The Illusion of Safety: Creditor Violence, Synthetic Liquidity, is there a storm brewing in European Credit Markets?
By: Stephen Phillips, Restructuring & Special Situations, FreiLibertas Law Firm London, UK — June 2026
Executive Summary
The restructuring market is somewhat becalmed. Is this quiet a signal that trouble is brewing? In the European credit markets of mid-2026, there are reasons to believe the answer is yes — even if headline default rates remain subdued.
This engineered calmness masks deepening structural stresses. Like the deceptive lull in a war film when the birds stop singing — the only indicator that something is amiss — underlying tensions are building. Distressed and special situations funds have increasingly morphed into large AUM aggregators in private credit. Intense competition for assets has driven rich entry prices, return compression, and — in many cases — aggressive Liability Management Exercises (LMEs) as managers seek to protect returns on their high cost basis.
While LMEs can serve legitimate purposes in stressed situations, their proliferation raises important questions about long-term value creation and creditor dynamics. Special situations professionals should prepare for a shift toward more macro-driven restructurings, supported by rigorous legal analysis, AI tools, and flexible evergreen structures. Questions are arising as to whether directors should just go along with these developments and whether junior creditors can fight back.
Is This Quiet a Signal That Trouble Is Brewing?
To walk through the European credit markets in 2026 is to witness a paradox. On one hand, the restructuring market is somewhat becalmed. Headline defaults stay contained, global risk appetite is high, and secondary markets are not pricing risk aggressively. The expectation was that supply constraints and high oil prices caused by the Iran war would create a wave of distress, but so far this has not materialised. On the other hand, macroeconomic indicators suggest deep structural friction, including heavy refinancing walls and sector-specific disruptions.
This is the classic “too damned quiet” moment — the lull in a war film when the birds stop singing, the only indicator that something is amiss. In past cycles, covenant trips provided timely warnings. Today, with maintenance covenants eroded or absent in most leveraged facilities, that early-warning system has been blunted. The result is an illusion of safety sustained by loose documentation and synthetic liquidity.
Yes — this quiet warrants close attention.
The Rise of Creditor Violence vs. Traditional Restructuring Discipline
A large number of funds branded as “distressed” or special situations investors have morphed into major AUM aggregators in private credit. This shift has created fierce competition for performing assets, pushing entry prices to rich levels and compressing prospective returns. In response, managers — especially those who paid premium prices to build large positions — have pushed and sought out sponsors to engineer Liability Management Exercises (LMEs) to protect or enhance yields.
These tools, including sub-group priming, uptiering exchanges, and asset stripping via unrestricted subsidiaries (J.Crew/Envision structures), are now common in European mid-market documentation. A prominent example is Altice’s late-2025 drop-down of roughly 75% to 80% of EBITDA to unrestricted subsidiaries[^1]. Similar patterns appear in distressed disposals such as Selecta[^2], Hunkemöller/Redwood[^3], and Hurter Grooten.
It is important to note that many of these features were heavily negotiated and accepted by investors at origination in a high-liquidity, yield-chasing environment. When used proportionately, LMEs can provide necessary breathing room and avoid the higher costs and value destruction of formal insolvency. However, when deployed primarily to transfer value between creditor classes rather than to support genuine operational recovery, they raise legitimate concerns about fairness and long-term outcomes.
Arguably the approach stands in sharp contrast to classical restructuring discipline. In a traditional “old school” restructuring, the process begins with a thorough diagnostic assessment of what is fundamentally wrong with the business. Multidisciplinary teams then work on operational improvements — cost rationalisation, revenue initiatives, and supply chain fixes — alongside balanced balance-sheet solutions designed to preserve and enhance enterprise value for the benefit of all stakeholders. The goal is sustainable viability rather than zero-sum extraction between creditor classes.
Junior Creditor Pushback and Enforcement Challenges
Junior creditors are not without recourse. Recent English court decisions show they can mount effective challenges by focusing on intercreditor agreement (ICA) interpretation, the validity of enforcement instructions, and valuation fairness. Aggressive liability management techniques often involve senior lenders enforcing security — frequently through share pledges — followed by a distressed disposal that triggers ICA release provisions to wipe out junior debt.
