Francesco Di Costanzo
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(9) When Equity Is Out of the Money, Information Becomes the Collateral

/11 min read

The Structural Problem Hidden Inside Asset-Based Private Credit

Asset-based lending is often considered one of the more conservative forms of credit. Instead of relying solely on enterprise value or projected cash flows, lenders advance funds against identifiable assets such as receivables, inventory, or property. Borrowing bases, field audits, advance rates, and lockbox arrangements are designed to ensure that lenders remain protected even if operating performance deteriorates. In theory, if the business weakens, the collateral remains. In practice, recent failures in private credit suggest that this assumption may be incomplete.

Several high-profile collapses have revealed a deeper structural vulnerability in asset-based lending. In situations such as First Brands, Tricolor Holdings, and Market Financial Solutions, the problem was not simply that collateral values declined. The problem was that lenders discovered they did not actually control the truth about the collateral itself. Assets that had supposedly been pledged to one facility had also been pledged elsewhere, and in some cases the underlying collateral had been materially overstated or manipulated.

These cases are often framed as isolated fraud events. But when examined through the lens of capital structure incentives, they reveal something more fundamental. The key turning point occurs when equity becomes economically worthless. At that moment, the incentives of the controlling shareholder change dramatically. Once equity is out of the money, the most valuable remaining asset is not the company’s inventory or receivables. It is control over the information that lenders rely upon to determine whether those assets exist and whether they remain available as collateral.

Equity as an Option and the Shift in Incentives

Corporate finance theory has long described equity as a call option on the value of a firm’s assets. If the value of the firm exceeds the face value of its debt, equity captures the upside. If the firm’s value falls below that threshold, equity’s intrinsic value approaches zero, but it retains time value because of limited liability. Shareholders cannot lose more than their initial investment, yet they retain the upside if asset values recover above the debt level.

This payoff structure creates a powerful asymmetry in distress. When equity is deeply out of the money, shareholders have an incentive to maximise volatility. Increasing risk, delaying recognition of losses, or extending liquidity all increase the chance that the option regains value. Historically this risk-shifting behaviour has manifested through riskier investments or aggressive capital structures.

Recent private credit cases reveal a more extreme variant. Instead of shifting into riskier investments, founders shifted into riskier information strategies. When legitimate business performance could no longer sustain the capital structure, the most powerful remaining lever was the ability to influence what lenders believed about the collateral.

Asset-Based Lending Is Ultimately a Data Structure

Asset-based lending is often described as collateral-driven lending, but in practice the entire framework depends on borrower-provided information. Borrowing base certificates are prepared by the borrower. Receivables ageing reports originate from the borrower’s internal systems. Inventory eligibility depends on classifications generated by the borrower’s ERP platform. Even cash collection and reconciliation often begin within the borrower’s accounting systems before funds reach lender-controlled accounts.

This means that asset-based lending is not simply a collateral structure. It is a data governance structure.

Lenders may hold legal security over assets, but the operational definition of those assets often sits inside the borrower’s systems. Field audits and periodic reconciliations provide verification, but these controls are typically sample-based and infrequent relative to the pace of lending activity. Between audits, lenders rely heavily on the borrower’s representation of reality.

Under normal circumstances this dependency is manageable. Borrowers have incentives to maintain credibility and avoid damaging relationships with lenders. But when equity becomes economically worthless and refinancing options narrow, those incentives change. The borrower’s remaining objective is often to extend liquidity for as long as possible. The most effective way to achieve that objective may be to manipulate the information that determines collateral availability.

How Double-Pledging Becomes Possible

The most visible manifestation of this vulnerability is double-pledging: using the same collateral to support multiple financing arrangements. In theory, security documentation and filing systems should prevent this. In practice, several features of modern private credit make duplication easier than expected.

Collateral in asset-based structures is often duplicable. Receivables, loan portfolios, and warehouse collateral accounts exist as datasets rather than physical assets. If the borrower controls the dataset, the same underlying assets can be presented differently to different lenders.

Verification mechanisms are also fragmented. Different facilities often involve different lenders, custodians, and monitoring processes. Each lender sees its own collateral pool but rarely has visibility into the borrower’s full capital structure. Filing systems establish legal priority but do not confirm the uniqueness of the underlying collateral.

The result is a system in which lenders may hold valid security interests in assets that have already been pledged elsewhere.

Three Cases, One Structural Pattern

The collapses of First Brands, Tricolor Holdings, and Market Financial Solutions illustrate different variations of this same mechanism.

