CIRA Negotiation & Workout Strategies 2 — Questions and Answers
Question 1: In an out-of-court workout, which factor most commonly causes negotiations to break down between a distressed borrower and its secured lenders?
- Holdout creditors who refuse to accept haircuts while free-riding on concessions from others (Correct answer)
- The borrower's failure to file audited financial statements
- Disagreement over the applicable interest rate during the forbearance period
- The lender's refusal to engage a financial advisor
Correct answer: Holdout creditors who refuse to accept haircuts while free-riding on concessions from others
Holdout problems are the classic impediment to out-of-court workouts because individual creditors have an incentive to reject a deal and benefit from improvements funded by others' concessions.
Question 2: A forbearance agreement typically requires the borrower to do which of the following in exchange for the lender temporarily refraining from exercising remedies?
- Immediately pay down 50% of the outstanding principal
- Acknowledge the default, agree to milestones, and provide enhanced reporting (Correct answer)
- File a voluntary bankruptcy petition within 90 days
- Replace its existing management team with a CRO appointed by the lender
Correct answer: Acknowledge the default, agree to milestones, and provide enhanced reporting
Forbearance agreements generally require the borrower to acknowledge the existing defaults, commit to operational or financial milestones, and provide lenders with greater information access.
Question 3: Which negotiation tactic involves a distressed company presenting a detailed liquidation analysis to lenders to anchor their expectations about recovery in a worst-case scenario?
- Zone of possible agreement (ZOPA) framing
- Best alternative to a negotiated agreement (BATNA) anchoring (Correct answer)
- Stalking horse bid submission
- Prepackaged plan solicitation
Correct answer: Best alternative to a negotiated agreement (BATNA) anchoring
Presenting a liquidation analysis as the BATNA anchors lenders to the reality that their alternative to a negotiated restructuring is a lower recovery in liquidation, encouraging concessions.
Question 4: When a company pursues a 'loan-to-own' strategy, what is the investor's primary objective?
- Earning above-market coupon income while maintaining a minority debt position
- Acquiring the company's equity by purchasing distressed debt at a discount and converting it through restructuring (Correct answer)
- Providing debtor-in-possession financing to earn priority repayment
- Purchasing trade claims to gain leverage in plan negotiations
Correct answer: Acquiring the company's equity by purchasing distressed debt at a discount and converting it through restructuring
Loan-to-own investors buy distressed debt cheaply intending to convert it to equity through a restructuring, effectively acquiring the enterprise at a discount to intrinsic value.
Question 5: In restructuring negotiations, 'equitization' refers to which of the following?
- Converting equity interests into subordinated debt to preserve tax attributes
- Converting debt claims into equity ownership in the reorganized company (Correct answer)
- Selling equity to strategic investors to fund a debt paydown
- Granting lenders warrants as a sweetener without altering principal
Correct answer: Converting debt claims into equity ownership in the reorganized company
Equitization is the conversion of creditor debt claims into equity in the reorganized entity, typically used when cash flow cannot support existing debt levels.
Question 6: Which document formally governs the rights and obligations of lenders during an out-of-court workout process before a definitive restructuring agreement is reached?
- Restructuring Support Agreement (RSA)
- Forbearance Agreement (Correct answer)
- Intercreditor Agreement
- Subordination Agreement
Correct answer: Forbearance Agreement
A forbearance agreement is the operative document during the workout negotiation period, specifying that lenders will refrain from enforcement actions while milestones are pursued.
Question 7: A 'death spiral' in distressed debt negotiations occurs when:
- A company files for bankruptcy protection before completing an out-of-court workout
- Continued interest payments on existing debt consume liquidity faster than operational improvements can generate cash, accelerating insolvency (Correct answer)
- Equity holders sue to block a debt-for-equity exchange
- A lender accelerates the loan following a covenant breach
Correct answer: Continued interest payments on existing debt consume liquidity faster than operational improvements can generate cash, accelerating insolvency
A death spiral describes the dynamic where debt service obligations outpace operational cash generation, depleting liquidity and making a successful workout increasingly unlikely.
CIRA Negotiation & Workout Strategies 2
In an out-of-court workout, which factor most commonly causes negotiations to break down between a distressed borrower and its secured lenders?