Advanced Financial Management · Financial reconstruction

Evaluating a Reconstruction Scheme for Each Party

Updated 11 October 2026 · Fact-checked

To evaluate a reconstruction scheme, work out what each party gets under the scheme and what it would get in liquidation or if nothing is done. Value the new securities, compare party by party, and check the scheme is acceptable to all. Then check the company's cash flow and gearing after the scheme.

Understand Evaluating a Reconstruction Scheme for Each Party

A financial reconstruction is a deal for a company in distress. Instead of being wound up, it swaps its old claims for new ones. Debenture holders, creditors and shareholders each give something up. In return the company survives.

No party will agree unless it expects to be better off than in the alternative. So the alternative matters. The usual alternative is liquidation: sell the assets, pay the costs, then pay claims in order of priority. Secured creditors are paid from their security first. Any shortfall ranks as unsecured. Unsecured creditors share what is left. Shareholders are paid last and often get nothing.

The scheme must beat liquidation for each party. This is the test of whether the scheme will be accepted. Parties are often given new debentures, loan notes or shares in place of old claims. You must put a value on each package. Debt is normally valued at face value. Shares are valued at the price or equity value given in the question.

The scheme must also work for the company. It needs enough new cash, an affordable level of interest, and a sensible gearing level. A scheme that every party prefers to liquidation can still fail if the company cannot service its new debt. Always comment on both points.

In the exam, a table of results by party usually earns the most marks. Add a short comment on what each party will do and why.

Key rules to remember

Liquidation order of payment: Secured claims (from their security) → liquidation costs and preferential claims → unsecured claims → shareholders; Any secured shortfall becomes an unsecured claim. Follow the order the question gives. Use the legal ranking in the question and do not assume your own.
Recovery rate for unsecured creditors: Recovery rate = cash available to unsecured ÷ total unsecured claims; Total unsecured claims include trade creditors and the unsecured shortfall of secured lenders. Cash available is after liquidation costs and after secured claims are paid from their security.
Value of a party's package under the scheme: Value = face value of new debt + (number of new shares × value per share); Use the share value given. If only total equity value is given, a party's share = its percentage holding × equity value.
Gain or loss versus the alternative: Gain/(loss) = value under scheme − value under liquidation (or no action); A party that is worse off is unlikely to agree unless the scheme is changed. Calculate this for every party.
Balance check for the pro forma statement of financial position: Total assets − total liabilities = share capital + reserves; Write-offs of debt create gains that raise equity. Asset write-downs reduce equity. New cash raises both assets and equity.

How to solve Evaluating a Reconstruction Scheme for Each Party questions

Use this method for any question that asks you to evaluate a reconstruction scheme for the parties involved.

1Read the requirement. Note which parties you must evaluate and what the alternative is (liquidation or no action).
2Set out the liquidation position. Pay secured lenders from their security, treat any shortfall as unsecured, deduct the liquidation costs, then share the rest among unsecured creditors. Work out the recovery rate.
3Calculate what each party receives in liquidation. Shareholders usually get nil unless there is a surplus.
4Value each party's package under the scheme. Use face value for new debt and the given share price or equity value for shares. Include any cash received.
5Compare scheme with liquidation for each party and show the gain or loss. Present it in a small table.
6Test whether the scheme is workable. Check new cash raised, the interest burden, gearing and whether the new debt can be serviced from forecast cash flows.
7Draw a conclusion. Say which parties are likely to accept, which may refuse, and what could be changed. Then give a clear recommendation.
8If asked, draw up the pro forma statement of financial position. Apply each change in turn and check that assets less liabilities equals equity.

Quickest way: Party-by-party comparison grid

When to use it: Use when the question gives liquidation values and the terms of the scheme, and you have limited time.