Under English law, an enforcing mortgagee or receiver owes an equitable duty of care to stakeholders. As established in the seminal case Cuckmere Brick Co Ltd v Mutual Finance Ltd [1971], they must take reasonable care to obtain the true market value or the "best price reasonably obtainable" at the time of sale. While courts grant mortgagees wide commercial latitude on the timing of a sale, they cannot simply dump an asset to cover their own exposure while ignoring the residual value. High-profile sale processes in cases like Hunkemöller and Selecta demonstrate that while seniors generally hold enforcement control, juniors can generate significant leverage by closely scrutinising procedural fairness and security agent obligations against this Cuckmere standard.
This equitable constraint is supported by Palk v Mortgage Services Funding plc [1993], which establishes the foundational principle that while a lender is entitled to act in its own commercial self-interest, it may not do so in a manner that unfairly prejudices the borrower or those holding derivative interests in the equity of redemption.
Furthermore, Meah v GE Money Home Finance Ltd [2013] provides critical guidance on how this duty is discharged in practice, emphasizing the mortgagee's obligation to expose the property sufficiently to the market. The process must ensure that potential purchasers are given proper notice and an opportunity to make competitive offers. High-profile sale processes in cases like Hunkemöller and Selecta demonstrate that while seniors generally hold enforcement control, juniors can generate significant leverage by closely scrutinising procedural fairness and security agent obligations against these combined marketing and non-prejudice standards.
The Mechanics of Standing and Structured Enforcements
This duty to obtain the best price is not a private matter between a senior lender and the debtor; it is a duty owed to anyone holding an interest in the equity of redemption—the fundamental right to reclaim charged property once a debt is discharged.
Consequently, standing to challenge an enforcement process extends down the entire capital structure. Because a distressed disposal usually cuts off the flow of funds down the waterfall, junior mortgagees, mezzanine lenders, and even equity sponsors have a direct legal right to sue if an artificial process robs them of value.
The legal risk escalates dramatically when aggressive senior lenders utilize a share pledge to orchestrate a non-competitive transfer to an entity where the enforcing or instructing lender holds a direct proprietary or economic interest in the purchaser (such as the €1 nominal sale seen in Hunkemöller). Under the landmark Privy Council authority of Tse Kwong Lam v Wong Chit Sen [1983], while a sale to a connected or interested counterparty is not automatically void, it triggers intense judicial scrutiny. The burden of proof shifts heavily to the enforcing parties to show that they acted with absolute propriety and took every possible step to robustly test the open market. Rushing a transaction to a purchasing vehicle in which the lender holds a proprietary stake, without transparent market exposure, is an open invitation for an under-the-money stakeholder to bring a claim.
The Creditor Battlefield vs. The Fiduciary Mandate
To understand the danger these zero-sum Liability Management Exercises (LMEs) pose to boards, one must contrast the rules governing creditor behaviour with the strict duties imposed on directors.
Amongst themselves, creditors operate in a ruthless contractual arena. As established in Redwood Master Fund Ltd v TD Bank Europe Ltd, majority lenders do not owe an inherent fiduciary duty of good faith to minority lenders; they are generally permitted to vote in their own commercial self-interest, relying on the strict mechanics of the facility agreement to amend terms or redirect value.
However, this majority right is subject to a vital common-law boundary known as the "abuse principle" (or the minority protection principle). Under English law, where a contract empowers a majority to bind a minority within a class, that power is not absolute—it must be exercised bona fide for the benefit of the class as a whole. This principle was famously applied in Assénagon Asset Management SA v Irish Bank Resolution Corp Ltd, where the High Court held that a majority could not use its voting weight to maliciously expropriate or destroy a minority’s rights for nominal consideration.
The cutting edge of this legal battle is currently playing out via the Hunkemöller litigation, which centers on an aggressive combination of a US-style uptier priming transaction and a European single-point-of-enforcement share pledge. In that case, Redwood Master Fund Ltd—acting as the majority holder—provided fresh super-senior liquidity and engineered an uptier exchange, rolling its own existing notes into a "first-out" priority position and leaving minority noteholders effectively subordinated. Following a subsequent payment default, Redwood instructed the security agent to enforce a share pledge, transferring the entire operating group to a vehicle in which Redwood itself held the primary proprietary interest, for a nominal sum (€1 plus the assumption of certain liabilities).