First Brands allegedly involved fabricated and inflated receivables combined with complex off-balance-sheet inventory financing. Prosecutors have alleged that collateral was pledged repeatedly across multiple financing channels while liabilities were concealed from lenders.

Tricolor Holdings presented a different asset class but a similar structural problem. The company operated a large subprime auto lending platform where loan portfolios served as collateral for warehouse lines and securitisations. Prosecutors allege that thousands of loans were pledged across multiple facilities while internal data manipulation made delinquent loans appear eligible for borrowing bases.

Market Financial Solutions, a UK bridging lender, reportedly experienced a substantial collateral shortfall linked to double-pledging of property-related assets across institutional funding lines.

Across these cases the asset classes differed, the geographies differed, and the lenders differed. Yet the mechanism was strikingly similar: founder-controlled organisations managing complex funding structures while simultaneously controlling the reporting systems used to verify collateral.

Private Credit’s Structural Amplifiers

Several characteristics of the private credit market can amplify these vulnerabilities.

Private loans are negotiated bilaterally and rarely trade in liquid secondary markets, limiting the role of market pricing in signalling distress. Portfolio valuations are typically updated quarterly rather than continuously. Lenders also often prefer to extend maturities through amendments rather than force immediate restructurings.

None of these features individually creates fraud risk. But together they can create an environment where problems accumulate slowly before becoming visible. When liquidity conditions tighten and refinancing attempts require deeper diligence, the borrower’s ability to sustain the narrative collapses.

The Governance Gap

The common thread across recent collapses is not simply weak documentation. It is a mismatch between legal rights and operational visibility.

Lenders may have contractual rights to collateral, reporting, and audits. But if the borrower controls the systems that generate the information, those rights do not necessarily translate into real-time understanding of the collateral pool.

This distinction becomes critical when equity loses economic value. At that moment the incentives of the controlling shareholder shift toward preserving optionality. The most effective lever may no longer be operational performance but the ability to shape the information lenders use to determine whether intervention is justified.

Re-Architecting Collateral Truth

If information control becomes the most valuable asset in a distressed capital structure, lenders must design structures that reduce borrower control over the collateral narrative.

This could involve earlier activation of cash dominion, stronger custody arrangements, or continuous verification of collateral pools rather than periodic sampling. Greater cross-lender visibility may also become necessary as borrowers increasingly operate with multiple financing arrangements.

More fundamentally, the industry may need to rethink how collateral is recorded and verified. Systems capable of confirming the uniqueness of pledged assets across lenders could materially reduce the risk of duplication.

None of these measures eliminates fraud risk entirely. But they shift the control of collateral truth away from the borrower at precisely the moment when borrower incentives are most distorted.

The Real Question for Private Credit

The recent collapses do not prove that asset-based lending is fundamentally broken. In many circumstances it remains a disciplined and resilient form of credit. But they do raise an uncomfortable structural question.

If equity becomes worthless and information control sits with the borrower, the incentives for manipulation become powerful. When that occurs inside fragmented funding structures and opaque markets, collateral fraud becomes a plausible outcome rather than an unimaginable one.

The challenge for lenders is therefore not only to secure collateral. It is to ensure they control the truth about that collateral before the capital structure reaches the point where incentives diverge.

Sources

Corporate Finance Theory (Equity as Call Option, Risk-Shifting)

  1. John Hull & Izzy Nelken, "Merton’s Model, Credit Risk, and Volatility Skews" https://www-2.rotman.utoronto.ca/~hull/downloadablepublications/mertonsmodelandvolatilityskews.pdf

  2. Wikipedia contributors, "Merton model" https://en.wikipedia.org/wiki/Merton_model

  3. MathWorks, "Default Probability Using the Merton Model for Structural Credit Risk" https://www.mathworks.com/help/risk/default-probability-using-the-merton-model-for-structural-credit-risk.html

  4. Finance Department, University of Connecticut, "Risk-shifting and investment asymmetry" https://finance.business.uconn.edu/wp-content/uploads/sites/723/2014/08/FRL2010.pdf

  5. Harvard Law School Forum on Corporate Governance, "Do Firms Engage in Risk-Shifting? Empirical Evidence" https://corpgov.law.harvard.edu/2016/09/25/do-firms-engage-in-risk-shifting-empirical-evidence/

  6. Patrick C. Mason et al., "Convertible Debt and Shareholder Incentives" (SSRN) https://papers.ssrn.com/sol3/papers.cfm?abstract_id=2159478

Asset-Based Lending, Borrowing Bases, and Legal Infrastructure

  1. British Business Bank, "What is asset-based lending?" https://www.british-business-bank.co.uk/business-guidance/guidance-articles/finance/asset-based-lending

