Financial sponsors are increasingly handing control of troubled companies to direct lenders through amicable out-of-court deals, offering the parties a cheaper alternative to bankruptcy as defaults start to rise in the asset class.

The approach means that private credit is largely skipping liability management exercises, the contentious out-of-court restructuring strategy that has become the go-to remedy for borrowers in the broadly syndicated market to address overleveraged capital stacks raised in the wake of the COVID-19 pandemic.

“In recent years, there’s definitely been a trend away from in court bankruptcies as the only way for restructurings or insolvencies. In place of Chapter 11 cases, we’ve been seeing an increased use of foreclosure actions,” said Fred Sosnick, global co-head of restructuring at A&O Shearman. “It’s always been easier to do key handing foreclosures in private credit documents than in the syndicated markets.”

“Liability management exercises simply don’t translate to private credit,” said Brett Pearlman, a partner at Cleary Gottlieb who advises private credit investors. “Sponsors are reluctant to play hardball with a lender they may be sitting across the table from on multiple other deals, and the cost of a full-blown bankruptcy process remains prohibitively high for all parties.”

The relationship-driven nature of direct lending, typically involving only a handful of lenders, contrasts with the broadly syndicated market where aggressive actions by sponsors and creditors have become the norm when parties are negotiating LME deals to give portfolio companies more runway to avoid bankruptcy.

“We’re seeing a lot of activity . . . because private equity firms are moving on,” said a private credit executive. “There’s no use tilting at a windmill.”

Foreclosures by lenders in private credit hit over USD 24bn in 2025, and they are on track to beat that by a substantial margin in 2026 based on current foreclosure data, said Eugene Lee, managing director at Lincoln International. There were over USD 10.7bn in private credit foreclosures in 2024 and USD 2.7bn in 2023, according to data gathered by the investment bank.

Having the ability to step in and take control is often the best way for private credit lenders to maximize value in an investment if a financial sponsor is unwilling to invest additional capital in a struggling portfolio company, said Meenal Mehta, senior managing director at Blue Owl, during a panel at Debtwire’s recent Private Credit Forum.

Mehta said that Blue Owl is bolstering its ranks of executives with operating experience, in addition to restructuring executives, to help the private credit giant with value creation in the event of key-taking scenarios. Still, distressed situations represent only a small portion of Blue Owl’s overall portfolio, and the firm has not been among the lenders involved in the major private credit restructurings of 2026.

The increase in restructuring activity comes as direct lending funds have come under public scrutiny this year in the wake of AI disruption fears that hammered the equity and debt of software companies that are frequent private credit borrowers. Market participants have been examining direct lending portfolios looking for signs of near-term stress.

So far, though, companies have been restructuring for an old-fashioned reason: too much leverage.

Vintage remains a key factor. Private credit loans originated in 2021 and 2022 are largely driving current default activity, as many large LBOs during that period were executed with elevated leverage, Lee said.

“A lot of these were COVID beneficiaries that just haven’t had the performance to catch up to their debt stack,” Lee said, adding that the BSL loans with the same vintages face the same problems.

There’s been a “steady increase” of private loans being marked down to stressed and distressed levels since 2022 as the base interest rates started rising, said Patrick Warren, who leads private credit research at MSCI.

“As those base rates went up, the debt burden became increasingly difficult to manage [for floating rate loans],” Warren said.

Private credit covenant default rates are around 3%, however, there is a shadow default rate on top of that around 5% when incorporating loans with “bad PIK” (loans in which PIK was not present at the initial deal but is present now), according to Lincoln International data.

In some recent examples of key taking, Thoma Bravo agreed this spring to hand Medallia to its private credit lenders without a fight, walking away from billions of capital invested in the troubled experience management software developer. Lenders have attributed the restructuring to problems specific to the credit rather than AI.

Earlier in the year, H.I.G. Capital Management agreed to transfer translation service provider Lionbridge to lender KKR. Aspira, meanwhile, is no longer backed by Alpine Investors, as reported. The financial sponsor bought the outdoor recreation software developer from Vista Equity Partners in 2021.

“A key-turning offers a cleaner path: sponsors get their release, lenders take the equity, and the close relationships that define private credit make it possible to negotiate these transitions efficiently. In many ways, a debt-to-equity swap accomplishes everyone’s objectives without the time, expense, and uncertainty of a Chapter 11,” said Cleary Gottlieb’s Pearlman.