Non-Pro-Rata Rewards In-Court: An Attempt to Loot Bankruptcy

Welcome to the 199th Pari Passu Newsletter.

Throughout 2025, we continued to observe lenders exhausting any and all options out-of-court to achieve non-pro-rata (NPR) economics in an ever-changing LME landscape, as discussed in our coverage of the 2025 Distressed Investing Conference and seen quantitatively in our LME Tracker. Given that inclusion of “out-group” participants in an LME typically dilutes economics for “in-group” creditors, creditors will almost always have an incentive to pursue NPR outcomes that exclude “out-group” creditors from a portion of distributable value. Historically, creditors have attempted to achieve these favorable outcomes out-of-court via LMEs. However, as evolving credit agreement language and LME blockers have constrained the ability to achieve NPR economics out-of-court, creditors have increasingly turned to in-court mechanisms during the bankruptcy process.

In today’s edition, we have prepared a comprehensive write-up to compare the legal mechanisms at play in three recent 2025 in-court attempts to achieve NPR economics: ATD, ConvergeOne, and Anthology. Similar to the Distressed Investing Conference recap, this write-up will encompass a heavier focus on the legal interpretations and judicial commentary of each case.

We are excited to dive into our legal analysis and the implications of this 2025 trilogy. To produce a more accurate and refined analysis, our analyst team worked with legal expert John McAdams, Counsel at Pallas Partners (US) LLP in New York. So let’s dive in!

The rapid expansion of the leveraged credit market over the past two decades shifted bargaining power towards borrowers, leading to the rise of covenant-lite structures, which most frequently refer to affirmative maintenance covenants such as minimum interest coverage or maximum leverage. Since 2000, the leveraged credit market has grown exponentially from $0.8tn to nearly $5.5tn in 2024, backed by strong issuance volumes ($1.2tn in 2024) from institutional investors seeking yield. This massive expansion of the leveraged credit markets made capital abundant and competing for deployment, shifting the bargaining power to borrowers and loosening provisions in credit documents. To continue to deploy capital, lenders accepted weaker protections, resulting in the proliferation of covenant-lite credit documentation. The growth of covenant-lite loan products has given sponsors and companies more flexibility to stay solvent, as the percentage of covenant-lite loans in total leveraged loan issuance has increased from 1% to 90% from 2000 to 2024. In other words, when capital and lenders are abundant at the negotiation table with a borrower, the negotiating leverage tends to favor the borrower/debtor.

Why was the leveraged credit market growing exponentially? A key driver of non-investment-grade credit markets was private equity expansion, as each LBO generally requires significant debt financing, providing a steady stream of issuances for high-yield and leveraged loan investors. When any of these LBOs became stressed, sponsors took advantage of these loosened provisions to extend runway for their stressed or distressed portfolio companies, rather than recognizing massive losses on their equity investments. Although it’s easy to presume that the J. Crew IP dropdown in 2016 or the Serta uptier in 2020 represented the first forms of liability management transactions, sponsors have been using forms of liability management for over a decade. An infamous example is Apollo and TPG’s PropCo/OpCo structure at Caesars Entertainment, which effectively isolated Caesars' valuable collateral in a separate, non-guarantor PropCo, away from its highly indebted OpCo, where most of its creditors resided. [1] 

In this looser contractual environment, as we all know, creditors increasingly use partial recapitalizations known as liability management exercises (LMEs) to extract non-pro-rata (NPR) economics at the expense of other lenders. At the outset of J. Crew and Serta, distressed creditors sought to take advantage of broad carveouts or expressed exceptions (i.e., open market purchase exception) to bypass pro rata treatment provisions requiring ratable sharing of payments or other forms of loan consideration among lenders in a given class. Distressed creditors took advantage of loose credit documentation out-of-court and amplified their recovery via non-pro-rata LMEs at the expense of other creditors, paving the way to the “creditor-on-creditor violence” trend. These transactions skew recovery towards the in-group (i.e., a select group of exclusive creditors obtaining an outsized slice of the pie), and away from the out-group (i.e., the group of creditors left out of the agreement). The “aggressiveness” of these LME transactions varied based on the disparity of in-group vs out-group economics and the general level of participation across the lender groups. Early implementations of LME technologies (i.e., Incora, Serta, Envision, etc.) were viewed to be aggressive as in-group participating creditors of LMEs amplified their recovery in a zero-sum game of value (at the loss of non-participating creditors). [2] [3]