  2. CoBrief, "Borrowing base certificates: Overview, definition, and example" https://www.cobrief.app/resources/legal-glossary/borrowing-base-certificates-overview-definition-and-example/

  3. Wall Street Prep, "Borrowing Base | Formula + Calculator" https://www.wallstreetprep.com/knowledge/borrowing-base/

  4. Finley, "What is a borrowing base?" https://www.finleycms.com/blog/what-is-a-borrowing-base

  5. Sikich, "Field Examination Services for Asset-Based Lending" (PDF) https://www.sikich.com/wp-content/uploads/2021/06/Field-Examination-for-Banking-Services.pdf

  6. Bank Advisors Ltd., "ABL Field Exam and Asset Quality Review" https://bankadvisorsltd.com/credit-risk-services/abl-field-exams/

  7. Rosenberg & Fecci Consulting, "ABL Field Examinations" https://www.rosenbergandfecci.com/services/field-examinations

  8. Office of the Comptroller of the Currency, "Asset-Based Lending – Comptroller’s Handbook" (PDF) https://www.occ.treas.gov/publications-and-resources/publications/comptrollers-handbook/files/asset-based-lending/pub-ch-asset-based-lending.pdf

  9. Cornell Law School Legal Information Institute, "UCC § 9‑322. Priorities among conflicting security interests" https://www.law.cornell.edu/ucc/9/9-322

  10. Wolters Kluwer, "Common mistakes when filing a UCC‑1" https://www.wolterskluwer.com/en/expert-insights/common-mistakes-when-filing-a-ucc-1

  11. Blank Rome, "Security Interests and Liens Priorities" (PDF) https://www.blankrome.com/sites/default/files/2020-06/security_interests_and_liens_priorities.pdf

  12. Barclay Damon, "Security Interest Priority Issues: First to File Might Not Be First in Right" https://www.barclaydamon.com/alerts/security-interest-priority-issues-first-to-file-might-not-be-first-in-right

Double-Pledging, Collateral Uniqueness, and Structural Commentary

  1. Wolters Kluwer, "Double pledging after Tricolor: Stop treating collateral like a suggestion" https://www.wolterskluwer.com/en/expert-insights/double-pledging-after-tricolor-stop-treating-collateral-like-a-suggestion

  2. Prasad Gollakota, "MFS and its discontents: when the security package triggers a run" (IFR) https://www.ifre.com/opinion/2393879/mfs-and-its-discontents-when-the-security-package-triggers-a-run

First Brands Group – Fraud, Double-Pledging, Off‑Balance‑Sheet Structures

  1. U.S. Department of Justice (SDNY), "First Brands Executives Charged With Multibillion-Dollar Fraud" https://www.justice.gov/usao-sdny/pr/first-brands-executives-charged-multibillion-dollar-fraud

  2. Global Trade Review, "First Brands accuses founder of receivables and inventory finance fraud" https://www.gtreview.com/news/americas/first-brands-accuses-founder-of-receivables-and-inventory-finance-fraud/

  3. Global Trade Review, "First Brands faces investigation into double financing of receivables and inventory" https://www.gtreview.com/news/americas/first-brands-faces-investigation-into-double-financing-of-receivables-inventory/

  4. Reuters, "Court orders independent probe into First Brands fraud allegations" https://www.reuters.com/business/finance/court-orders-independent-probe-into-first-brands-fraud-allegations-2025-11-19/

  5. Reuters, "First Brands founder indicted for fraud after bankruptcy that spooked Wall Street" https://www.reuters.com/business/finance/first-brands-founder-patrick-james-his-brother-indicted-fraud-2026-01-29/

  6. The New York Times, "Founder of First Brands, Whose Bankruptcy Spooked Wall Street, Is Indicted on Fraud" https://www.nytimes.com/2026/01/29/business/first-brands-fraud-indictment.html

  7. CNBC, "First Brands founder Patrick James and his brother indicted for fraud" https://www.cnbc.com/2026/01/29/first-brands-founder-patrick-james-and-his-brother-indicted-for-fraud.html

  8. D&O Diary, "First Brands Sues Its Founder for ‘Grievous Misconduct’" https://www.dandodiary.com/2025/11/articles/director-and-officer-liability/first-brands-sues-its-founder-for-grievous-misconduct/

  9. Stretto / Chapter11Cases, "First Brands Seeks Court Approval for Reconciliation Procedures After Uncovering Billions in Factoring Irregularities" https://chapter11cases.com/blogs/news/first-brands-seeks-court-approval-for-reconciliation-procedures-after-uncovering-billions

