Describe out-of-court and court-supervised restructurings and calculate recoveries under absolute priority.
Falling EBITDA against fixed debt; covenant breaches; debt trading well below face value; a looming maturity that cannot be refinanced; shrinking supplier credit; going concern language from the auditor.
| Route | What happens | Pros and cons |
|---|---|---|
| Amend and extend | Lenders waive covenants or push out maturities, for a fee and a higher rate | Fast and private; solves liquidity, not solvency |
| Exchange offer | Bondholders swap into new debt with a lower face value or longer maturity, or into equity | Avoids court; needs high participation |
| Debt-for-equity swap | Creditors become owners; existing shareholders are heavily diluted or wiped out | Fixes the balance sheet |
| Court-supervised reorganization | The company keeps operating under court protection while a plan is negotiated | Binds dissenting creditors; costly and public |
| Liquidation | Assets are sold and proceeds distributed | Last resort |
Claims are paid in order; a junior class receives nothing until senior classes are paid in full.
A distressed company is worth 500 as a reorganized business. Its claims are: secured loan 300, senior unsecured bonds 300, subordinated notes 100, plus equity.
| Class | Claim | Value received | Recovery |
|---|---|---|---|
| Secured loan | 300 | 300 | 100% |
| Senior unsecured bonds | 300 | 200 | 67% |
| Subordinated notes | 100 | 0 | 0% |
| Equity | n/a | 0 | 0% |
Value runs out in the senior unsecured class. That class is the fulcrum security: it is only partly covered, so it typically receives most of the new equity and controls the company after the restructuring. Distressed investors try to identify and buy the fulcrum security at a discount.
Senior creditors argue for a low enterprise value, so they receive more of the company. Junior creditors and shareholders argue for a high value, so that something reaches them. Each side hires bankers to produce the DCF, comps and precedents from RS 301.
Advises either the company (debtor side) or a creditor group, on liquidity forecasting, capital structure alternatives, negotiation, raising DIP or exit financing and selling assets. Restructuring work is counter-cyclical: it grows when the rest of the bank slows.
Senior unsecured bonds trade at 40 cents on the dollar before a restructuring. If the expected recovery is 67 cents, as in the module's waterfall, the return is 67 / 40 minus 1 = 67.5%, before the time and legal costs of the process. If the valuation settles lower and recovery is 30 cents, the investor loses a quarter of the purchase price. Distressed investing is a bet on the valuation fight.
The same capital structure (secured 300, senior unsecured 300, subordinated 100) at three enterprise values:
| Enterprise value | Secured | Senior unsecured | Subordinated | Equity |
|---|---|---|---|---|
| 500 | 100% | 67% | 0% | 0% |
| 600 | 100% | 100% | 0% | 0% |
| 650 | 100% | 100% | 50% | 0% |
A 30% difference in valuation moves the subordinated holders from nothing to half their claim. This is why each class hires its own bankers.
New lending to a company in Chapter 11 or CCAA usually receives super-priority, ranking ahead of existing claims, sometimes even 'priming' existing secured lenders with court approval. Without it, no one would lend to a bankrupt company and it could not keep operating. Existing lenders often provide the DIP themselves to protect their position.
Reorganization makes sense when the business is worth more as a going concern than its assets would fetch in a sale. A retailer with a recognized brand and profitable stores may be worth reorganizing; one whose stores lose money everywhere is worth more liquidated.
A court-appointed monitor, usually an accounting firm, reports to the court on the company's cash flow and the fairness of the process. The initial stay of proceedings protects the company from creditors while a plan is negotiated. Key employee retention plans (KERPs) and interim financing need court approval. Creditors vote by class; each class must approve by a majority in number and two-thirds in value of those voting.
In recent years, US borrowers with loose loan documents have done 'liability management' transactions: moving assets away from existing lenders or offering some lenders a better position in exchange for new money. These deals can leave non-participating creditors worse off and have led to lawsuits, and lenders now negotiate tighter documents to prevent them.
Pick a company that entered Chapter 11 or CCAA protection in the last five years. From news coverage and court summaries, list its debt classes before filing, the outcome for each class and for shareholders, and who owned the company afterward.
Educational content only; not investment, tax or legal advice. Companies, tickers and figures are illustrative examples, not recommendations. Rules, rates and limits change, so check current details with the regulator, exchange or tax authority before relying on them. Worked examples are not forecasts. Written by Elizabeta Dimoska. RiskStock is not a registered dealer or adviser.