---
title: "Distressed Debt | Altss Glossary"
description: "Distressed debt investing is the purchase, usually at a deep discount, of debt and other claims on companies in or near default, bankruptcy or financial…"
canonical: "https://altss.com/glossary/distressed-debt"
---

Glossary · Strategy

# Distressed Debt

Also called: distressed credit · distressed investing

Distressed debt investing is the purchase, usually at a deep discount, of debt and other claims on companies in or near default, bankruptcy or financial stress, to profit from price recovery, the restructuring outcome or control of the reorganised company.

Publisher: Altss LLC Published 2026-06-20 Content modified 2026-10-02

ALTSS-CREDIT-026

When a company cannot meet its obligations, its loans and bonds fall in price because holders expect to recover less than face value and many cannot or will not hold defaulted assets. A distressed investor buys those claims from sellers who want out, does its own estimate of what the claims will be worth after a restructuring, and earns the difference. Some distressed investors trade the claims; others take an active role in the restructuring or aim to end up owning the company.

## What counts as distressed

"Distressed" is a market label, not a status defined in the bankruptcy statutes cited on this page. Common screening conventions treat a bond as distressed when it trades at a spread of 1,000 basis points or more over government bonds, or a loan as distressed when it trades below a set price (for example, 80 cents). Thresholds differ by manager and data provider, so state the one used. Distress can be:

- **financial**: a capital structure the business cannot support, approaching maturities, or liquidity shortfalls;
- **operational**: a failing business model;
- **event-driven**: litigation, fraud, or a sector shock.

## Approaches

- **Trading (non-control).** Buy discounted claims expecting the price to recover or the claim to be repaid or exchanged at a higher value. No effort to steer the process.
- **Active non-control.** Join or lead creditor committees and negotiate plan terms, without seeking ownership.
- **Control, or loan-to-own.** Accumulate a position in the fulcrum security, the most senior class whose claims are not fully covered by enterprise value and which therefore converts into the equity of the reorganised company. The aim is a stake large enough to block or carry that class's vote. In a US Chapter 11 case, a holder of more than one-third of the amount of the claims in a class that vote on a plan can stop that class accepting it, unless the court designates its vote under section 1126(e) (see the voting rule below). Control is not automatic. It depends on holding a decisive position in the right class.

## What a distressed investor can buy

- loans and bonds at every level of the capital structure;
- trade claims, meaning amounts owed to suppliers and vendors, bought from those creditors;
- lease, litigation and other unsecured claims;
- new-money financings such as debtor-in-possession (DIP) loans. In the US, if unsecured credit cannot be obtained, the court can give new credit priority over administrative expenses or secure it with a lien on unencumbered property or a junior lien; it can authorise a lien ranking ahead of or equal to existing liens only if no other credit is available and the existing lienholders are adequately protected (Bankruptcy Code section 364(c) and (d)(1));
- post-reorganisation equity.

## How restructurings resolve

- **Out of court**: exchange offers, amend-and-extend transactions, liability management exercises and consensual debt-for-equity swaps. These usually leave creditors with reduced claims, longer maturities or equity. Repayment at par is not a typical out-of-court outcome.
- **In court**: in the US, a Chapter 11 reorganisation. The company proposes a plan that classifies claims, and creditors vote by class. A class of claims accepts when creditors holding at least two-thirds in amount and more than one-half in number of the allowed claims that voted accept it (section 1126(c)). Confirmation requires, among other conditions, that each class has accepted or is not impaired (section 1129(a)(8)). If an impaired class rejects the plan, the court, at the request of the plan's proponent, shall still confirm it (cramdown) when every other applicable requirement of section 1129(a) is met, including that at least one impaired class of claims has accepted without counting insiders' votes (section 1129(a)(10)), and the plan does not discriminate unfairly and is fair and equitable towards each rejecting impaired class (section 1129(b)(1)). Assets can also be sold outside the ordinary course after notice and a hearing (section 363(b)(1)), and a secured creditor can bid its claim at such a sale unless the court orders otherwise for cause (credit bidding, section 363(k)). Other jurisdictions have their own regimes, such as UK schemes of arrangement (Part 26 of the Companies Act 2006) and restructuring plans for companies in financial difficulty (Part 26A). See debt restructuring.

## Return drivers and risks

Returns come from buying below the eventual recovery value, interest received where the claim is still paying, and the value of equity received in the restructuring.

Risks include:

- error in estimating enterprise value and claim priority;
- process length, as the example shows;
- legal risk: priming by other creditors, challenges to liens, or, in a US case, equitable subordination of claims by the court (11 U.S.C. 510(c));
- illiquidity of defaulted claims.

LPs assess managers on realised outcomes by approach (trading vs control), restructuring and legal capability, and how they deploy capital across the default cycle.