Early LME structures were enabled by flexible amendment provisions. For example, pro rata sharing provisions, which are “fair share” provisions in credit agreements that require economic distribution proportional to a lender’s claim within a legal class, were oftentimes amendable with a simple majority of lender consent. At this point, pro rata sharing was not commonly treated as a “sacred right,” which prohibits terms in a credit agreement from being amended without the solicitation of each affected lender’s consent (or sometimes 90% consent, rather than unanimous). Thus, a majority group of lenders could band together to amend the pro rata sharing provision in the syndicated loan agreement without the consent of affected minority lenders, leaving room for value extraction at the minority lenders’ expense. [2]

However, although NPR economics persist out-of-court, rising litigation risk and coordination among creditors have pushed LMEs toward more inclusive structures with reduced economic disparity. While the economics of aggressive LMEs seemed attractive for in-group creditors, these LMEs faced heightened litigation risk from excluded creditors who litigated to claw back the value extracted by participating in-group creditors. Regardless of whether these appeals were successful, the litigation overhang of these early aggressive transactions became both burdensome for the debtor and expensive for participating creditors. Additionally, the risk of excluded lenders suing to unwind these transactions if the enterprise later filed for Chapter 11 was impractical and disruptive for both parties. In fact, Incora’s uptier continues to go through an exhaustive legal tug-of-war since the transaction in 2022. Consequently, in the backdrop of the rise of cooperation agreements (which we covered here and here), the litigation threat incentivized lenders to engage in “less aggressive” LMEs with higher participation. For example, Oregon Tool, a February 2025 extend-and-exchange LME, is highlighted by high participation (99% of TLB lenders and 81% of unsecured noteholders) and minimal in-group vs out-group economic differential (exchange rates of 88.75 cents for AHG and 82 cents for non-AHG).

These recent LMEs reveal that modern out-of-court recapitalizations are marked by higher inclusivity and are often offered to all creditors and minimize the economic disparity between in-group and out-group creditors (for data on in-group vs. out-group economics, our clients can refer to our LME Tracker). To clarify, NPR economics persist out-of-court, but largely with higher participation from creditors to reduce litigation risk. For example, a common technique is to offer the opportunity to participate to all creditors, but on differential terms, resulting in an outcome with high participation but likely several disgruntled participants. The aforementioned Oregon Tool LME and many of our recent LME coverage are examples of this modern technique. Moreover, pro rata sharing provisions were increasingly elevated to a sacred right, typically requiring unanimous or 90% consent for any amendment that raises the difficulty in achieving the most aggressive NPR outcomes due to the difficulty in soliciting consent from minority lenders. In other words, achieving full NPR economics at the expense of minority lenders became increasingly difficult. [3]

