The Backstop Party

In recent years, rights offerings ‘backstopped’ by select creditor groups—who commit to buy any unsubscribed equity—have become a common feature in Chapter 11 exit financing. In our paper, titled The Backstop Party, we present empirical evidence suggesting that these arrangements may serve as a mechanism to circumvent a key principle of the Bankruptcy Code.

At the heart of our study is a simple but pressing question: Is the benefit received by      backstop parties purely compensation for the underwriting risk they assume, or does it serve quietly to provide them superior treatment vis-a-vis creditors of the same class in exchange for supporting the debtor’s plan of reorganization?

In a standard rights offering, creditors receive the option to acquire shares in the reorganized entity, typically at a favorable price. These offerings help the debtor raise the capital needed to emerge from Chapter 11. However, to ensure that sufficient funds are raised regardless of the level of creditor participation, the debtor often engages a group of creditors to ‘backstop’ the offering. In return, these backstop parties receive compensation, usually in the form of discounted equity or exclusive carve-outs. Participation as a backstop party is typically limited to a subset of creditors—those who, together, hold enough claims to approve a plan on behalf of their class.

If backstop arrangements function, as they ostensibly do, solely as insurance against      undersubscription, the compensation paid for the backstop guarantee should be expected to reflect only the underwriting risk. In contrast to this expectation, our findings suggest that backstop arrangements are consistently and significantly mispriced in relation to the underwriting risk, to the benefit of the backstop parties. The disparity between the compensation received by backstop parties and their risk exposure implies that backstop parties are capturing value for another reason—the most plausible of which is their support of the debtor’s plan. Backstop arrangements may thus be functioning as a way to     circumvent the principle of equal treatment of creditors of the same class enshrined in §1123(a)(4) of the Bankruptcy Code.  

To explore the economic substance of backstop transactions, we studied the returns to      backstop commitments in 49 bankruptcies featuring equity rights offerings since 2016. In 19 of these, we identified a credible market valuation for the equity, enabling us to assess actual outcomes, not just projections disclosed in plan documents.  

Our findings are striking. Across the full sample, backstop participants receive fees (including the projected value of carve-outs) averaging 20.1% of the capital raised. In the 19 cases where market pricing is available, that figure rises to 25.1%. These percentages far exceed those observed in comparable contexts such as IPOs or seasoned equity offerings, where the percentage captured by underwriters typically ranges from 3% to 7%. Given that Chapter 11 rights offerings involve no marketing or distribution responsibilities, the gap is even more dramatic.

Moreover, the risks assumed by backstop parties appear to be far lower than the plan would suggest. In practice, equity is typically offered at prices well below market value. Using plan-assumed values, we find an average discount of 25%. However, market evidence indicates that the effective markdown is closer to 50%, suggesting that the likelihood of the put option (implicit in the backstop) being exercised is minimal.

This combination—high fees and limited risk—translates into strong returns for backstop participants. Using plan-based valuations, we estimate that backstop parties recover 21 cents per dollar of eligible claim, compared to 8 cents for similarly situated creditors who participate fully but do not backstop. When we turn to actual trading prices, the gap grows: 35 cents versus 19 cents. These differentials cannot be explained by underwriting risk alone.

To be clear, we do not claim that these outcomes violate the Bankruptcy Code per se. However, they do challenge the formal distinction often drawn between contractual compensation and plan distributions. When only select claimholders are offered lucrative exit financing terms—and when those terms yield returns that ordinary creditors cannot match—the notion of parity within a class becomes strained.

Our conclusions are subject to limitations. Our ‘market’ subsample consists of only 19 cases, and outcomes in unobservable cases may differ. Nonetheless, the pattern we uncover is persistent. Across our sample, backstop participants consistently outperform peers not because they bear greater risk but because they occupy a pivotal position in plan negotiations.

What is at stake here is not merely the pricing of capital but the architecture of reorganization. Backstopping has become a mechanism for transferring value within classes, negotiated outside the plan but embedded in its outcome. That evolution demands closer scrutiny from courts, practitioners, and scholars concerned with preserving the collective ethos of Chapter 11.

Vincent S.J. Buccola is a Professor of Law at the University of Chicago Law School.

Adi Marcovich Gross is a J.S.D. candidate at Columbia Law School and a Postdoctoral Fellow at the Wharton Initiative on Financial Policy and Regulation.

Matthew R. McBrady is a Professor of Practice at the Darden School of Business, University of Virginia.

The authors' paper, The Backstop Party, can be found here.