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The Emergency Lawsuit and Its Rapid Collapse
Capital One and HPS Investment Partners now control Discovery Behavioral Health. A New York Supreme Court judge refused to block the lender takeover, Discovery withdrew its emergency motion six days after filing, and the company’s board was replaced by directors the lenders chose. That is the short version every behavioral health operator needs to internalize before reading anything else.
The longer version starts on December 12, 2025. Court filings show that Capital One, acting as Administrative Agent under the credit agreement, sent notices at roughly 5:53 p.m. On a Friday divesting Discovery of voting rights over two key subsidiaries and replacing both subsidiary boards with individuals the lenders presumably control. Three days later, Discovery, represented by Goodwin Procter, filed Discovery Behavioral Health, Inc. V. Capital One, National Association, No. 656437/2025, in the Commercial Division of New York County Supreme Court, seeking to halt what it called an unlawful takeover of its 130-plus programs.
The court held one hearing, on December 16, before Justice Anar Rathod Patel. Behavioral Health Business reported that the judge rejected Discovery’s arguments and the only restraint he indicated he would impose was preventing Capital One and the new board from running a “fire sale” of the company. Discovery filed a notice of discontinuance on December 21. The case is now closed and dismissed.
Inside the Alleged Default and Lender Takeover
This was not a missed payment. Discovery’s attorneys stated plainly in their filings that the company did not miss debt service. The fight was over a single line in the covenant math: how to treat the rent and utilities on facilities Discovery had already shut down.
Capital One disputed a December 2024 change in how Discovery calculated its debt-to-earnings ratio for quarterly compliance reports. The lenders argued that without the adjustment, Discovery would have breached its maximum debt-to-EBITDA covenant outright. Discovery pointed to the credit agreement’s plain text, which expressly permits the company to deduct “gains or losses on abandoned or discontinued operations.”
That disagreement escalated into a formal Notice of Potential Default in May 2025. By December, Capital One had converted “potential” into an actual declared default, removed the board, and installed its slate. The takeaway for any sponsor-backed operator: covenant interpretation, not payment performance, can be the decisive trigger. We have repeatedly told clients in Florida, Texas, and Arizona that reporting definitions and EBITDA add-back conventions deserve the same rigor as a state licensing survey window. This case is the live demonstration of why.
Facility Closures, Strategy Shifts, and Financial Stress
Discovery’s pivot from residential to outpatient was the strategic backdrop. Since 2023, Discovery shuttered dozens of facilities under then-CEO John Peloquin, who described the move as a deliberate shift away from residential toward outpatient care. The clinical logic was defensible. The balance sheet logic was not.
Long-term leases and utility obligations on closed sites stayed on the books even after programs went dark. Acuity’s analysis described these as the operational drag of unwinding long-term commitments, and the credit agreement had already been amended multiple times to accommodate missed covenants. Each amendment bought time without resolving the underlying strain.
The macro picture made this worse. Mertz Taggart’s Q4 2025 report noted addiction treatment saw the lowest total deal volume in six years, and lenders spent 2025 conducting forensic-level diligence on insurance receivables in behavioral health deals. FOCUS Investment Banking pegs addiction treatment platforms at 8 to 11 times EBITDA, with add-ons at 4 to 7 times, the lower end of the behavioral health spread. A company carrying $280 million in debt against a contracting SUD valuation environment has very little margin for error.
Credit Agreement Amendments and Failed Negotiations
The amendment history reads like a chronicle of slow-burn distress. Discovery entered the debt agreements with Capital One and HPS in June 2021. The August 2022 amendment increased one tranche from $25 million to $30 million. The May 2024 amendment waived prior defaults, including a Q4 2023 covenant breach and late financial reporting, and reset the permitted debt-to-earnings ratio to 6.63 to 1.
After the May 2025 potential default notice, Webster Equity Partners, Discovery’s sponsor, agreed to sell Discovery’s outpatient division, Discovery Medical Services, and use the proceeds to settle the dispute. Documentation progressed into October. Then, on October 13, 2025, Capital One learned that Discovery and Webster were no longer consummating the sale or executing the amendment. Within weeks, the lenders moved.
Chris Larson, the Behavioral Health Business reporter who has covered the sector for nearly a decade, framed the significance bluntly: “this is the first time in my decade-plus career as a journalist that I’ve seen a bank essentially repossess and run a behavioral health provider.” Operators who have been waiting out three rounds of forbearance should read that sentence twice.
