A leveraged company misses an interest payment. Now the question is who gets paid, in what order, and whether the business reorganizes or sells itself for parts. As a banker, you must know the waterfall, the loan documents that built it, and the filings that govern a deal struck inside bankruptcy.
When a company runs out of cash, claims get paid in a fixed order called the waterfall. Each tier must be paid in full before the next tier sees a dollar. The lower you sit, the more likely you recover nothing.
KEY: "Secured" means a lien on specific collateral. Secured lenders recover from that collateral first; only the shortfall drops down to compete as unsecured. Equity holders are residual claimants, paid only if every creditor is made whole.
The waterfall is built by contract. Credit agreements govern bank loans; indentures govern bonds and name a trustee to act for dispersed holders. Both spell out four things you must know.
Common mistakes
- Putting common stock above creditors. Common is last in the waterfall, paid only after every creditor including preferred-ranking debt. Equity is residual.
- Thinking a trustee always runs Chapter 11. The debtor-in-possession keeps control; a trustee appears only for fraud or cause.
- Treating DIP financing as ordinary debt. DIP loans get super-priority and can prime existing secured lenders, paid before pre-petition claims.
Bottom line
- The waterfall pays senior secured first, then junior secured, then unsecured (trade), then mezzanine, then preferred stock, then common stock last
- Credit agreements govern loans; indentures govern bonds; both set repayment, prepayment, events of default, and covenants
- Chapter 11 reorganizes the business; the debtor stays in control as debtor-in-possession (DIP); Chapter 7 liquidates
- DIP financing is new post-petition loan money that primes existing lenders with super-priority
Exam shortcut
Memorize the waterfall top to bottom: senior secured, junior secured, unsecured, mezzanine, preferred, common. Equity is always last. DIP = debtor stays + super-priority money. If a question mentions new bankruptcy financing, it is paid before pre-petition lenders. Stock deal filings: S-4 registers shares, 145/165/425 cover the offer and communications, Regulation 14A runs the vote.
The full lesson (about 1,753 words, 12 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C27
Browse all free Series 79 lessons or jump into free Series 79 practice questions.