Bankruptcy poses a national security risk

The United States is facing a significant national security risk due to the increasing reliance on private contractors by the Department of Defense for critical defense functions. This practice, known as defense outsourcing, has become a dominant model for various aspects of national defense, from arms manufacturing to cyber operations. In 2023, the Department of Defense spent over half of its total federal defense budget on goods and services provided by contractors, totaling USD $431.4 billion. While this privatized structure has become essential for US military capabilities, it has also introduced a substantial risk: the rise of private equity ownership in the defense industry.

Central to this risk is the leveraged buyout (LBO) model, where private equity firms have acquired more than 1,500 defense contractors between 2000 and 2022. Through LBOs, the acquiring company borrows funds using the target company’s assets and future cash flows as collateral, often resulting in a significant debt burden. By leveraging assets at a debt-to-equity ratio of 9:1, these transactions have made the defense industry one of the most indebted sectors in the US, with over 40% of defense mergers and acquisitions being driven by private equity. This accumulation of debt poses a looming threat of financial collapse.

Data from 2024 shows that private equity-owned firms accounted for 16% of all US bankruptcies, marking the highest share since 2010. Companies acquired through LBOs face a higher risk of bankruptcy compared to their publicly listed counterparts, with a bankruptcy rate of approximately 20% within a decade of acquisition. This heightened risk is particularly concerning in the defense sector, where the government heavily relies on a limited number of specialized contractors. The failure of a single contractor can lead to a chain reaction of disruptions, including defaults, foreclosures, and bankruptcies, ultimately jeopardizing critical defense capabilities.

Several high-profile defense contractors, such as Intelsat, MD Helicopters, and Constellis, have already filed for bankruptcy under Chapter 11 of the US Bankruptcy Code, underscoring the fragility of the current defense outsourcing model. The existing legal framework in the US is ill-equipped to handle this mounting risk, as bankruptcy law, designed to facilitate debtor rehabilitation, contrasts with national security law’s intent to maintain public control over defense operations. Both legal realms fail to address the upstream risks posed by private equity involvement in the defense industry.

Private equity transactions often evade oversight from both bankruptcy and national security laws, creating a regulatory gap that allows private equity firms to restructure and sell defense contractors without triggering review or accountability. These transactions can alter the substance of defense contracts, introducing new parties, terms, and risks not originally contemplated by the government. Furthermore, the structure of private equity transactions isolates owners from liability when a portfolio company fails, while allowing them to reap the profits when it succeeds—shifting the balance of risk and reward in the federal procurement regime.

This loophole in the legislative framework exemplifies a disconnect between economic efficiency and public accountability, enabling private equity firms to exploit the defense industry for profit while externalizing risks. To address this emerging legal blind spot, an ex ante risk mitigation approach is proposed to proactively manage the risks associated with private equity involvement in critical defense functions. This tailored approach aims to close the regulatory gaps and prevent speculative financial behavior that threatens national security in the long run.