Ultimately, lenders have faced increasing difficulty in extracting enhanced economics out-of-court as contracting frictions over new and existing LME technologies persist. For example, occurrences of Serta blockers, which are designed to prohibit transactions that effectively subordinate or alter priority without affected lenders’ consent, in new issue loan agreements tripled to 90% after Serta Simmons’ 2020 uptier exchange. Though Serta represents a relatively strong market response, the threat of litigation, coupled with new contracting frictions on LMEs and defensive co-operation agreements ahead of distressed situations, has weakened economics out-of-court for opportunistic lenders (and sponsors). This is further exacerbated out-of-court by tightened post-LME credit documents that arise from out-of-court dynamics of LME negotiations wherein the sponsors and participating lenders expect the post-LME pro-forma documentation to be materially tighter (constrain incurrence, amendment flexibility, cap exchange mechanics, etc). The tighter language makes effectuating subsequent LMEs more difficult and locks in participating lenders’ superior position achieved in the LME. This is important because participating lenders need to protect themselves from future value leakage by the dissenting minority. Thus, any further recapitalization typically requires broader creditor buy-in (such as in City Brewing) or must be done in-court. This reality of post-LME docs raises the difficulty in achieving subsequent LMEs, wherein creditors may attempt to achieve favorable NPR economics again. In our Weight Watchers write-up, we discussed how this litigation threat can spill over into Chapter 11 to affect the debtor’s and creditors’ decisions in bankruptcy. [4]

As out-of-court LMEs face increasing contractual and litigation constraints, creditors are testing in-court mechanisms to extract NPR economics, but courts are beginning to limit these strategies, especially at the plan stage, while leaving more flexibility at the DIP stage. Whether this trend to more Chapter 11s is driven by the relative attractiveness of in-court tools or simply reflects the exhaustion of out-of-court options following the 2022-2024 wave of LMEs remains an open question. However, both factors appear to be at play as contractual provisions tighten and the marginal benefit of pursuing NPR outcomes out-of-court has slightly diminished, prompting creditors to test in-court alternatives. Once companies deploy their “one-shot” LME to extend runway and attempt an operational turnaround, post-LME documentation tends to become significantly tighter to lock in the participating lenders’ superior position. Thus, without another LME option today, many companies of the 2022-2024 LME batch that are consistently struggling will file with creditors seeking NPR economics, especially as distressed debt trades down further and lenders become more aggressive closer to filing. Irrespective of the exact underlying cause, practitioners are expecting a wave of contentious Chapter 11s in 2026 and beyond.

In this write-up, we will discuss two key avenues that lenders have attempted to exploit for NPR rewards in Chapter 11: (1) NPR roll-ups of debtor-in-possession (DIP) financing and (2) backstop arrangements for equity rights offerings (EROs). [5]

In our discussion of in-court attempts to achieve NPR rewards, we will discuss three recent Chapter 11 cases: American Tire Distributors, ConvergeOne, and Anthology. This write-up will focus on the legal framework involved across the various cases and their implications, as opposed to a deep dive into the entire situation (business model, industry, path to distress, and more). It’s time to take off our banker hats and put on our lawyer hats for this write-up. 

One of the primary in-court tools creditors have used to extract NPR economics is DIP financing, which offers both economic upside and structural advantages early in the Chapter 11 process. This section examines the evolution of DIP financing from its origins as a court-sanctioned liquidity lifeline into a tactical tool for (1) securing outsized risk-adjusted returns and (2) asserting creditor control.

While traditional DIPs were designed to maintain operational stability and incentivize lending through risk-adjusted premiums, the modern landscape has shifted. Attractive risk-adjusted returns have made DIP financing a particularly compelling avenue for creditors to capture enhanced economics in bankruptcy. Today’s facilities frequently feature interest rates exceeding SOFR + 800bps, compounded by a complex stack of OID, exit fees, backstop premiums, and milestone bonuses. In 2025, effective yields have surged to 15% or higher, reflecting a market where prepetition secured lenders leverage their position as "lenders of last resort" to extract maximum economic concessions [7]. Although DIPs are rarely impaired (receive <100% recovery), investing in DIPs does not come without risk. In fact, Circuit City, Toys R Us, and First Brands Group are all cases in which the DIP has been impaired. As a form of emergency liquidity, DIPs are often approved at the outset of the Chapter 11 process and have different legal standards than the traditional “plan stage” of the bankruptcy. The DIP approval occurs through first-day motions or on an interim basis where there is minimal judicial scrutiny, focusing on obtaining enough liquidity for the debtor to stabilize operations before the “plan stage”.  Once the more extended “plan stage” begins, judicial scrutiny (especially for excessive or “unfair” rewards to certain lenders) increases as this stage is strictly governed by the confirmation standards, as the ultimate allocation of distributable value is determined. Notably, these confirmation standards include the equal treatment clause of similarly situated creditors pursuant to Section 1123(a)(4) of the bankruptcy code, which we will discuss more in C1 and Anthology. [6] [7]

