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The short answer: lenders won, the court refused to intervene, and HPS now owns the company
Capital One and HPS Investment Partners took operational control of Discovery Behavioral Health in December 2025, a New York judge declined to block them, and by June 2, 2026 HPS had converted its debt position into majority ownership pending regulatory approval. Justice Anar Rathod Patel of the New York County Supreme Court refused to grant a temporary restraining order beyond restraining a fire sale of assets. Discovery filed a notice of discontinuance six days after filing its complaint. Directors chosen by the lenders replaced the board.
The longer version starts on December 15, 2025, when Goodwin Procter filed Discovery Behavioral Health, Inc. V. Capital One, National Association, et al., Index No. 656437/2025, in the Commercial Division of the New York County Supreme Court. The complaint sought to halt what Discovery called an unlawful takeover of the company’s 130-plus behavioral health programs. Court documents show Capital One and HPS found Discovery to be in default on $280 million of debt, and that Discovery filed emergency motions on Dec. 15, 2025, only to withdraw its efforts six days later on Dec. 21.
Then the next shoe dropped. On June 2, 2026, Discovery announced that, pending regulatory approval, investment funds managed by HPS Investment Partners would take over majority ownership in exchange for a substantial reduction of its debt obligations, and named Pete Clarke as CEO alongside a new Board of Directors. A debt-for-equity endgame. Not a court reversal.
Inside the alleged default: covenant math, not a missed payment
This was not a missed payment. Discovery’s December 2025 complaint stated the company had maintained compliance with financial covenants and timely loan payments. The fight was over a single line in the covenant math: how to treat rent and utilities on facilities Discovery had already shut down.
Capital One took issue with a change in December 2024 in how Discovery calculated its debt-to-earnings ratio for quarterly financial compliance reports, which culminated in Capital One effectively seizing the company’s assets, dismissing its board and installing its own. Discovery pointed to the credit agreement’s plain text, which it said permitted the deduction. That disagreement escalated into a formal Notice of Potential Default in May 2025. Then it went quiet for six months.
On December 8, 2025, Capital One sent a Notice of Existing Events of Default. Four days later, the board was gone. Court filings describe how, at about 5:53 p.m. On Friday, December 12, 2025, defendants sent a notice purporting to divest Discovery of voting rights over two key subsidiaries and installed replacement boards through written stockholder consents. Behavioral Health Business summarized the trigger this way: “a change in debt-to-earnings ratio accounting acted as the final straw of repeated default events”.
Here is the takeaway for any sponsor-backed operator: covenant interpretation, not payment performance, can be the decisive trigger. Founders and CFOs in Florida, Tennessee, and Arizona should treat reporting definitions and EBITDA add-back conventions with the same rigor a compliance officer brings to a state licensing survey window. This case is the live demonstration of why.
Closed facilities, a collapsed sponsor-led sale, and five months that ran out
The strategic backdrop was Discovery’s pivot from residential to outpatient. Discovery had been pivoting from residential care toward outpatient services under then-CEO John Peloquin, a strategic shift that required closing dozens of facilities. The clinical logic was defensible. The balance sheet logic was not, because long-term leases and utility obligations on closed sites stayed on the books after the doors closed.
Webster Equity Partners tried to buy time. A five-month negotiation nearly produced a resolution through the sale of Discovery’s outpatient division, Discovery Medical Services, but the deal collapsed on October 13, 2025. That collapse was the inflection point. Within weeks, the lenders moved.
Court filings show the credit agreement had already been amended multiple times. The May 2024 amendment waived a Q4 2023 covenant breach and retroactively increased the permitted debt-to-earnings ratio from Q3 2023 to Q4 2024, with the ratio then set at 6.63 to 1. Repeated covenant amendments are a warning sign, not a solution. Operators sitting on their third round of forbearance should read that history twice.
The macro picture: more deals overall, fewer addiction-treatment deals, tighter credit
The sector is bifurcating. Well-capitalized platforms are absorbing add-ons; the distressed pool keeps growing. Mertz Taggart counted 180 total behavioral health transactions in 2025, slightly up from 176 in 2024, with mental health leading Q4 activity at 27 deals while addiction treatment hit a low of 7 Q4 deals and 33 for the year. Kevin Taggart also flagged that distressed deals are becoming common for operators who over-borrowed during the cheap-money era or failed to integrate rapid acquisitions.