The minority noteholders have launched heavy challenges in both the US and the English High Court. Among the primary grounds for challenge advanced by the claimants in England is the argument that Redwood, as the creditor instructing enforcement, acted in a manner that was oppressive and/or otherwise unfair to the minority senior secured creditors, and failed to exercise its powers bona fide in the interests of the class of senior secured creditors as a whole, in contravention of the abuse principle. They allege the enforcement was an engineered, non-competitive transfer to a purchaser in which the instructing lender held a proprietary interest—effectively sitting on both sides of the table—designed to strip-mine value from the minority in breach of the Tse Kwong Lam requirements.
The Redwoods of Restructuring: From Shield to Sword
There is a profound, cyclical irony in these developments. The fund leading the aggressive enforcement in Hunkemöller is the exact same entity that brought the original 2002 Redwood case. More than twenty years ago, a young Redwood Master Fund stood as an aggrieved minority lender, unsuccessfully begging the English court to protect it from a ruthless majority. Redwood’s definitive defeat in 2002 established the bedrock paradigm that lenders owe no duty to one another and are free to vote in their own commercial self-interest.
Fast forward to today, and Redwood has fully transformed from the victim of contractual ruthlessness into its ultimate practitioner—using the very legal mechanics that once defeated them as a sword to squeeze out a new generation of minority lenders. The fund that failed to establish an implied duty of good faith among lenders in 2002 is now the target of a massive lawsuit claiming they breached that exact same standard by orchestrating a transfer to a party where they hold a proprietary interest.
Fiduciary and Insolvency Duties of Boards
Crucially, directors cannot adopt or rely on the aggressive logic of the majority creditor. While funds switch roles from shield to sword and fight over intercreditor abuse principles, the company's board faces an entirely different, non-negotiable legal standard.
These transactions raise serious questions about consistency with directors’ fiduciary duties under statutory companies law. Under Section 170(1) of the Companies Act 2006, the general duties specified in the Act are explicitly "owed by a director of a company to the company."
In an ordinary solvent environment, Section 172(1) mandates that a director must act in the way they consider, "in good faith, would be most likely to promote the success of the company for the benefit of its members as a whole." However, Section 172(3) explicitly contains a carve-out stating that this duty "has effect subject to any enactment or rule of law requiring directors, in certain circumstances, to consider or act in the interests of creditors of the company."
As established in Liquidator of West Mercia Safetywear Ltd v Dodd[^4] and affirmed by the Supreme Court in BTI 2014 LLC v Sequana SA[^5], when a company is insolvent or approaching insolvency, this Section 172(3) trigger is pulled. Directors must shift their perspective and have proper regard to the interests of the company’s creditors as a whole. This is not a freestanding duty owed directly to creditors, but a modification of the duty to the company, with creditors (rather than shareholders/members) now representing the primary economic interest.
The duty applies to creditors as a class — the general body of creditors — and is not limited to in-the-money creditors or the loudest senior syndicate. It operates on a sliding scale: the more precarious the company’s position, the greater the weight that must be given to creditors’ interests. Therefore, a board cannot simply rubber-stamp a transaction because it is contractually permitted under the Redwood doctrine or executed via an enforcement mechanism. Directors risk breaching their statutory duties if they facilitate an LME or look away during an enforcement sale to an entity in which the enforcing lenders hold a proprietary stake, if that transaction unfairly prejudices one segment of the creditor class merely to benefit another or to preserve out-of-the-money equity options.
Recent Court of Appeal decisions on restructuring plans (Thames Water[^6] and Petrofac[^7]) arguably reflect a similar judicial attitude. Courts are increasingly emphasising both horizontal fairness (ensuring equitable treatment among similarly situated creditors within the same economic tier) and vertical fairness (upholding priority principles unless robustly justified). Consequently, judges are reluctant to dismiss the interests of out-of-the-money creditors entirely, even when they would recover little or nothing in the relevant alternative. This broader approach serves as a useful corollary for directors when evaluating LMEs and drop-downs.
