Financial Restructuring and Bankruptcy

The whole unit on one sheet: the priority waterfall, the loan documents and covenants, the Chapter 11 machinery, the plan-vote math, and the M&A registration overlay the exam loves.

The One-Liners That Win Points

• The priority waterfall, highest to lowest: DIP financing (super-priority), administrative expenses, senior secured, junior secured, senior unsecured, subordinated debt, mezzanine / convertible debt, preferred stock, common stock. Memorize this order top to bottom.
• Absolute Priority Rule (APR): each rank is paid in full before the next receives anything; within a rank, allowed claims share pro rata. Enforced at confirmation in any cramdown.
• Equity gets wiped before junior debt is impaired. Old equity can sometimes keep reorganized equity only via a substantial, necessary "new value" contribution.
• Trade suppliers are senior UNSECURED creditors: ahead of subordinated and mezzanine debt, but behind all secured creditors.
• Mezzanine ranks as DEBT, not equity: above preferred and common stock, below the senior classes. It is neither "equity-like" nor "senior debt."
• Administrative agent is ACTIVE (credit agreement); trustee is PASSIVE (indenture). This is the single most-tested document distinction.
• Maintenance covenants are tested every fiscal quarter and trip default automatically; incurrence covenants trip only when the borrower attempts the prohibited action.
• A bankruptcy filing is AUTOMATIC default with no grace period, and the automatic stay takes effect the instant the petition is filed (no court order).
• Chapter 11 default is the debtor-in-possession (DIP) running the business; a separate Chapter 11 trustee is appointed only for fraud, dishonesty, or gross mismanagement.
• Chapter 7 trustee ALWAYS replaces management (mandatory liquidation); Chapter 11 keeps management in place.
• Class acceptance = more than two-thirds (2/3) in AMOUNT AND more than one-half (1/2) in NUMBER of holders actually voting. Both prongs must clear.
• The merger-vote-as-sale rule TRIGGERS registration (it is not an exemption); a stock-for-stock merger vote is a "sale" of acquirer securities, registered on Form S-4.
• All-cash deals need no Form S-4: no securities are issued, so there is no registrable sale.

Numbers to Lock In

Top Gotchas

• DIP super-priority and administrative expenses are POST-petition (administrative-status) claims that sit above pre-petition secured creditors; the pre-petition secured-before-unsecured waterfall only runs after those are satisfied.
• A priming lien (Tier 4 DIP) can outrank pre-petition secured lenders, but only with adequate protection for the primed lender AND a showing the debtor could not obtain credit otherwise. Most DIP facilities are consensual.
• Adequate protection compensates for DIMINUTION in value, not the full secured claim; if collateral is not depreciating, no payment may be owed. Its failure is grounds for relief from the stay.
• The U.S. Trustee is NOT a Chapter 11 trustee: the U.S. Trustee (a Department of Justice office) supervises every case and appoints the Official Committee of Unsecured Creditors (UCC); a Chapter 11 trustee is a rare, cause-based replacement of management.
• Best interests is a HOLDER-by-holder test: every holder in an impaired class must receive at least Chapter 7 liquidation value, even if the class accepts.
• Cramdown requires impairment, at least one impaired NON-INSIDER class accepting, and fair-and-equitable plus no unfair discrimination against the dissenting class; a plan with no impaired accepting class cannot be crammed down.
• A class can be paid in full and still be IMPAIRED: impairment is a rights question (any alteration), not a recovery question. Reinstatement preserves unimpaired status.
• Cross-default vs cross-acceleration: cross-default trips when other debt defaults; cross-acceleration trips only when the other debt is actually accelerated (borrower-friendlier).
• Change of control is usually a PUT right, not an event of default.
• Make-whole = net present value (NPV) of remaining interest at a benchmark Treasury rate plus a spread; a discounted debt-for-debt swap can generate cancellation-of-indebtedness income (CODI).
• "Free and clear" does not erase creditor claims: liens come off the sold assets and attach to the sale proceeds in the estate.

Capital Structure, Loan Documents, and Covenants

• Credit agreement: private bank loan, administrative agent, mix of maintenance and incurrence covenants, floating rate, easier to amend.
• Indenture: public bond contract, passive trustee, mostly incurrence-only covenants, fixed coupon, hard to amend; governed by the Trust Indenture Act of 1939 for public debt over $10 million.
• Ratios: leverage (Total Debt / earnings before interest, taxes, depreciation, and amortization (EBITDA)) is CAPPED; interest coverage and fixed-charge coverage are FLOORED.
• Negative covenants police debt incurrence, liens, restricted payments, asset sales, affiliate transactions, and change of control. Asset-sale proceeds are typically trapped (reinvest or repay debt).
• Exit consents strip covenants from stub bonds in an exchange offer; they work because indenture covenants can be amended only by solicited holder consent, and the trustee cannot amend them unilaterally.