The structural pull is real. HRSA’s State of the Behavioral Health Workforce, 2025 reports that as of December 2, 2025, 40% (137 million) of the U.S. Population lives in a Mental Health HPSA. Demand is not the problem. Capital structure and covenant discipline are.
Lenders are behaving accordingly. Mertz Taggart’s Q4 report describes lengthened deal timelines as lenders conducted “forensic” diligence on insurance receivables and cash collections, an effect lingering from the Change Healthcare disruption and ongoing Medicaid uncertainty. A company carrying $280 million in debt against a contracting addiction-treatment valuation environment has very little margin for error.
What operators in Florida, Tennessee, Georgia, and Arizona should do this quarter
Three things AHS clients are acting on right now.
- Reread the credit agreement’s EBITDA definition, this quarter. If your CFO is using add-backs the lender did not pre-approve in writing, you are running Discovery’s playbook. The dispute here turned on a single accounting treatment for closed-facility rent and utilities. That was enough to lose a board.
- Treat lease obligations on closed sites as live debt. Operators pivoting from residential to outpatient consistently underestimate how legacy real estate sits on the covenant math for years. If your Florida or Tennessee footprint just contracted, model those obligations into every quarterly compliance certificate.
- Build a real plan B for amendment negotiations. When a sponsor-led sale process collapses, the negotiating window closes fast. Courts are not going to save you once a default is declared. Justice Patel would not even grant a TRO beyond restraining a fire sale.
Operators who want to keep control of their companies should 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, more than 130 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 December 2025 complaint in New York County Supreme Court (Index No. 656437/2025) asserted the company had maintained compliance with financial covenants and timely loan payments. Behavioral Health Business reported the dispute turned on a December 2024 change in how Discovery calculated its debt-to-earnings ratio, not on payment performance.
What did the New York court actually decide?
Justice Anar Rathod Patel declined to grant a temporary restraining order beyond restraining a fire sale of Discovery’s assets. Discovery filed a notice of discontinuance six days later, on December 21, 2025, ending the case. On June 2, 2026, Discovery announced that HPS Investment Partners would assume majority ownership pending regulatory approval, in exchange for a substantial reduction of the company’s debt.
Is this a one-off or a sign of broader behavioral health distress?
Both. Mertz Taggart’s Q4 2025 report shows addiction treatment fell to 33 deals for the year while mental health posted the strongest Q4 at 27 deals, and deal timelines lengthened as lenders ran forensic diligence on receivables tied to the Change Healthcare disruption and Medicaid uncertainty. HRSA data as of December 2, 2025 show 137 million Americans (40% of the U.S. Population) live in a Mental Health HPSA, so demand is not the constraint. Capital structure is.
What should sponsor-backed behavioral health operators do this quarter?
Read the credit agreement’s EBITDA definition and any add-back language before the next quarterly compliance certificate. If the finance team is using accounting treatments the lender has not approved in writing, the exposure is the exact failure mode Discovery hit. Treat lease and utility obligations on closed sites as live debt in the covenant math, and remember that repeated covenant amendments are a warning sign, not a solution.
References
- Behavioral Health Business. Capital One Seizes Control of Discovery Behavioral Health After Defaulting on Debt (Feb. 9, 2026)
- Behavioral Health Business. HPS Takes Majority Stake in Discovery Behavioral Health Amid CEO Change (June 2, 2026)
- Law.com Radar. Discovery Behavioral Health, Inc. V. Capital One, National Association (Index No. 656437/2025)
- UniCourt. Docket, Discovery Behavioral Health, Inc. V. Capital One, National Association et al.
- Acuity. Discovery Behavioral Health’s $280M Default: The Risk of Over-Borrowed Scaling
- HMP Global / Treatment Center Investment & Valuation Retreat. Q4 2025 Behavioral Health M&A Report Summary
- Mertz Taggart. Q4 2025 Behavioral Health M&A Report
- HRSA Bureau of Health Workforce. State of the Behavioral Health Workforce, 2025