(1) Beyond pricing, DIP structures have become a vehicle for prepetition lenders to fortify their standing by elevating their claims via roll-ups to capture NPR advantages over similarly situated lenders. The "roll-up", which has become increasingly common in filings and disproportionate to new money portions, allows creditors to reclassify prepetition debt into superpriority DIP claims. To put simply, a DIP roll-up allows a legacy secured lender to take their “old claim” and raise its priority in the capital structure above all prepetition lenders. For example, assume a prepetition capital structure with $300mm of term loans. If the debtor obtains a $200mm DIP with a 1:1 roll-up to new-money ratio ($100mm each), then $100mm of the existing term loans are rolled into the DIP, effectively priming the remaining $200mm of prepetition term loans and creating a capital structure with the $200mm DIP senior to the primed $200mm term loans. Nevertheless, despite its prevalence, DIP roll-ups are not presumptively permissible in bankruptcy and are, in fact, closely scrutinized by the judge due to concerns with contractual pro-rata sharing provisions and judicial fairness standards. Absent a clear new-money justification or creditor consent, bypassing similarly situated secured lenders can be viewed as favoritism in favor of the priming creditors. 

However, unlike plan-stage distributions of distributable value, DIP financing is evaluated under more flexible, judicially developed standards, creating an initial window for creditors to pursue these structures. To continue our discussion on (1), while courts often consider whether the DIP is a product of competitive bidding and reflects the sound business judgment standard, the reality often falls short of this ideal. After all, who wouldn’t want to fund a AAA credit instrument that is priced like it’s CCC? As 9fin legal analyst Lara Sheikh highlights, comprehensive market testing is crucial to demonstrate that a debtor has secured the best available terms [41]. However, the time-sensitive nature of insolvency often complicates this assessment and limits the number of creditors canvassed for interest in funding the DIP. As we will see in the ATD and Anthology cases, this can lead to discrepancies between the interim (temporary approval of an early order to give the debtor immediate liquidity) and final court orders (permanent approval usually ~30 days after filing) for DIPs. In other words, a DIP structure approved early in the proceeding through the interim order may be different in the final order. In practice, the time-sensitive nature of DIP financing combined with the use of roll-ups often results in facilities being funded primarily by prepetition creditors rather than third-party lenders. Since a roll-up does not cost the company anything and is effectively a cost-free sweetener to prepetition creditors, it is difficult for third parties to compete with an existing creditor proposing a roll-up. Additionally, debtors typically look first to prepetition creditors with existing relationships for liquidity support. Together, both of these factors practically limit “total competition” for DIPs. 

From the court’s perspective, approving a DIP order with a prepetition lender group is more timely than marketing the DIP to third parties, who then have to sign NDAs, conduct diligence, and provide bids (the process can take weeks). For bankruptcy courts, this evolution presents a delicate tradeoff: timely DIP financing remains essential to preserve going-concern value, but its structure increasingly favors prepetition lenders and influences plan outcomes. Consequently, DIPs featuring aggressive, lucrative fees and roll-up ratios (larger prepetition roll-ups and relatively less new money) are increasingly permitted, provided they offer new liquidity and a fair process as determined by the bankruptcy court. To sum up, the urgency of DIP financing and structural advantages such as roll-ups often result in facilities being dominated by prepetition creditors, limiting meaningful competition from third-party lenders. This permits prepetition DIP lenders to receive enhanced recoveries on legacy exposure via lucrative economics with significant roll-ups. [8] [9] [37]

