Creditor-on-Creditor Violence and Secured Debt Dynamics

Abstract

Secured lenders have recently demanded a new condition in distressed debt restructurings: competing secured lenders must lose priority. We model the implications of this "creditor-on-creditor violence" trend. In our dynamic model, secured lenders enjoy higher priority in default. However, secured lenders take value-destroying actions to boost their own recovery: they sell assets inefficiently early. We show that this creates an ex-ante tradeoff between secured and unsecured debt that matches recent empirical evidence. Introducing the recent creditor-conflict trend in this model endogenously increases secured credit spreads. Importantly, it also increases ex-ante total surplus: restructurings endogenously introduce efficient state-contingent debt reduction.

Keywords: Continuous-time capital structure models, Liability management, Secured debt, Bankruptcy, Creditor-on-creditor violence, Dropdowns, Uptiers

JEL Classification: G32, G33, K22