiary as collateral for new financing. In other cases, borrowers have found ways to amend their credit documentation to give improved security or priority to new money lenders, leaving legacy creditors behind and facing the prospect of a diminished recovery should the borrower ultimately fail.

Thus, in the current environment, truly consensual workouts have fallen by the wayside in favor of a winner-takes-all approach to out-of-court restructurings. Unsurprisingly, many of these transactions have resulted in litigation in state and federal courts, including bankruptcy courts, across the country. With creditors and borrowers alike pursuing increasingly creative and aggressive maneuvers to protect their interests at the expense of others, the need for counsel capable of navigating the complex and ever-evolving vagaries of restructuring litigation is paramount.