Secondary market stress and covenant pressure: navigating the new distressed landscape.
Introduction
The current macroeconomic landscape is shaped by two reinforcing developments: (i) increasing investor withdrawals from private credit funds, and (ii) rising energy prices driven by geopolitical tensions, including the conflict in Iran. Together, these trends are creating liquidity pressure, repricing of risk, and a growing number of distressed situations.
This blog explores the legal and strategic implications of these developments, focusing on (a) the forced sale of loan participations by private credit funds and the role of distressed debt investors (sometimes referred to in market parlance as ‘vulture funds’ where strategies are more opportunistic or control-driven), and (b) the impact of the energy crisis on financial covenants and restructuring strategies for borrowers, including a jurisdictional perspective where relevant.
Liquidity Pressure in Private Credit and Loan Participation Sales
Investor Withdrawals and Forced Sales
Private credit funds are increasingly facing investor redemptions and constraints on raising new capital. While these funds are typically structured as relatively illiquid vehicles, sustained pressure may force them to dispose of assets — including loan participations.
This dynamic is driving a more active secondary market, where loan exposures are sold at a discount, often under time pressure.
Opportunities for distressed debt investors and Loan-to-Own Strategies
Distressed debt investors are well-positioned to capitalise on these conditions. By acquiring loan participations at a discount, they may pursue loan-to-own strategies, including:
building a blocking position within a lender group;
influencing restructuring negotiations;
exercising control over enforcement decisions; and/or
ultimately converting debt positions into equity through debt-to-equity swaps.
In practice, these investors are often highly strategic, leveraging both contractual rights and collective action dynamics among lenders.
Legal Framework for Loan Transfers
The transfer of loan participations raises several key legal considerations:
Transfer restrictions and consent requirements
Loan agreements typically strike a negotiated balance between the lender's ability to freely transfer its exposure and the borrower's interest in maintaining a stable and controllable lender group. One the one hand transferability is important for liquidity and the functioning of the secondary market, on the other hand borrowers seek to avoid the entry of unsuitable or strategically adverse creditors. In distressed situations, these provisions can become particularly relevant, as consent rights and eligibility criteria may influence which investors are able to acquire positions and at what stage of the process.
Where the facilities agreement is governed by Dutch law, the interpretation of these provisions will generally need to be assessed in accordance with the Haviltex standard. This means that, in addition to the language of the contract, the meaning of the parties could reasonably attribute to the relevant provisions and what they could reasonably expect from each other in the circumstances will be taken into account.
Structure of the transfer
The distinction between assignment, transfer of contract, novation, and sub-participation is critical and should be assessed from a Dutch law perspective prior to the transfer:
Assignment transfers contractual rights (and sometimes obligations) and transfer of contract transfers the entire or part of the legal relationship (including contractual rights and obligations);
Novation replaces a party entirely and could under circumstances lead to the termination of Dutch and other security rights;
Sub-participation creates a contractual exposure without direct privity with the borrower.
Intercreditor arrangements
Existing intercreditor agreements determine ranking, enforcement rights, and decision-making among creditor classes.
The Importance of Robust Legal Due Diligence
For purchasers of distressed loan participations, legal due diligence is essential. Key areas of focus include:
Validity and enforceability of the finance documentation
Are all agreements properly executed and legally binding?
Security package
Are security interests valid, perfected, and enforceable? Have security rights terminated (due to events prior to the transfer)?
What is the ranking and scope of collateral?
Are there jurisdiction-specific perfection requirements?
How can the security be enforced? Are there any jurisdiction-specific restrictions or liability issues in play?
Covenant compliance and defaults
Are there existing events of default (and can enforcement take place on basis thereof)?
Have waivers or other amendments been granted?
Are there hidden or cross-default triggers?
Transfer mechanics and restrictions
Are consents required?
Can transfers be delayed or blocked?
Are there eligibility criteria for transferees?
Insolvency and avoidance risks
Exposure to clawback actions (e.g., actio pauliana in Dutch law);
Risks of transactions being challenged in (pre-)insolvency proceedings;
Recharacterization risks.
Information asymmetry
Buyers often operate with limited access to borrower information, making contractual protections (representations, warranties, indemnities) and pricing adjustments critical.
Without thorough due diligence, an attractive entry discount may conceal significant legal, structural, and enforcement risks.