## Worked example

### Illustrative price, recovery and time

An investor buys a defaulted first-lien loan at 60 cents on the dollar and expects a plan of reorganisation to deliver value worth 78 cents in two years. The IRR is **14.0%**. If the same 78 cents arrives after four years, the IRR falls to about 6.8%. The recovery is identical, but the timing of the process decides the return.

Examples are illustrative; figures are not market data.

## Not the same as

- Special Situations: Special situations is broader: event-driven and complex financings, often to companies that are not in default. Distressed focuses on claims of companies in or near default.
- Rescue Financing: Rescue financing provides new money to a stressed company. Distressed investing usually buys existing claims.
- Non-Performing Loan: Non-performing loan (NPL) investing buys portfolios of defaulted loans, often consumer or small-business loans from banks, and recovers through servicing. Distressed debt usually targets corporate claims and restructurings.

## Common mistakes

- Describing trade claims as a strategy. They are a type of claim (amounts owed to suppliers) that distressed investors can buy.
- Assuming a distressed investor controls the restructuring. Control requires a blocking or controlling position in the fulcrum class.
- Treating par repayment as a normal out-of-court outcome.
- Ignoring the time to resolution, which can halve the IRR on the same recovery.

## Edge cases

- A performing bond can trade at distressed levels because of a sector sell-off. Price-based screens include it even though the issuer is not in default.
- DIP lenders lend into a bankruptcy with court-approved priority. This is often classed as distressed or rescue lending, although the priority or liens granted under section 364 reduce the lender's credit risk.

## Sources

1. [11 U.S.C. 1126 - Acceptance of plan (Chapter 11)](https://www.law.cornell.edu/uscode/text/11/1126). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 1126(c) — supports: Class of claims accepts with at least two-thirds in amount and more than one-half in number of allowed claims voting, excluding entities designated under (e)
2. [11 U.S.C. 1129 - Confirmation of plan (Chapter 11)](https://www.law.cornell.edu/uscode/text/11/1129). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 1129(a)(8), (a)(10), (b)(1) — supports: Each class accepts or is unimpaired; at least one impaired class accepts excluding insiders; on the proponent's request the court shall confirm notwithstanding (a)(8) if all other applicable (a) requirements are met and the plan does not discriminate unfairly and is fair and equitable
3. [11 U.S.C. 363 - Use, sale, or lease of property (Bankruptcy Code)](https://www.law.cornell.edu/uscode/text/11/363). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 363(b)(1), (k) — supports: Sale outside the ordinary course after notice and a hearing; credit bidding by a secured creditor unless the court orders otherwise for cause
4. [11 U.S.C. 364 - Obtaining credit (Bankruptcy Code)](https://www.law.cornell.edu/uscode/text/11/364). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-01). Status: in force (checked 2026-10-01). Sec. 364(c), (d)(1) — supports: Court-authorised DIP credit with superpriority or liens; priming lien only if credit is otherwise unavailable and existing lienholders are adequately protected
5. [11 U.S.C. 510 - Subordination (Bankruptcy Code)](https://www.law.cornell.edu/uscode/text/11/510). U.S. Congress (US Code via LII), Current US Code text as published by LII (accessed 2026-10-02). Status: in force (checked 2026-10-02). 11 U.S.C. 510(c) — supports: Equitable subordination of claims by the court
6. [Companies Act 2006, Part 26 - Arrangements and reconstructions: general (schemes of arrangement)](https://www.legislation.gov.uk/ukpga/2006/46/part/26). UK Parliament (legislation.gov.uk), Revised text on legislation.gov.uk (accessed 2026-10-02). Status: in force (checked 2026-10-02). Part 26 (ss. 895-901) — supports: Schemes of arrangement (compromises or arrangements sanctioned by the court)
7. [Companies Act 2006, Part 26A - Arrangements and reconstructions: companies in financial difficulty (restructuring plans)](https://www.legislation.gov.uk/ukpga/2006/46/part/26A). UK Parliament (legislation.gov.uk), Revised text on legislation.gov.uk (accessed 2026-10-02); Part 26A inserted by the Corporate Insolvency and Governance Act 2020 (26 June 2020). Status: in force (checked 2026-10-02). Part 26A (ss. 901A-901L) — supports: Restructuring plans for companies in financial difficulty, inserted by the Corporate Insolvency and Governance Act 2020

## Related terms

1 term

- [Private Credit](https://altss.com/glossary/private-credit)

## Referenced by

2 terms

- [Hedge Fund Strategies](https://altss.com/glossary/hedge-fund-strategies)
- [Opportunistic Real Estate](https://altss.com/glossary/opportunistic-real-estate)

## Concept record

Concept ID

ALTSS-CREDIT-026

Classification

Strategy

Topics

Private credit

Version

2.0.0

Last reviewed

2026-10-02

Structured data

[JSON](https://altss.com/reference/concepts/distressed-debt.json)

Source check

Legal statements checked against the cited primary sources on 2026-10-02 ([how](https://altss.com/methodology)). General information, not advice.

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