Financial Restructuring and Bankruptcy

Review claim priorities, Chapter 11 procedures, plan voting, and merger registration.

Which One-Liners Win Points?

• Recovery order: identify the legal debtor, collateral pools, liens, statutory priorities, and subordination terms. Common equity ordinarily receives residual value; no single numbered list governs every case.
• Absolute priority rule (APR): a rejecting unsecured class in a corporate cramdown receives full value, or junior holders receive no property on account of their junior position. Secured classes have separate alternatives. Pro rata is within-class allocation. New-value arguments are limited and fact-dependent, not automatic exceptions.
• Ordinary pre-petition trade claims are generally unsecured; liens or statutory priority can change treatment. An undersecured loan generally splits into collateral value and an unsecured deficiency. Mezzanine/convertible: determine rank from documents and entity structure; unconverted debt remains debt.
• Maintenance covenants trip quarterly, automatically; incurrence covenants trip only on a prohibited action. Filing = AUTOMATIC default, no grace period; automatic stay starts instantly, no court order. DIP runs the business by default; a trustee only for fraud, dishonesty, or gross mismanagement.
• Class acceptance = 2/3 AMOUNT AND over 1/2 NUMBER of holders; both prongs must clear. Merger-vote-as-sale TRIGGERS Form S-4 for stock deals (not an exemption); all-cash: none.

Which Numbers Matter Most?

Which Gotchas Trip Students Up?

• Administrative superpriority does not itself prime liens. A priming lien requires court authorization, inability to obtain credit otherwise, and adequate protection of the existing lienholder. Administrative expenses generally require full cash on the plan’s effective date unless the holder agrees otherwise. The U.S. Trustee is NOT a Chapter 11 trustee (it supervises cases); a Chapter 11 trustee is rare and cause-based.
• Best interests is HOLDER-by-holder: each holder in an impaired class must accept or receive at least Chapter 7 liquidation value; paid in full can still be IMPAIRED (a rights question, not recovery). Cramdown needs impairment, one impaired NON-INSIDER class accepting, fair-and-equitable, no unfair discrimination; no accepting class means none.
• Cross-default trips on any default; cross-acceleration only when accelerated (borrower-friendlier); change of control is usually a PUT, not default. Make-whole = net present value (NPV) of remaining interest at a Treasury rate plus spread (a discounted swap can generate CODI, cancellation-of-indebtedness income); "free and clear" liens shift to sale proceeds.

How Do Loan Documents, Chapter 11, and M&A Registration Work?

• Credit agreement: private bank loan, ACTIVE agent, floating rate, easier to amend. Indenture: public bond, PASSIVE trustee, mostly incurrence covenants, fixed coupon, hard to amend; under the Trust Indenture Act of 1939. Amortizing (term loan A) repays on schedule; bullet (term loan B, high-yield) repays mostly at maturity.

• Leverage (Debt / EBITDA, earnings before interest, taxes, depreciation, amortization) is CAPPED; coverage is FLOORED. Negative covenants restrict debt, liens, payments, asset sales; proceeds are typically trapped.

• Automatic stay halts collections, lawsuits, foreclosures, lien enforcement; relief needs court-shown cause. DIP tiers: 1-2 unsecured (no approval, then notice/hearing); 3 super-priority/junior liens (no Tier 1-2 credit); 4 priming lien over secured lenders (no other credit, adequate protection).

• Plan sequence: disclosure statement ("adequate information") FIRST, voting, then a SEPARATE hearing (good faith, administrative-claim treatment, subject to agreed exceptions, an accepting impaired class, best-interests, feasibility). Rejecting SECURED (pick one): retain liens plus deferred payments (claim value); sell free and clear, liens to proceeds; or "indubitable equivalent." Rejecting UNSECURED: full value, or no junior property on account of a junior claim or interest.

• Three flavors: prepackaged (pre-filing vote), prearranged (restructuring support agreement, votes after), free fall (post-filing). Going-concern sale: "free and clear" if one of five statutory conditions is met, via a stalking-horse auction; FASTER than confirmation (skips disclosure, voting, hearing).

• Same-issuer exemption: issuer swaps securities with EXISTING holders. Bankruptcy-plan exemption: securities under a CONFIRMED plan, for a pre-petition/admin claim, are exempt, FREELY TRADEABLE by non-affiliates (new pre-confirmation money doesn't qualify). Form S-4 registers acquirer shares to target stockholders, doubling as a proxy/prospectus.

• Three communications rules: merger-vote-as-sale TRIGGERS registration; a pre-filing safe harbor allows early communication; same-day EDGAR filing is the price (anti-fraud applies).

• Regulation M-A is a disclosure OVERLAY pulled into Schedule TO, 14D-9, 13E-3, S-4, 14A (Item 1001 = summary term sheet; Items 1013-1014 going-private). Schedule 14A Item 14 (M&A carve-out): a stock merger satisfies it via Form S-4 info; all-cash needs less disclosure.

One-Breath Recap

Model recoveries by debtor, collateral, priority, and plan treatment. Administrative status does not itself prime liens. Cramdown protects rejecting classes; pro rata allocates within a class. Chapter 11 ordinarily keeps the debtor in possession under an automatic stay. Confirmation requires statutory findings beyond a successful vote. Alternatives include a prepackaged case, a going-concern sale, or an out-of-court exchange. Stock mergers generally use Form S-4 unless an exemption applies.

Need more than the recap? Read the full Financial Restructuring and Bankruptcy unit.