Case 075Liability management and refinancingHard

A retailer's pari passu term loan lenders split: a 55% majority swaps into a new super-senior loan and adds new money, leaving the rest behind. Compute each group's recovery before and after the uptier.

The situation

Chakrika Retail has a Rs 1,000 crore term loan held by several lenders, all ranking equally. Trading is poor and the business is worth about Rs 800 crore. Lenders holding 55% of the loan agree a deal with the company: they exchange their Rs 550 crore for a new super-senior loan of the same amount and lend Rs 100 crore of new money that ranks first of all. The other lenders, holding Rs 450 crore, are not invited and stay in the old loan, now behind the new debt.

The majority has enough votes under the loan agreement to amend it and permit the new senior debt. Assume the Rs 100 crore of new money is spent on the business and does not change its Rs 800 crore value.

Your task

What does each group recover before and after the uptier, where does the value come from, and what could the minority have done?

Quick check

After the uptier, what do the Rs 450 crore of left-behind lenders recover?

Worked solution

Try it on paper, then open one step at a time.

30-second answerThe answer to give first

Before, every lender recovers 80%; after, the majority recovers 100% and the minority about 33%. Rs 650 crore of new super-senior debt takes the first Rs 650 crore of value, leaving Rs 150 crore for Rs 450 crore. The minority loses Rs 210 crore: Rs 110 crore goes to the majority and Rs 100 crore funds the new money. Protection lies in the loan agreement's voting terms.

Step 1How does an uptier move value without changing the business?

Think of a queue at a ticket counter where everyone arrived together and shares the tickets equally. A group holding more than half the places persuades the counter to open a new, faster queue just for them, and the rest keep waiting behind it. The tickets are the same; who gets them is not. An uptierA transaction in which some lenders exchange their loans into new debt ranking ahead of the lenders left in the old loan, using majority voting rights to amend the agreement. changes only the order in which the same Rs 800 crore of value is paid. Before, Rs 800 crore over Rs 1,000 crore of equal claims gives everyone 80%. After, the Rs 100 crore of new money and the Rs 550 crore of exchanged debt are paid first.

An uptier moves the minority to the back of the queueMajority 550Minority 450Before: one classall recover 80%New money 100Majority 550150unpaid 300After: super-senior firstminority recovers 33%Value 800Rs crore of claims, first paid at the bottomMajority 100%Minority 33%
Before the uptier Rs 800 crore covers Rs 1,000 crore of equal claims, 80% each; after it, Rs 650 crore of super-senior debt is paid first and the Rs 450 crore minority receives Rs 150 crore, 33%.
Rs croreClaimBeforeAfterRecovery after
New money, super-senior100100100%
Majority lenders, exchanged550440550100%
Minority lenders, left behind45036015033.3%
Total1,100800800
The same Rs 800 crore is shared differently: the majority's recovery rises from Rs 440 crore to Rs 550 crore and the minority's falls from Rs 360 crore to Rs 150 crore.
Step 2Where exactly does the minority's loss go?

Track the Rs 210 crore. Rs 110 crore goes to the majority, whose recovery on its old claim rises from 80% to 100%, and Rs 100 crore pays for the new money, which is repaid in full even though it was spent without adding value. The minority is funding both the majority's upgrade and the company's new cash. If the new money had been used well and lifted value to Rs 900 crore, the minority would recover Rs 250 crore, 56%, which is why sponsors of these deals always argue the new money creates value. The minority's first question should be whether it does.

Who pays for the uptierMajority, 550 old claimbefore 440after 550Minority, 450 old claimbefore 360after 150New money, 100before 0after 100Minority loses 210; majority gains 110 on its old claim; the other 100 paid forthe new money, which was spent. If it had lifted value to 900, the minority would get 56%.
The minority's recovery falls from Rs 360 crore to Rs 150 crore; Rs 110 crore of that loss moves to the majority, whose recovery rises from Rs 440 crore to Rs 550 crore, and Rs 100 crore funds new money that added no value.
Step 3What protects a minority lender?

The loan agreement, read before lending. Terms that require every affected lender's consent to subordinate its loan or to change how payments are shared, often called sacred rights, stop a bare majority from moving the minority down the queue. Tighter definitions of what debt may rank ahead, and a right for every lender to join any exchange on the same terms, do the same job. Without them, the minority's options after the fact are to negotiate to join, to sell the loan, or to litigate, each costly. The lesson interviewers want: in a stressed credit, the voting terms of the documents can be worth as much as the collateral.

Where candidates lose it

Candidates assume equal ranking means equal recovery forever, and answer 80% for everyone. An uptier changes the ranking after the fact, which is the whole point of the question.

The second miss is treating the new money as free value. If it is spent without lifting enterprise value, the left-behind lenders pay for it, and the recovery falls to 33% rather than 56%.

What the interviewer asks next

  • How would the numbers change if the minority were offered the chance to join the exchange at 80 cents on the rupee?
  • What is a drop-down transaction, and how does it differ from an uptier?
  • If you were the majority lenders' adviser, how would you justify the deal to the court?
  • Which terms would you negotiate into a new loan to avoid being left behind?

Company names and figures are illustrative.