Implications for Behavioral Health Operators and Investors
The sector is consolidating into a smaller pool of well-capitalized winners and a growing pool of distressed assets. Irving Levin Associates reported 104 publicly announced behavioral health transactions in 2025, a 42 percent jump from 73 in 2024 and the most active year since 2022. But the same report showed quarterly activity declining steadily, from 32 deals in Q1 to 18 in Q4. The Private Equity Stakeholder Project tracked 56 PE-backed behavioral health deals in 2025 inside a broader 1,029-deal healthcare universe.
What does this mean for operators in our home states of Florida, Tennessee, Georgia, and Arizona? Three things AHS clients are acting on right now.
- Pull the credit agreement and re-read the EBITDA definition. If your CFO is using add-backs your lender did not pre-approve in writing, you are running Discovery’s playbook.
- Treat lease obligations on closed sites as live debt. Operators pivoting from residential to outpatient often underestimate how legacy real estate sits on the covenant math for years.
- Build a real plan B for amendment negotiations. When a sponsor-led sale process collapses, the negotiating window closes fast. Mertz Taggart’s 2025 report documented credit committees scrutinizing revenue numbers more closely after Change Healthcare and ongoing Medicaid uncertainty.
Courts are not going to save you once a default is declared. The judge in Discovery’s case would not even grant a TRO beyond restraining a fire sale. Operators who want to keep control of their companies need to manage covenant compliance with the same discipline they bring to a CARF or Joint Commission survey. The cost of not doing so is in the public record now: a $280 million credit facility, 130-plus programs, and a board replaced by email on a Friday evening.
Frequently asked questions
Did Discovery Behavioral Health actually miss a loan payment?
No. Discovery’s attorneys stated in the December 2025 filings in New York County Supreme Court (Case No. 656437/2025) that the company did not miss any debt service payments. The default Capital One asserted was based on covenant interpretation, specifically how Discovery calculated its debt-to-EBITDA ratio after excluding rent and utilities tied to closed facilities, not on payment performance.
What is the takeaway for behavioral health operators with sponsor-backed debt?
Read your credit agreement’s EBITDA definition and any add-back language before your next quarterly compliance certificate. If your finance team is using accounting treatments your lender has not approved in writing, you are exposed to the exact failure mode Discovery hit. Repeated covenant amendments are a warning sign, not a solution; Discovery’s facility had been amended multiple times since June 2021, including a May 2024 amendment that reset the permitted debt-to-earnings ratio to 6.63 to 1, and lender tolerance still ran out.
What did the court actually decide?
Justice Anar Rathod Patel held one hearing on December 16, 2025 and declined to grant a temporary restraining order. Per Behavioral Health Business’s reporting, the only restraint the judge indicated he would impose was preventing Capital One and its newly installed board from initiating a fire sale of Discovery’s assets. Discovery filed a notice of discontinuance on December 21, 2025, ending the case.
Is this a one-off or a sign of broader behavioral health distress?
Behavioral Health Business reporter Chris Larson, who has covered the sector since 2016, called this the first time in his decade-plus career he had seen a bank essentially repossess and run a behavioral health provider. Mertz Taggart’s Q4 2025 report documented addiction treatment at its lowest deal volume in six years and noted lenders are now running forensic-level diligence on insurance receivables. FOCUS Investment Banking places addiction treatment platforms at 8 to 11 times EBITDA, with add-ons at 4 to 7 times, the lowest band in behavioral health. The combination of heavy debt loads, contracting SUD valuations, and tighter credit committees creates conditions where more enforcement actions are plausible.
References
- Behavioral Health Business: Capital One Seizes Control of Discovery Behavioral Health After Defaulting on Debt (Feb. 9, 2026)
- Law.com Radar: Discovery Behavioral Health, Inc. V. Capital One, N.A. (Case No. 656437/2025)
- UniCourt Docket: Discovery Behavioral Health, Inc. V. Capital One, N.A. Et al., NY Supreme Court, New York County
- Behavioral Health Business: What Capital One’s Takeover Means for the Industry (Feb. 13, 2026)
- Acuity: Discovery Behavioral Health’s $280M Default: The Risk of Aggressive Scaling
- Irving Levin Associates / LevinPro HC: Behavioral Health Care M&A Activity Increases 42% in 2025
- Mertz Taggart: Q4 2025 Behavioral Health M&A Report
- FOCUS Investment Banking: Behavioral Health EBITDA Multiples 2025 Update
- Private Equity Stakeholder Project: PE Healthcare Dealmaking 2025