Draw a grid with a row for each party and columns for liquidation, scheme and difference.
Fill the liquidation column first. Start with the secured lender and finish with the unsecured recovery rate.
Fill the scheme column. Add new debt at face value and new shares at the given value.
Subtract to get the gain or loss. Check that the total across parties equals total scheme value less net liquidation proceeds.
Write one sentence per party: accept or reject, and why. Add one sentence on feasibility and a recommendation.

Common mistakes in Evaluating a Reconstruction Scheme for Each Party

Treating a secured lender's shortfall as lost entirely.
Students stop once the security is exhausted and forget the unpaid balance.
Fix: Move the shortfall into the unsecured pool. The lender then shares in the unsecured recovery rate.
Forgetting liquidation costs.
The costs are often a small line in the question and are easily missed.
Fix: Deduct liquidation costs from the assets available to unsecured creditors before calculating the recovery rate, unless the question says otherwise.
Comparing the scheme with the old claim rather than with liquidation.
A party that gets less than its full claim looks worse off, so students stop there.
Fix: The test is whether the party is better off than in the alternative. Compare with liquidation or no action.
Valuing new shares at nominal value.
Students use the par value printed in the question instead of the value stated for the shares.
Fix: Use the share price or equity value given. If none is given, state your assumption clearly.
Ignoring the position of existing shareholders.
Shareholders get nothing in liquidation, so students skip them.
Fix: Show what shareholders keep under the scheme and compare it with nil. Comment on dilution and control.
Producing a pro forma statement of financial position that does not balance.
Students forget that debt write-offs create gains in equity or that capital reductions credit reserves.
Fix: Record each step separately and run the balance check. Assets less liabilities must equal equity.

Worked examples

Example 1

Rexel Ltd is in financial difficulty. In liquidation, property secured on the $6.0m debentures would realise $5.0m. Other assets would realise $3.0m. Liquidation costs would be $0.4m. Trade creditors are owed $4.0m, all unsecured. Shareholders would receive nothing. Under a proposed scheme: debenture holders would exchange their $6.0m debentures for $4.5m new debentures plus 1.2m new shares. Trade creditors would receive $1.5m new unsecured loan notes plus 1.2m new shares. Existing shareholders would keep 1.6m shares. The total of new shares would be 4.0m, valued at $1.00 each. Evaluate the scheme for each party against liquidation.

Show the solution

Liquidation: the debenture holders receive $5.0m from the property. Their shortfall is $6.0m − $5.0m = $1.0m, which ranks as unsecured.
Cash for unsecured claims: $3.0m other assets − $0.4m costs = $2.6m.
Total unsecured claims: $4.0m trade creditors + $1.0m shortfall = $5.0m. Recovery rate = 2.6 ÷ 5.0 = 52%.
Debenture holders in liquidation: $5.0m + (52% × $1.0m) = $5.52m. Trade creditors: 52% × $4.0m = $2.08m. Shareholders: nil.
Scheme, debenture holders: $4.5m new debentures + (1.2m × $1.00 = $1.2m) = $5.7m. Gain = 5.70 − 5.52 = $0.18m.
Scheme, trade creditors: $1.5m loan notes + $1.2m shares = $2.7m. Gain = 2.70 − 2.08 = $0.62m.
Scheme, shareholders: 1.6m × $1.00 = $1.6m. Gain = $1.6m versus nil.
Check: total scheme value = 5.7 + 2.7 + 1.6 = $10.0m. Net liquidation proceeds = 5.0 + 2.6 = $7.6m. The difference is $2.4m, which equals the sum of gains (0.18 + 0.62 + 1.6).
Feasibility: new debt is $4.5m + $1.5m = $6.0m against equity valued at $4.0m. Gearing is high at 60% of total capital. Debenture holders gain only a small margin, so they are the party most likely to resist. The company must show it can service the interest.

Answer: Every party is better off under the scheme than in liquidation. Debenture holders gain $0.18m ($5.70m against $5.52m), trade creditors gain $0.62m ($2.70m against $2.08m) and shareholders gain $1.6m (against nil). The scheme should be accepted, subject to the company showing it can service $6.0m of new debt. Debenture holders have the smallest gain and may need more favourable terms.