A Warning to Boards
As advisers to boards, we see directors frequently relying on sponsor-provided analysis and opinions focused on contractual permissibility. However, the ultimate responsibility rests with the directors. Full scrutiny often only arises in formal insolvency.
Directors must ultimately look to their own personal interests; the private equity sponsors pushing the transaction and the aggressive creditors benefiting from it may be long gone by the time those directors are standing alone in a courtroom trying to justify their decisions.
In jurisdictions with heightened personal liability exposure, obtaining truly independent legal and financial advice, together with robust fairness opinions, remains the strongest protection. Particularly in multi-jurisdictional group structures under strain, each board has separate legal personality. Directors must carefully review their duties under the specific law of each jurisdiction in which a group company is incorporated, as some regimes are significantly more punitive toward directors than others.
Empirical Outcomes
Studies indicate that while some LMEs successfully stabilise situations, many only delay formal distress. Only a minority of companies avoid eventual restructuring or insolvency after major LMEs, highlighting that these exercises are often bridges rather than permanent solutions.
The Synthetic Liquidity Alarm: PIK Toggles as the New Barometer
For restructuring professionals looking for an objective barometer of systemic distress, the rate at which borrowers switch from cash-pay to Payment-in-Kind (PIK) interest has become one of the most reliable indicators available. With the widespread erosion of maintenance covenants, traditional early-warning signals have been blunted. In this environment, escalating PIK usage — particularly “bad PIK” amended after origination — stands out clearly.
Recent data from Lincoln International shows that bad PIK now represents a significant portion of tracked private market loans with PIK activity[^8]. Public BDCs derive an average of around 8% of their investment income from PIK[^8]. While some toggles reflect legitimate pre-agreed flexibility, the growing number of reactive amendments, especially among smaller borrowers and those exposed to software disruption, points to acute free-cash-flow shortfalls.
This dynamic acts as a lagging indicator of terminal credit deterioration and future restructuring needs. The PIK trap is quietly building behind the scenes and is likely to drive a wave of refinancings, many of which will be executed through continuation vehicles or secondary portfolio transactions.
Cracks Across the Atlantic: BDCs and Macroeconomic Transmission
The picture is clearer across the Atlantic, where Business Development Companies (BDCs) are already showing visible strain. Redemption requests have spiked to around 12% in early 2026, prompting many funds to gate withdrawals. Heavy exposure to legacy software and SaaS businesses — now facing rapid obsolescence due to artificial intelligence — is causing collateral values to erode faster than anticipated[^9].
Macro Transmission Note: Because many of the large AUM private credit aggregators operate globally, liquidity pressures or asset gating within their US BDC structures inevitably ripple into the European market. These structural constraints restrict global capital deployment, forcing funds to tighten their underwriting standards across London and continental Europe, thereby accelerating the exhaustion of synthetic liquidity locally. This serves as an important cautionary signal for the broader market regarding hidden vulnerabilities in seemingly stable credit portfolios.
Restructuring Plans – The Fairness Pivot
Judicial oversight continues to tighten. Court of Appeal decisions in the Thames Water and Petrofac cases have made clear that the era of near-automatic sanction of restructuring plans is over. Judges are demanding robust valuation evidence, transparent explanations of benefit allocation, new-money pricing, and fair treatment even of out-of-the-money creditors. This heightened scrutiny increases execution risk and timeline uncertainty for transactions that move from LMEs into formal restructuring plans.
Fund Architecture: Evergreen Mandates vs. the Risks of Fixed-Term Structures
The current environment also highlights a structural mismatch in fund design. Traditional closed-end funds,with their fixed 10-year life and 3-to-5-year investment periods, create artificial timing pressures. Managers may be forced to deploy capital in unfavourable conditions simply because commitment periods are expiring, or to exit complex positions prematurely to meet harvest deadlines. In the event of a sudden credit repricing or macroeconomic shock — reminiscent of the liquidity crises before and during the Global Financial Crisis — funds with rigid redemption schedules become particularly vulnerable to fire sales, gates, or loss of investor confidence.
