Restructuring waterfall basics

Restructuring teams advise companies, or groups of their creditors, when a business cannot service its debt. Restructuring boutiques and the restructuring groups at larger banks test a specific set of ideas at superdays: who ranks where, how much each class of creditor recovers, and which class ends up owning the business. This lesson covers the logic and the simple arithmetic, with the main UK processes in the background.

Why companies end up in restructuring

Distress usually comes from a mix of too much debt and a business that has weakened: falling sales, rising costs, a big contract lost, or higher interest rates on floating-rate debt. The trigger is often a looming maturity the company cannot refinance, a breach of a covenant in a loan agreement, or simply running out of cash. At that point the question becomes how to share a business that is worth less than its claims.

The priority of claims

The waterfall pays claims in order of seniority. Each class is paid in full before the next class receives anything, a principle often called absolute priority. A simplified capital structure, from most to least senior, looks like this.

• Super senior revolving credit facility (RCF), which ranks first on enforcement
• Senior secured debt, such as a term loan or senior secured notes
• Second lien secured debt
• Senior unsecured notes and other unsecured claims, such as trade creditors
• Subordinated debt
• Shareholders, who receive only what is left

Security matters because secured creditors have a claim over specific assets, or over the whole business through fixed and floating charges. In a formal UK insolvency, the statutory order is more detailed. Fixed charge holders are paid from the assets they hold security over. From floating charge realisations, the costs of the process come first, then preferential creditors, which include some employee claims and, since December 2020, HMRC for certain taxes such as VAT and PAYE. Then a ring-fenced "prescribed part" is set aside for unsecured creditors, capped at £800,000 for more recent floating charges, before floating charge holders and finally unsecured creditors are paid.

Working out recoveries

When several claims rank equally, known as pari passu, they share what is left in proportion to their claims. If £100m is left for £200m of notes and £50m of trade creditors ranking equally, each recovers £100m ÷ £250m = 40%, so the noteholders get £80m and trade creditors £20m.

The value you run through the waterfall matters as much as the order. A going concern value assumes the business keeps trading, usually valued with multiples or a DCF. A liquidation value assumes the assets are sold off piece by piece, which is normally much lower. Creditors compare what they would get in a restructuring with what they would get if the company were liquidated, and that comparison shapes what they will accept.

The fulcrum security

The fulcrum security is the class where the value runs out: it recovers something, but not everything. In the example, that is the senior unsecured notes. Classes above it are fully covered, so they have little to gain from a restructuring. Classes below it are out of the money, so they have little leverage. The fulcrum class usually drives the negotiation and often ends up owning the business through a debt-for-equity swap.

UK restructuring tools

• Scheme of arrangement (Part 26 of the Companies Act 2006): each class votes, needing a majority in number and 75% by value of those voting, then court sanction
• Restructuring plan (Part 26A, since 2020): similar, but a court can impose the plan on a dissenting class if, among other conditions, that class is no worse off than in the most likely alternative, known as cross-class cram down
• Company voluntary arrangement (CVA): a compromise with unsecured creditors, often used against landlords, that cannot change secured creditors' rights without their consent
• Administration: an insolvency practitioner takes control, protected by a moratorium, and may sell the business, sometimes through a pre-pack agreed before appointment

Out-of-court deals, such as amending and extending loans or a consensual equity injection, are cheaper and faster when enough creditors agree. The formal tools matter because they set what each side could get if talks fail, which shapes every negotiation.