A shipping company in restructuring is worth Rs 600 crore against Rs 820 crore of claims in five classes. Run the waterfall, find each recovery and name the fulcrum security.

The DIP, administrative claims and first lien recover 100%, the second lien recovers Rs 130 crore of Rs 150 crore, 86.7%, and the unsecured notes recover nothing; the second lien is the fulcrum. Rs 600 crore pays Rs 100, Rs 20 and Rs 350 crore in order, leaving Rs 130 crore when it reaches the second lien, and nothing below. Because value runs out inside the second lien, that class is paid in the shares of the reorganised Aranyak and ends up owning the company.

The value of the company is poured in at the top and each class is filled completely before a drop reaches the next. Nothing is shared between classes: a class recovers 100% or whatever is left when the value reaches it, which may be a part or nothing. It is a queue at a counter with a fixed amount of cash: the first in line takes all they are owed, and the person at whom the cash runs out gets part of their claim while everyone behind goes home empty-handed. The whole skill is knowing the order of the queue.

The DIP loan is first because it was lent after the filing on the promise of super-priority; without that promise nobody would fund a company in restructuring. Administrative claims come next because the process itself has to be paid for. The first lien is next because it has a charge over the ships; the second lien has a charge too, but behind the first. Unsecured notes have no security and rank after every secured claim. Equity is last and is usually wiped out. Write that order down before touching a number; the arithmetic is trivial once the order is right.

The fulcrum securityThe class in the capital structure at which value runs out, which is partly paid and therefore receives the equity of the reorganised company. is the class where the value stops: paid in part, not in full. Here it is the second lien, with Rs 130 crore of value against Rs 150 crore of claims, and because it is the last class with any value it is paid mostly in new shares and ends up controlling Aranyak. Everyone above it is made whole, often with new debt or cash, and has no interest in the company's future. Everyone below it gets nothing and has nothing to negotiate with, except the cost of a fight. That is why distressed investors buy the fulcrum: it is the cheapest way to own the company on the other side of the process.

Say where the fulcrum moves, because the interviewer will push on the Rs 600 crore. The second lien is made whole at an enterprise value of Rs 620 crore, above which the unsecured notes become the fulcrum; at Rs 800 crore the notes would recover 90%. Below Rs 470 crore the first lien is impaired and becomes the fulcrum. Rs 600 crore is a negotiated number, and each class argues for the valuation that makes it the fulcrum: the second lien wants a low value so it keeps the equity cheaply, the notes want a high one so they are in the money. The valuation fight is the restructuring.

Two limits to name. The order assumes the first lien's security covers the whole Rs 350 crore; if the ships were worth less than that, the unsecured part of the first lien would rank alongside the notes, and the picture changes. And a plan can depart from strict priority if the classes agree: the second lien might give the notes a sliver of equity or warrants to buy their vote and avoid a long fight. The waterfall tells you where everyone starts; the plan tells you where they end up.