By contrast, evergreen (open-ended) mandates are far better suited to special situations and distressed credit. They align capital duration with the often idiosyncratic and prolonged nature of these investments. This structure allows managers to sit patiently on cash when opportunities are expensive, deploy quickly when dislocations arise, and manage complex remediations without an artificial clock ticking. Evergreen vehicles therefore offer superior resilience and the ability to compound returns across market cycles.
The AI Edge: Defensive Documentation Audit
In an era defined by hyper-complex, fragmented legal documentation, leading special situations funds are gaining a decisive competitive advantage by integrating specialised large language model (LLM) frameworks into their core risk management processes. Rather than acting simply as an efficiency tool for drafting investment memos, these AI systems serve as a critical line of defense.
They enable rapid algorithmic screening of credit opportunities and a sophisticated, proactive audit of complex credit agreements. By identifying hidden LME vulnerabilities, loose asset-stripping basket capacities, and priming risks before a sponsor attempts to trigger them, technology has transitioned from an operational luxury to a strategic necessity.
Outlook: When the Shooting Starts
Yes — this quiet is a signal that trouble is brewing. As the runways of synthetic liquidity eventually exhaust and the refinancing wall approaches, the market is likely to shift from negotiated, bespoke LMEs toward broader and more macro-driven restructurings. Participants equipped with strong documentation discipline, credible valuation work, genuine process fairness, AI-enhanced velocity, and the structural flexibility of evergreen vehicles will be best positioned to navigate the adjustment successfully.
Conclusion
The current relative calm in European credit markets is deceptive. While many LMEs reflect rational responses to contractual realities and prevailing market conditions, their scale and intensity — combined with widespread PIK reliance and loose documentation — sustain an illusion of safety. When conditions eventually tighten, disciplined underwriting, balanced stakeholder management, and structural resilience will determine who survives and thrives.
Crucially, company directors must recognize that they need to look after themselves and safeguard their own positions. The private equity sponsors and aggressive creditors who orchestrate and benefit from these complex liability management exercises are often long gone by the time the directors find themselves standing alone in a courtroom or facing aggressive, retroactive correspondence from insolvency practitioners. Ultimate accountability cannot be outsourced, and independent, rigorous protection remains paramount.
References (Selected)
Fitch Ratings, Lincoln International, Court of Appeal decisions (Thames Water, Petrofac)
West Mercia Safetywear v Dodd [1988] and BTI v Sequana [2022]
S&P Global / CreditSights LME studies
[^1]: See CreditSights Report on Altice Drop-down (BondbloX Analysis) and S&P Global Ratings on Altice International S.a.r.l. Downgrade.
[^2]: For legal proceedings on intercreditor arrangements and cross-border restructuring tools, see Selecta Group B.V. documentation via English Scheme of Arrangement updates.
[^3]: For lender-led enforcement mechanisms via share pledges under English law, see contested enforcement reviews under Hunkemöller BV asset-disposal reports.
[^4]: Liquidator of West Mercia Safetywear Ltd v Dodd [1988] BCLC 250; see case background on South Square Legal Review.
[^5]: BTI 2014 LLC v Sequana SA [2022] UKSC 25; see full Supreme Court judgment analysis via Travers Smith Legal Insights and Cooley LLP Litigation Hub.
[^6]: In the matter of Thames Water Utilities Finance Plc [2024/2025 Restructuring Decisions]; see judicial review updates tracking horizontal class equity.
[^7]: In the matter of Petrofac Limited [2024/2025 Restructuring Appeals]; see restructuring plan scrutiny under the English Companies Act Part 26A framework.
[^8]: Data on proprietary shadow default rates and reactive PIK trends can be verified through the [Lincoln Private Market Index Analysis](https://www.lincolninternational.com/news/the-lincoln-private-market-index-ends-the-year-with-its-slowest-quarter of-growth-in-2025/) and PE Professional market digests.
[^9]: For technology multiples and asset depreciation assessments, see the U.S./European mid-market tracking components within the Lincoln Private Market Index (LPMI) Tech Index.