CIRA Negotiation & Workout Strategies 5 — Questions and Answers
Question 1: Under the 'new value' exception to the absolute priority rule, existing equity holders may receive new equity in the reorganized company only if they:
- Were equity holders for at least two years prior to the bankruptcy filing
- Contribute new, substantial, reasonably equivalent, necessary, and non-insider value to the reorganization plan (Correct answer)
- Agree to waive all pre-petition dividend claims against the estate
- Receive less new equity than the unsecured creditors receive in aggregate
Correct answer: Contribute new, substantial, reasonably equivalent, necessary, and non-insider value to the reorganization plan
The new value exception permits equity retention if existing owners inject value that is new (not pre-existing), substantial, necessary to the plan, and reasonably equivalent to what they receive, subject to a market test.
Question 2: A 'lender liability' claim against a secured creditor is most likely to arise when:
- A lender accelerates a loan following a documented material default
- A lender exercises so much control over a borrower's operations that it is deemed to have assumed a duty of care or is treated as an equitable insider (Correct answer)
- A lender sells its position in the secondary market without providing notice to the borrower
- A lender charges a default interest rate permitted under the loan agreement
Correct answer: A lender exercises so much control over a borrower's operations that it is deemed to have assumed a duty of care or is treated as an equitable insider
Lender liability arises when a lender's behavior crosses from enforcement of contractual rights into de facto management control, exposing the lender to equitable subordination, fiduciary duty claims, or tort liability.
Question 3: In evaluating whether an out-of-court workout is preferable to a Chapter 11 filing, which of the following is the most significant cost disadvantage of a formal bankruptcy proceeding?
- The requirement to maintain an unsecured creditors' committee
- Substantial professional fees, reputational damage, and customer/supplier disruption that erode enterprise value (Correct answer)
- The 180-day exclusivity period that limits the debtor's negotiating leverage
- The automatic stay, which prevents the debtor from paying pre-petition trade claims
Correct answer: Substantial professional fees, reputational damage, and customer/supplier disruption that erode enterprise value
Chapter 11 proceedings impose significant direct costs (professional fees, administrative expenses) and indirect costs (customer attrition, supplier tightening, employee departures) that can reduce the reorganized enterprise value.
Question 4: Which of the following best describes the 'zone of insolvency' and why it matters in restructuring negotiations?
- The period during which the company's assets are legally frozen pending a liquidation sale
- The period when a company is near but not yet insolvent, during which directors' fiduciary duties expand to include creditors, creating legal risk for decisions favoring equity over creditors (Correct answer)
- The range of enterprise values within which a company's debt trades at par
- The geographic region in which a company's assets are located and which determines applicable insolvency law
Correct answer: The period when a company is near but not yet insolvent, during which directors' fiduciary duties expand to include creditors, creating legal risk for decisions favoring equity over creditors
In the zone of insolvency, creditors become the residual economic stakeholders, and directors who favor equity holders over creditors may face breach of fiduciary duty claims, influencing negotiating behavior.
Question 5: A 'priming lien' in a DIP financing context refers to a situation where:
- The DIP lender receives a junior lien behind existing secured lenders
- The DIP lender's lien is granted priority over pre-petition secured liens, subject to court approval and adequate protection for the primed lenders (Correct answer)
- Existing secured creditors voluntarily release their liens to facilitate new financing
- The DIP loan automatically converts to exit financing upon plan confirmation
Correct answer: The DIP lender's lien is granted priority over pre-petition secured liens, subject to court approval and adequate protection for the primed lenders
A priming DIP lien is granted priority over existing secured creditors under Section 364(d), requiring the court's approval and the provision of adequate protection to the primed secured creditors.
Question 6: When a CIRA structures a 'settlement payment' between a debtor and a dispute creditor as part of a workout, which risk must be most carefully evaluated?
- Whether the payment could be characterized as a preferential transfer or fraudulent conveyance if a bankruptcy filing occurs within the applicable look-back period (Correct answer)
- Whether the payment exceeds the creditor's claimed amount
- Whether the settlement requires approval from the debtor's equity holders
- Whether the payment triggers a change-of-control provision in the existing credit agreement
Correct answer: Whether the payment could be characterized as a preferential transfer or fraudulent conveyance if a bankruptcy filing occurs within the applicable look-back period
Payments made within 90 days (or one year for insiders) of a bankruptcy filing may be recoverable as preferences, and payments made while insolvent for less than reasonably equivalent value may be avoided as fraudulent conveyances.
Question 7: In restructuring negotiations, an 'adequate protection' payment is best described as:
- A priority administrative claim paid monthly to the unsecured creditors' committee's professionals
- Compensation provided to a secured creditor whose collateral position is diminishing during a bankruptcy proceeding, ensuring the creditor does not lose the benefit of its bargained-for security interest (Correct answer)
- A reserve fund set aside by the debtor to cover disputed claims at plan confirmation
- A payment made to critical vendors to maintain supply chains during the Chapter 11 case
Correct answer: Compensation provided to a secured creditor whose collateral position is diminishing during a bankruptcy proceeding, ensuring the creditor does not lose the benefit of its bargained-for security interest
Adequate protection under Sections 361–363 compensates secured creditors for any decrease in their collateral value during the bankruptcy case, which may take the form of cash payments, replacement liens, or other relief.
CIRA Negotiation & Workout Strategies 5
Under the 'new value' exception to the absolute priority rule, existing equity holders may receive new equity in the reorganized company only if they: