By Jason Jia-Xi Wu (Law Clerk; Harvard Law School)
Defense contractors lie at the heart of the U.S. national security regime. Each year, over half of the federal defense budget is allocated to contracts outsourcing military operations, projects, and services to private companies. However, defense outsourcing carries a ticking time bomb: mounting private debt. Today, the defense industry is among the nation’s most indebted sectors, fueled largely by the rise of private equity. Over the past two decades, more than 1,500 defense contractors have been acquired by private equity firms through leveraged buyouts (LBO)—high-risk takeovers funded almost entirely by debt. At any moment, this private debt time bomb could detonate, triggering a cascade of financial failures destabilizing the defense supply chain.
This rapid debt accumulation has introduced a new national security risk: bankruptcy. Private equity’s aggressive use of debt in LBOs has heightened the risks of default and foreclosure of defense contractors they acquire. Yet, private equity firms shield themselves from these risks through “bankruptcy-remote” structuring. As a result, a rising tide of LBO-induced defense contractor bankruptcies have disrupted critical defense supply chains, jeopardizing national security.
The existing legal regime is ill-suited to address this risk. Despite the interconnection between bankruptcy and national security, Congress has designed them as separate regimes with conflicting goals. The Bankruptcy Code respects contractual freedom and prioritizes efficient debtor rehabilitation through private ordering. In contrast, the Anti-Assignment Acts impose strict limits on contractual freedom when national security is at stake. Private equity exploits this gap by operating beyond both regimes. Though the Bankruptcy Code prevents third-party abuses that hinder debtor rehabilitation, it does not address risks outside of bankruptcy—where LBO-induced risks originate. Likewise, private equity exploits a loophole in the Anti-Assignment Acts, which restrict contract assignments but do not prevent entire companies from being resold. This allows private equity to extract value from defense contractors and exit without accountability.
This article proposes ex ante risk mitigation as a solution. Existing law offers only ex post remedies after a defense contractor files for bankruptcy, even though the seeds of failure are often sowed years before filing—beginning with the private equity LBO. The proposed solution has three components: (1) deleverage the defense industry by altering incentives for debt financing; (2) hold private equity accountable through an LBO review mechanism; and (3) make defense contractors less vulnerable in bankruptcy by amending the executory contract exception in the Bankruptcy Code.
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