Many financially distressed firms remain highly levered, invest little, and perform poorly after emerging from a debt restructuring. As a consequence, they often reenter distress shortly after the restructuring. This paper presents a theory of dynamic liquidation that is consistent with these findings. Postponing the liquidation decision allows creditors to learn about the firm’s prospects and implement a better liquidation policy. However, there is a trade-off between optimal liquidation and optimal investment because creditors learn more about the firm’s prospects if the firm forgoes some profitable long-term projects. When creditors resolve this trade-off in favor of learning, the firm suffers from the consequences of distress even after emerging from the restructuring. The theory has implications for the costs of financial distress and bankruptcy law.