Energy Crisis and Impact on Financing Documentation
Rising Costs and Cash Flow Pressure
Energy price volatility and increased input costs are putting significant pressure on borrowers, particularly in energy-intensive industries. This results in:
reduced EBITDA margins;
increased leverage ratios;
constrained liquidity positions.
Impact on Financial Covenants
Borrowers are increasingly exposed to:
leverage covenant breaches;
interest coverage covenant breaches;
liquidity shortfalls.
In addition, Material Adverse Change (MAC) clauses may become more relevant, depending on how broadly they are drafted and interpreted.
Other covenant mechanics also come under scrutiny:
EBITDA adjustments and add-backs;
equity cure rights;
testing periods and frequency;
springing covenants in revolving credit facilities.
Strategic Options for Borrowers
Borrowers facing covenant pressure typically consider a range of restructuring and liability management tools:
Covenant Resets
Renegotiation of financial covenants;
Adjustments to EBITDA definitions;
Recalibration of financial ratios to reflect revised projections.
Waivers and Amendments
Temporary waivers for covenant breaches;
Structural amendments to financing terms;
Consent solicitations from lenders.
Amend-and-Extend Transactions
Extension of maturities in exchange for revised pricing or terms;
Alignment of lender incentives with borrower runway.
Additional Liquidity Solutions
New money facilities (often super senior);
Shareholder injections or sponsor support;
Asset disposals to generate liquidity.
Intercreditor Dynamics and Lender Conflicts
Restructurings often involve tensions within the lender group, particularly where:
new distressed investors acquire positions at a discount;
minority lenders seek to block or influence amendments;
majority lenders pursue outcomes that may not align with all stakeholders.
Key mechanisms that may come into play include:
sacred rights provisions (i.e. provisions that protect minority lenders by requiring their consent for certain fundamental amendments);
majority voting thresholds;
disenfranchisement rules;
pro rata sharing and turnover provisions.
The entry of new investors with different return expectations can significantly alter negotiation dynamics.
Legal Considerations in Restructurings
Consent thresholds
Determining the level of lender approval required for amendments or waivers is critical.
Equal treatment principles
Whether certain lenders can be treated differently depends on documentation and intercreditor arrangements.
Liability management transactions
Techniques such as up-tiering, dropdowns, and exchange offers may be used to reshape capital structures, but often raise legal and reputational considerations.
Insolvency frameworks (including the WHOA in the Netherlands)
In relevant jurisdictions, restructuring tools such as the Dutch WHOA (Wet Homologatie Onderhands Akkoord) allow for court-sanctioned restructuring plans that can bind dissenting creditors under certain conditions. This can be a powerful tool in managing fragmented creditor bases and cross-border capital structures.
Convergence of Both Trends
The combination of liquidity pressure in private credit and macroeconomic stress from the energy crisis creates a reinforcing cycle:
Private credit funds sell participations —> new lenders enter at discounted levels;
Borrowers face deteriorating financial performance —> increased covenant pressure;
New lenders may adopt more assertive restructuring or enforcement strategies.
This leads to:
more complex creditor landscapes;
increased likelihood of contested restructurings;
greater emphasis on contractual interpretation and enforcement rights.
Practical Takeaways
For Investors:
Focus not only on pricing but also on legal enforceability and control rights;
Conduct comprehensive due diligence, particularly on security and intercreditor arrangements;
Anticipate limited transparency and price in information asymmetry;
Consider strategic positioning within lender groups (e.g., blocking stakes).
For Borrowers:
Engage with lenders early, ideally before covenant breaches occur;
Stress-test financial projections under adverse energy and cost scenarios;
Prepare for evolving lender compositions and potential shifts in negotiation dynamics;
Consider proactive restructuring options, including amendments, extensions, or formal frameworks such as the WHOA where applicable.
Conclusion
The intersection of private credit market liquidity constraints and ongoing energy-driven economic pressure is reshaping the lending and restructuring landscape. These developments are not occurring in isolation but are mutually reinforcing, creating both opportunities and risks for market participants. Success in this environment requires a combination of financial acumen, legal precision, and strategic foresight. Investors, borrowers, and advisors who understand the interplay between documentation, market dynamics, and restructuring tools will be best positioned to navigate this increasingly complex landscape.
If you would like to discuss how these developments may impact your financing arrangements, feel free to get in touch.
This blog is intended as a general overview and does not constitute legal advice.