(2) DIPs are also starting to come with more strings attached. Lenders now commonly embed restrictive control mechanisms in DIP facilities that force companies to sell assets or confirm a restructuring plan quickly. This shortened timeline reduces the time a company has to stabilize its business and explore alternatives, reducing debtor operational flexibility. DIP lenders also gain significant power through superpriority liens and specific governance provisions, which allow them to mandate or veto key decisions before alternative stakeholders can mobilize. These and similar provisions may push companies into fast, pre-determined outcomes rather than negotiated solutions. At the same time, DIP lenders can leverage their DIP roll-ups for a subsequent larger credit bid. This gives DIP lenders additional power to engineer restructuring paths that align with their own exit strategies and recovery goals. [7] [10]

The ATD case is instructive as an early example of creditors attempting to use DIP financing to extract NPR economics and the court’s willingness to initially permit, but ultimately constrain, those efforts. As discussed in the prior section, the ATD case is a key example of prepetition creditors negotiating NPR economics with massive DIP roll-ups that could be used advantageously for a larger credit bid. Given our previous write-up on ATD, we will focus on the legal discussions of the case rather than the other technical content. Nevertheless, for a brief review, ATD filed an RSA in October 2024 that contemplated a $1.1bn DIP Term Loan, which included $250mm of new money and the remaining $842mm as a roll-up of prepetition claims (3.4:1 roll-up to new money ratio!). Notably, the DIP, approved on an interim basis, would be offered only to the participating lenders (90% of prepetition term loan lenders), implying that the excluded lenders would not be able to participate in the massive roll-up and would get primed by $1.1bn of debt (effectively an NPR in-court uptier). Furthermore, the DIP proposed a sale of ATD to the participating lenders through a credit bid of their DIP loan, which would deliver all post-reorg equity and $100mm+ in fees to the participating lenders. [11] [12] [13]

Unsurprisingly, the excluded lenders litigated against the NPR DIP structure, focusing their legal attack on the key provisions outlined in the prepetition credit agreement, which included a Serta blocker (which prevents change of priority of debt without consent of all affected lenders). However, many Serta blockers include a DIP loan exception that permits the DIP loan to prime existing lenders to ensure the business continues to operate as a going concern. In ATD, the excluded lenders accepted the carve-out to the Serta Blocker in the prepetition credit agreement for new money portions of the DIP, but contended that the carve-out applied only to the incurrence of new priming debt, not roll-ups of existing loans. As roll-ups did not constitute postpetition financing as defined under Section 364 of the Bankruptcy Code, but did constitute paydown, the excluded lenders argued that the NPR conversion of prepetition debt into superpriority DIP claims violated the pro rata payment and sharing provisions of the prepetition credit agreement. In other words, excluded lenders argued that the in-group can provide new-money but could not receive roll-ups on a NPR basis, reinforcing the dynamic of creditors testing NPR extraction in court but facing meaningful legal constraints. [14] [15] [16]

In response, the participating lender group countered that the roll-up avoided breaching pro rata provisions by falling outside the restricted definitions of "payment" or "purchase." Their core argument rested on the "cashless" nature of the transaction: because no actual cash changed hands, the requirements for ratable paydowns remained dormant. Under this theory, the roll-up was framed as an exchange of consideration for the new DIP facility rather than a standard debt repayment, effectively exempting the maneuver from the pro rata protections found in the prepetition credit agreement. [16]