  10. Bloomberg, "First Brands’ Fallout Exposes Risks of Lending Private Debt" https://www.bloomberg.com/news/articles/2025-10-02/first-brands-fallout-exposes-risks-of-lending-private-debt

Tricolor Holdings – Double-Pledging Auto Loans and Data Manipulation

  1. Reuters, "Tricolor executives charged with fraud over subprime lender's collapse" https://www.reuters.com/legal/government/us-unseals-charges-against-bankrupt-tricolors-executives-over-fraud-2025-12-17/

  2. Bloomberg Law, "Tricolor Founder Chu Charged With Alleged Fraud, DOJ Says" https://news.bloomberglaw.com/white-collar-and-criminal-law/tricolor-founder-chu-charged-with-alleged-fraud-doj-says-1

  3. Reuters, "JPMorgan, Barclays, Fifth Third sued by investors for missing ‘giant red flags’ at Tricolor" https://www.reuters.com/legal/government/jpmorgan-barclays-fifth-third-sued-by-investors-missing-giant-2026-02-27/

  4. Banking Dive, "JPMorgan, Barclays, Fifth Third sued over Tricolor" https://www.bankingdive.com/news/jpmorgan-barclays-fifth-third-sued-tricolor-fraud/813504/

  5. Bloomberg, "Federal Prosecutors Looking Into Fraud Allegations at Tricolor" https://www.bloomberg.com/news/articles/2025-09-11/federal-prosecutors-looking-into-fraud-allegations-at-tricolor

  6. ElevenFlo, "Tricolor Holdings: Chapter 7 Bankruptcy After $800M Fraud" https://elevenflo.com/blog/tricolor-holdings-bankruptcy

  7. Wolters Kluwer, "Double pledging after Tricolor: Stop treating collateral like a suggestion" https://www.wolterskluwer.com/en/expert-insights/double-pledging-after-tricolor-stop-treating-collateral-like-a-suggestion

  8. Beyond Banks newsletter, "Tricolor 29,000 Loans Pledged Twice" https://newsletter.cobaltintelligence.com/p/tricolor-29-000-loans-pledged-twice

Market Financial Solutions (MFS) – Double-Pledging and Collateral Shortfall

  1. Bloomberg Law, "MFS Creditors Warn of £930 Million Shortfall in Collateral" https://news.bloomberglaw.com/bankruptcy-law/mfs-creditors-warn-of-930-million-shortfall-from-double-pledges

  2. The Globe and Mail (via Reuters content), "Wall Street hit by UK mortgage lender collapse, raising fears of more credit 'cockroaches'" https://www.theglobeandmail.com/investing/article-wall-street-hit-by-uk-mortgage-lender-collapse-raising-fears-of-more/

  3. Temie Laleye, "Major bank faces £600million hit after UK mortgage lender collapses" (GB News) https://www.gbnews.com/money/barclays-mortgage-provider-collapse-fraud-ftse100-market-financial-solutions

  4. Prasad Gollakota, "MFS and its discontents: when the security package triggers a run" (IFR) https://www.ifre.com/opinion/2393879/mfs-and-its-discontents-when-the-security-package-triggers-a-run

  5. Contextual Solutions, "MFS Collapse: A £2.4B Warning to Private Credit & Fintech" https://www.contextualsolutions.de/blog/market-financial-solutions-collapse-private-credit

Private Credit Market Structure and Opacity

  1. Morgan Stanley, "Private Credit Market: 2024 Outlook & Opportunities" https://www.morganstanley.com/ideas/private-credit-outlook-considerations-legacy

  2. MSCI, "Private-Credit Funds Eclipsed Private Equity in 2024" https://www.msci.com/research-and-insights/quick-take/private-credit-funds-eclipsed-private-equity-in-2024

  3. AIMA, "Strong growth sees private credit market reach US$3.5 trillion" https://www.aima.org/article/press-release-strong-growth-sees-private-credit-market-reach-us-3-5-trillion.html

  4. Cambridge Associates, "Do the Recent Bankruptcies of First Brands and Tricolor Suggest Trouble Ahead in Private Credit?" https://www.cambridgeassociates.com/insight/do-the-recent-bankruptcies-of-first-brands-and-tricolor-suggest-trouble-ahead-in-private-credit/

  5. Private Debt Investor, "Smoke signals: Lessons from First Brands and Tricolor" https://www.privatedebtinvestor.com/smoke-signals-lessons-from-first-brands-and-tricolor/