Example 2

Kora Ltd has the following statement of financial position: non-current assets $8m; current assets $3m; share capital (5m shares of $1) $5m; reserves (deficit) $(6)m; 10% debentures $6m; trade payables $6m. A scheme is proposed. (1) Existing shareholders exchange every 5 shares for 1 new $1 share. (2) Debenture holders exchange $6m debentures for $3m new 8% debentures plus 2m new $1 shares. (3) Trade payables accept a write-off of $2m. (4) A new investor subscribes for 2m new $1 shares at par in cash. (5) Non-current assets are written down by $1m. Prepare the pro forma statement of financial position after the scheme and show the ownership of the new company.

Show the solution

Share capital: existing holders 5m ÷ 5 = 1m shares. Debenture holders 2m shares. New investor 2m shares. Total = 5m shares, share capital $5m.
Non-current assets: $8m − $1m = $7m.
Current assets: $3m + $2m cash from the new issue = $5m. Total assets = $12m.
Debentures: $3m new 8% debentures. Trade payables: $6m − $2m = $4m. Total liabilities = $7m.
Reserves: start with $(6)m. The capital reduction on the old shares credits reserves by $5m − $1m = $4m, giving $(2)m.
Debenture exchange: $6m of debt is replaced by $3m of debt and $2m of shares, so the gain is $1m. Reserves become $(1)m.
Payables write-off adds $2m, giving $1m. The asset write-down deducts $1m, giving reserves of nil.
Check: assets $12m − liabilities $7m = $5m. Share capital $5m + reserves nil = $5m. It balances.
Ownership: existing shareholders 1m ÷ 5m = 20%. Debenture holders 2m ÷ 5m = 40%. New investor 2m ÷ 5m = 40%.

Answer: Pro forma statement: non-current assets $7m; current assets $5m; total assets $12m. Share capital $5m; reserves nil; 8% debentures $3m; trade payables $4m. Total equity and liabilities $12m. Ownership: existing shareholders 20%, debenture holders 40%, new investor 40%. The existing shareholders keep 20% of a solvent company, which is better than nil in liquidation, but they lose control.

Exam tips

Always state the alternative and calculate it first. Marks are usually awarded for the liquidation figures even if the scheme figures go wrong.
Put the results in a short table by party. Examiners can then see your numbers and credit them quickly.
Do not stop at the numbers. Write a sentence for each party on whether it will accept and why. This earns professional skills marks for analysis and judgement.
Comment on feasibility: new cash raised, interest cover, gearing and whether the forecasts are realistic. Many answers leave this out.
If the pro forma statement of financial position is asked for, show each adjustment as a separate line so that you can still earn marks if one figure is wrong.

Practice questions from Financial reconstruction

Evaluating a Reconstruction Scheme for Each Party: frequently asked questions

How do I evaluate a reconstruction scheme from the shareholders' point of view?

Find what shareholders would get in liquidation, which is often nothing. Then value the shares they keep under the scheme, using the given share value. Comment on dilution and any new money they must put in, and conclude whether they are better off.

What should I compare the scheme with, liquidation or no action?

Use what the question asks for. Liquidation is the usual comparison because it shows what each party would lose if the scheme fails. If the company could continue without any change, compare with no action as well.

How do I value new debentures and shares in the scheme?

Value new debt at face value unless the question gives a market value. Value shares at the price or equity value given. If neither is given, state a sensible assumption and say it is an assumption.

What if a party is worse off under the scheme than in liquidation?

It is unlikely to agree. Say so, and suggest changes such as more shares, higher-ranking debt or cash. Then explain what the change would do to the other parties and to the company's ability to pay.

How do I build a pro forma statement of financial position after reconstruction?

Take the existing statement and apply each change in order: share exchanges, debt swaps, write-offs, new cash and asset write-downs. Debt written off or swapped for shares increases equity. Finish by checking that assets less liabilities equals equity.