Judge Goldblatt ultimately approved the interim DIP with the aggressive roll-up on the basis that it was necessary for the company’s survival, an illustration of the aforementioned tension between the need to satisfy the “sound business judgement” standard (evaluating competitive alternative bids for the DIP) and the reality of immediate liquidity required by the estate, as discussed in part (1) of the DIP section. In other words, if the DIP was truly the most competitive, market-tested financing, there would likely not be a lucrative 3.4:1 roll-up that enabled participating lenders to leverage its creditor control (superpriority lien + massive roll-up) to receive $100mm+ in fees from its subsequent credit bid. However, at this stage for ATD, there were no immediate alternative DIP proposals; the company desperately needed liquidity, and the unresolved legal issue could be dealt with later. Although Judge Goldblatt allowed the DIP to proceed, Judge Goldblatt signaled his support for the minority lenders' view that the cash advanced in the DIP and used to pay down majority creditors’ prepetition claims (when exclusively rolling up) was likely a violation of the pro-rata sharing provisions of the prepetition loan documents.  Given his warning against the NPR roll-up, the majority participating lenders amended their original DIP shortly after the judge’s ruling and eliminated the entire $842mm NPR roll-up. In sum, ATD reinforces that efforts to extract NPR economics through DIP financing are feasible at the outset, but increasingly constrained under judicial scrutiny. [17] [18]

In March 2026, a similar issue involving an NPR roll-up arose in the Del Monte bankruptcy, but Judge Kaplan reached a different conclusion. Judge Kaplan held that the DIP roll-up itself did not constitute a prohibited "payment or reduction" of debt because it was a cashless exchange in which the participating lenders' prepetition claims were not discharged, but rather converted into higher-priority DIP obligations. Judge Kaplan briefly distinguished ATD on the basis that, in Del Monte, all similarly situated lenders were initially offered the opportunity to participate in the DIP. However, Judge Kaplan left open the possibility that future repayment of the rolled-up DIP could potentially constitute a payment on the original prepetition debt that would trigger the pro-rata sharing provisions. As a result, participating lenders may obtain the negotiating leverage and priority benefits associated with a roll-up during the bankruptcy process, while still facing the possibility that some portion of their eventual recoveries may need to be shared pro rata with non-participating lenders. To this extent, Del Monte shifts the focus away from whether the NPR roll-up itself constitutes an immediate breach of the pro rata sharing provisions (implicated in ATD) and toward the economic value ultimately received through the roll-up structure. [40]

Ultimately, even if the judge approves the interim NPR DIP as in ATD (given, as we said, there is less scrutiny in the interim) to provide emergency liquidity, unequal treatment can still be scrutinized by the judge later in the proceeding. In fact, the Del Monte ruling demonstrated this when Judge Kaplan held that value could still accrue back to the minority lenders on a pro-rata basis, even after permitting the roll-up. From ATD, the relevance of prepetition docs aligns with the fact that DIPs are dealt with at the forefront of bankruptcy, before plan-stage bankruptcy requirements are considered. Thus, the final DIP order for ATD was approved in November 2024 (one month since interim approval) without the NPR roll-up based on legal concerns over the pro rata sharing provisions. In contrast, the majority group maintained the NPR roll-up in Del Monte after Judge Kaplan’s favorable ruling (currently being appealed by the minority group), highlighting how outcomes may vary on a case-by-case basis. Nevertheless, Del Monte demonstrates that preserving an NPR roll-up does not necessarily eliminate litigation risk, as Judge Kaplan left open the possibility that minority lenders could share in a portion of the value ultimately realized through the roll-up. Accordingly, both ATD and Del Monte suggest that courts are increasingly willing to scrutinize the economic consequences of NPR structures in-court and the attempts to replicate LME-like outcomes, even where the roll-up itself remains intact.  

Beyond DIP financing, creditors are increasingly using Equity Rights Offering (ERO) backstop agreements to secure NPR benefits at the plan stage, where courts have imposed more stringent constraints. While DIP financing is negotiated at the outset of the Chapter 11 process to provide emergency financing, EROs, which is a court-approved capital raise that allows eligible creditors to purchase post-emergence equity, are typically structured as a part of exit financing to fund the debtor’s emergence. This mechanism provides the debtor with essential exit liquidity while enabling participating creditors to protect their ownership stakes against dilution. Typically, the rights are offered proportionally to claim size and must be exercised during a specific window leading up to the plan confirmation. Let’s see an example to understand from first principles.