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FRM Part II · FRM Exam Part II · Distress Symptoms and Remedies

Which of the following is a typical reason an out-of-court restructuring may fail and force a firm into formal bankruptcy?

Workouts tend to fail when debt is spread across many creditors with different seniority and conflicting incentives, which creates holdout and coordination problems. Few aligned creditors, good information and majority-amendment clauses facilitate agreement and make an out-of-court deal more likely to succeed.

  1. AThe firm has a small number of creditors with aligned interests
  2. BA large share of debt is held by many dispersed creditors with conflicting priorities and incentives to hold outCorrect
  3. CCreditors have good information about the firm's true condition
  4. DThe firm's debt contracts permit amendments by simple majority vote

Explanation

Coordination is hard when debt is widely dispersed, claims differ in seniority, and creditors can free-ride. Few aligned creditors, good information and majority amendment clauses all make agreement easier.

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