The role of private credit in distressed debt

Private credit has emerged as a central feature of today’s restructuring landscape, supplying capital and expertise required in situations that traditional banks may view as too risky. Private credit fills a structural gap, as it is not constrained by banking capital requirements and can therefore underwrite complex, time sensitive risk. For distressed companies and their stakeholders, this could mean the difference between a value-destructive insolvency and a credible turnaround.

This article outlines the core elements of private credit in distress, the opportunities and risks for borrowers and lenders, and the developments to watch.

Private Credit – what is it, and how does it fit distress?

Private credit is an overarching term used to refer to lending strategies outside of the traditional banking industry and other public syndicated debt markets. Capital is typically provided by private equity firms, private credit funds and alternative asset managers. In private credit, a single lender or a syndicate of lenders negotiate terms directly with the borrower, which, when combined with the fact that private credit is not traded on the public market, allows for bespoke terms that align with the interests of both borrower and lender.

Private credit includes direct lending, senior secured/performing loans, mezzanine and other subordinated instruments, ABL facilities and distressed/special situations investments. In the distressed context, private credit funds frequently operate across the capital structure, purchasing existing debt at a discount, extending new money or effecting liability management transactions that re‑rank claims to create a runway for a restructuring. Investors in this area often take on a higher level of risk in exchange for higher pricing and better returns.

Private credit is uniquely suited for distressed companies for several reasons, including:

• Risk appetite: Traditional bank lenders are often unable to lend to companies with a lower credit rating and a higher risk of default, or at least unable to do so quickly.   
• Strategy: Due to the lack of regulation and no public market involvement, there is an opportunity to create precise strategies and avail expertise to rescue the company in distress using options that may not otherwise be available.
• Speed: Companies in distress need to make decisions and access capital quickly. Private credit firms can usually advance funds without lengthy credit processes and capital constraints and so can act rapidly.

Implications for borrowers

For distressed borrowers, private credit offers a path to liquidity and an investor with aligned incentives to preserve enterprise value, but at a price. Floating interest rates often coupled with tighter covenants and enhanced information rights increase ongoing obligations on borrowers. However, where the alternative is an uncontrolled default or no access to liquidity, these features can be a rational trade off, particularly when private credit providers bring operational expertise, oversight, and access to follow on capital that are often absent in syndicated markets.

It is also true, however, that some borrowers are not interested in this trade off and so, mindful of opportunistic distressed investors, will tighten transfer provisions in their facility agreements to limit assignments to non‑bank institutions and prevent a fractured lender group in which private credit funds may lead a loan‑to‑own strategy or other methods of enforcement.

Implications for lenders

For lenders, distressed situations combine high interest rates with negotiated control. The ability of investors to set their own interest rate can shield them from wider market interest rate fluctuations. However, underwriting distressed debt entails greater lender due diligence, an internal expertise to manage the ongoing lender involvement and keep close scrutiny on the borrower because there is, by its very nature, usually a heightened legal risk.

Trends and looking forward

Private credit and its use in distressed situations is now fairly entrenched and looks set to stay. In our view, some of the specific trends in this area going forward include:

• The rise of Liability Management Exercises (LMEs): LMEs are out-of-court debt restructuring tools that borrowers use to incur new debt or restructure existing indebtedness without involving all lenders or using formal insolvency proceedings. This usually means borrowers working with a set group of creditors and the exercise is done within the parameters of the existing finance documents. We’ve seen their prevalence in the US and their rise in Europe, largely due to the dilution of previously non-negotiable creditor protections in finance documents, perhaps because the rise in private credit has provided liquidity into the market and allowed borrowers to negotiate such provisions.
• Macro backdrop: Credits with exposure to geopolitical risks and cyclical revenues are at a higher risk of default. Similarly, the impact of the current trade war, inflation and high public debt is providing an uneven, but noticeable impact, across Europe. Private credit is proving to be, and will continue to be, well positioned to supply bespoke capital in this regard.
• The Boom in the Middle East: The growth of private credit is global, but the Middle East is notable for the scale and speed of its development. Traditional lenders in the region allocate a small share of funding to SMEs compared to globally, which reflects the substantial capital demands of large-scale public infrastructure initiatives, particularly in Saudi Arabia and the UAE. This creates a financing gap for growth companies that private credit is increasingly filling. Legal reforms are reinforcing this evolution: new bankruptcy and insolvency frameworks came into effect in 2018 in Saudi Arabia and in 2024 in the UAE, for instance, which have provided clearer enforcement and restructuring pathways, encouraging institutional debt investors and strengthening the flow of debt financing across the region.

Conclusion

For distressed borrowers, engaging early with private credit can expand the number of options available to them, provided the borrower is well advised on the risks which come with private credit.

For private credit lenders, tailored documentation, especially around transfer baskets and intercreditor mechanics can preserve value and reduce litigation risk if stress deepens.

For both sides, transparency and speed are paramount.

Private credit’s growing role in distressed debt reflects a re‑allocation of risk away from regulated banks towards specialised managers with flexible capital. As market norms and supervisory frameworks evolve, private credit is likely to remain a pivotal force in restructurings, by delivering liquidity and, in many cases, enabling second chances for viable businesses.