Corporate governance and corporate finance operate very differently as legal academic topics. With governance, there’s always some new legal development—a Delaware ruling, a provision in a corporate code, or a new SEC regulation. Failing that, the international corporate governance machine is a reliable generator of new material, whether a new wrinkle on a monitoring process or a substantive initiative falling inside the big tent of corporate purpose. With finance, law and legal theory are more in the back seat while practice takes the lead. Bankruptcy is the one important exception, but even there, practice has been trumping law in recent years as bankruptcy courts have passively turned the reins over to controlling creditors. Not that there aren’t developments in the practice to write about. There are. But this will be more a matter of tracking new wrinkles than accounting for great upheavals.
It is, accordingly, a big deal for legal finance when a whole new mode of financing springs up on the upper part of the right side of corporate balance sheets. The quick rise of private credit in recent years is just such a development. Jared A. Ellias and Elisabeth de Fontenay, The Credit Markets Go Dark, 134 Yale Law Journal 779 (2025), lays out the territory with diligence, clarity, and sophistication.
Private credit is to bonds and notes what private equity is to common stock. A financial intermediary organizes a limited partnership and sells limited partnership interests to institutional investors. Unlike private equity, where the partnership takes over companies, here the partnership lends money to companies, which are mostly medium and small sized. The terms of the loans tend to run three to six years. The loans are direct – no underwriter is involved. The partnership holds the loans to maturity—at least as yet, there is no secondary trading market in the paper. The partnership also jacks up its risk/return profile by borrowing up to one-half of its total capitalization (“back leverage”). The sector’s rapid growth has come mainly at the expense of bank term loan syndications.
Ellias and de Fontenay account for all of this by detailing what’s in it for each of the major players. It is a cogent way to proceed. First come the borrowers. They get speed, flexibility, and enhanced certainty and confidentiality. There’s an extra bonus in a case where the borrower has no publicly traded debt—going the private credit route deflects debt market discipline. Second come the equity investors in the private lender. They use the private credit vehicle as an indirect way of making loans themselves. They are in economic substance lenders, lenders which, instead of originating and monitoring loans through their own departments, outsource lending and monitoring to the private credit firm. These players get higher yields than are available in the bank syndication and junk bond markets. The loans come with tighter covenants and are made in an institutional context insulated from the creditor-on-creditor violence that has turned the syndicated loan market into a financial charnel house. Third and last come the asset managers. They get fees, which can be expected to scale down from the classic private equity two and twenty rip. They also get freedom of action: Because they are unregulated, they get to do things banks can’t do, like take positions in a company up and down its entire capital structure. (Yes, private credit lenders sometimes take stock positions in investee companies, interpolating the equity kicker into the portfolio directly rather than sneaking it in under a convertible security.) They also get favorable accounting treatment: Because they hold the loans to maturity, they can manage their portfolios free of the markdowns triggered by market price declines.
Now, I would have thought that a turn to hold-to-maturity lending under strict covenants would be a cause for celebration. But Ellias and de Fontenay see some problems. While the removal of market discipline might be nice for the borrowers and asset managers, there is a net loss of public information about the borrower. Jumping across the private-public divide (ahem), Ellias and de Fontenay term this “de-democratization.” They also identify a problem of growing intermediary power—the private lending firms overlap to some extent with the private equity firms. In effect, Blackstone, et al., are moving under the cover of darkness to get hold of the entire capital structures of large numbers of companies and nobody does anything to impose transparency or otherwise hold them in check. Even where the players are new (and not active on the private equity side), as they gain market share they displace markets as intermediaries, exposing the economy to institutional failure even as they shield it from market failure. Finally, once the private credit borrowers get into financial distress in large numbers (and they will), we are going to see a significant change in the chapter 11 fact pattern. Ellias and de Fontenay predict that private credit lenders will be more likely to accord slack to troubled companies, with potentially negative consequences for corporate performance. In addition, private credit lenders, as compared to the banks, will be looking to end up as the owners of reorganized companies. Lastly, the absence of market pricing will enhance the burden imposed on bankruptcy judges reviewing asset sales and reorganization plans.
I will close with a note regarding the study’s empirical basis. Because private credit is private, we don’t know as much about it as we know about regulated sectors like banking. Ellias and de Fontenay get high marks for doing what they can to surmount this barrier by gathering information on the portfolios of business development companies (BDCs). BDCs are regulated closed-end investment companies that raise capital from retail investors to make debt and equity investments in smaller companies. They report their portfolio holdings to the SEC. Private lenders raise about 10 percent of their capital through BDCs. The BDCs’ SEC filings thus offer an empirical, albeit indirect, picture of the private credit sector. Ellias and de Fontenay survey this data, yielding hard pictures of dollars loaned over time (up), numbers of loans (up), portfolio value (up), and lender debt-equity ratios (down).