Chapter 11 Machinery and the Plan

• Automatic stay halts collections, lawsuits, foreclosures, setoffs, and lien enforcement the instant the petition is filed; relief from stay must be sought from the court for cause.
• DIP financing tiers: Tier 1 ordinary-course unsecured (no approval); Tier 2 unsecured outside ordinary course (notice and hearing); Tier 3 super-priority / junior liens / liens on unencumbered assets (must show inability to obtain Tier 1-2 credit); Tier 4 priming lien senior to secured lenders (inability to obtain credit otherwise AND adequate protection).
• DIP features: super-priority administrative claim, roll-up of the pre-petition revolver, tight budget covenants, and milestones that give the DIP lender control.
• Plan sequence: disclosure statement approved on an "adequate information" standard FIRST, then solicitation and voting, then a SEPARATE confirmation hearing.
• Consensual confirmation needs good faith, administrative expenses paid in full on the effective date, at least one impaired non-insider class accepting, the best-interests test, and feasibility.

Prepack, 363-Style Going-Concern Sale, and Chapter 7

• Three flavors of Chapter 11: prepackaged (plan negotiated AND voted before filing, roughly 38 days), prearranged (terms set pre-filing via a restructuring support agreement (RSA), votes solicited post-filing), traditional / free fall (all post-filing, 300+ days).
• Going-concern asset sale lets the debtor sell estate property "free and clear of liens, claims, interests, and encumbrances" if one of five statutory conditions is met (for example, lien-holder consent, or sale price exceeds the aggregate liens), usually via a stalking-horse auction with a break-up fee.
• A going-concern sale is FASTER than plan confirmation because it skips disclosure-statement approval, voting, and the confirmation hearing (often 60-90 days).
• Chapter 7 is mandatory-trustee liquidation; conversion runs both directions between Chapter 7 and Chapter 11.

Out-of-Court Restructuring and the Registration Paths

• Same-issuer exchange exemption: an issuer swaps new securities with its EXISTING holders, no contingent solicitation commission (flat advisory fees are fine), security-for-security; the new securities take the resale character of the old.
• Bankruptcy-plan securities exemption: securities issued under a CONFIRMED Chapter 11 plan, principally in exchange for a pre-petition or administrative-expense claim, are exempt from registration and FREELY TRADEABLE by non-affiliates (no holding period). New money invested pre-confirmation does not qualify.
• Four registration paths: same-issuer exchange exemption (no registration), bankruptcy-plan exemption (no registration, freely tradeable), Form S-4 registered exchange offer (registered, no non-affiliate resale limits), private-placement / Regulation D (exempt but restricted securities).
• Out-of-court is faster but hostage to holdouts (needs a 95-99% tender rate); in-court binds dissenters through cramdown and yields plan-exempt tradeable securities.

M&A Registration, Regulation M-A, and Proxy Solicitation

• Form S-4 registers acquirer shares issued to target stockholders and, for public stock-for-stock deals, doubles as a joint proxy statement / prospectus (content from Regulation S-K, Regulation S-X, and Regulation M-A).
• Three communications rules: the merger-vote-as-sale rule TRIGGERS registration; the pre-filing communications safe harbor lets written deal communications go out before the registration statement is filed; the same-day filing requirement is the price (every such written communication filed on EDGAR the day it is first used, no grace period). Anti-fraud liability still applies.
• Regulation M-A is a disclosure OVERLAY (Items 1000-1016), not a stand-alone filing; its items are pulled into Schedule TO, Schedule 14D-9, Schedule 13E-3, Form S-4, and Schedule 14A. Item 1001 is the plain-English summary term sheet at the front; Items 1013 and 1014 are the going-private items (Schedule 13E-3).
• Proxy solicitation rules apply only to Exchange Act-registered securities; materials are filed in preliminary form for SEC review, then mailed in definitive form.
• Schedule 14A Item 14 is the M&A carve-out: for a stock-for-stock merger it is satisfied by furnishing the Form S-4 information (the joint proxy statement / prospectus does both jobs); all-cash deals require less acquirer disclosure.

One-Breath Recap

Distress is a waterfall, and the Absolute Priority Rule is its engine: debtor-in-possession financing and administrative expenses sit on top, secured beats unsecured, mezzanine ranks as the bottom of the debt stack, and equity is wiped before junior debt is impaired. Chapter 11 keeps the debtor in possession under an automatic stay, funded by tiered DIP financing (a priming lien can outrank pre-petition secured lenders with adequate protection), and a plan confirms only after a separate "adequate information" disclosure statement and a class vote of more than two-thirds in amount and one-half in number, or a non-consensual cramdown of an impaired dissenting class. The company can also move faster through a prepackaged case, a free-and-clear going-concern asset sale via a stalking-horse auction, or an out-of-court exchange offer with exit consents (though holdouts can sink it), while a confirmed plan issues freely tradeable exempt securities. On the M&A side, the merger-vote-as-sale rule triggers Form S-4 registration for stock deals, the pre-filing safe harbor and same-day filing rule govern deal communications, and Regulation M-A plus Schedule 14A Item 14 fold everything into one joint proxy statement / prospectus. Place any fact pattern into one of two protective regimes (the Bankruptcy Code protecting creditors, or the M&A registration regime protecting target stockholders) and the answer follows.

Need more than the recap? This is a condensed summary. If it is not enough, read the full Financial Restructuring and Bankruptcy unit for the complete lesson.