A business can remain valuable while running out of cash. Your restructuring advice must connect payment deadlines, creditor rights, and the value available for recovery.
When a company cannot satisfy every obligation, you first identify who can claim each asset. A claim is a right to payment. The claim priorities waterfall allocates available value according to creditors’ legal rights before reaching equity.
A secured creditor has a lien, a legal claim against specified collateral supporting repayment. Pay senior and junior secured creditors according to lien priority and collateral value. A second lien reaches only collateral value remaining after the first lien. Priority against one asset does not establish priority against every asset.
The United States Code (U.S.C.) addresses undersecured claims in 11 U.S.C. Section 506(a): an undersecured claim generally separates into secured and unsecured portions. For a $45 million loan backed by $30 million collateral, the unsecured deficiency is $45 million − $30 million = $15 million. The secured portion is $30 million.
Common mistakes
- Treating an undersecured loan as fully secured. Only the collateral value is secured; the deficiency is a separate unsecured claim.
- Placing $10 million of convertible debt below suppliers solely because it converts. Read security and subordination terms.
- Giving every $5 million DIP facility first priority against collateral. Super-priority administrative status alone does not establish a priming lien.
Bottom line
- Secured recovery follows lien priority and collateral value; deficiencies generally become unsecured claims.
- Priority unsecured claims precede ordinary unsecured claims, contractual subordination follows its terms, and equity receives residual value.
- Financial covenants and liquidity forecasts test different aspects of repayment risk.
- Chapter 11 usually retains the debtor in possession; Chapter 7 uses a liquidating trustee.
Exam shortcut
Mark each asset pool before ranking creditors. Separate collateral-backed recovery from an unsecured deficiency, then divide each class’s distribution by its own claim amount. Circle “according to the agreement” and “under the court order.” Those phrases control misleading labels such as senior subordinated, convertible, and DIP. On a covenant problem, calculate the ratio, then inspect the cash calendar.
The full lesson (about 4,210 words, 28 min read) adds 2 worked examples, all 6 common mistakes, a self-check, free in the app.
Learning objectives
- C27
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