If subordinated debt is secured, but there is unsecured senior debt, would it ever be possible that the secured subordinated debt is paid off (by the collateral) but the unsecured senior debt is not?
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Yes this is possible (someone correct me if I'm wrong though). As an example, say your new TEV is $600 with 200 unencumbered and 400 of collateral. Old TEV of $1000 (100 bank loan, 100 1L, 200 2L, 350 unsecured, 250 equity). Because there's 400 of collateral, bank loan, 1L and 2L are fully covered. The remaining 200 of unencumbered is allocated to the unsecured for a 57% recovery.
So in the above the 2L secured is paid off by collateral but the unsecured is only partially recovered.
Someone please correct me if i'm wrong though
Are there usually debt covenants that prevent something like this from happening? Seems confusing for a distressed company to have its junior debt trading higher than its seniors.
I'm sure there are covenants for this (experts please chime in haha). I think probably a lot of factors could make this possible. Junior debt could be at opco level while seniors are at parent co so when thinking about recoveries that could be important (again not an rx expert but just my thoughts)
With debt, anything is technically possible because debt is just a contract made between parties. It's possible that a creditor could write in the debt docs that the debtor needed to send them a video of the CEO hopping on one leg singing the star spangled banner if they wanted to raise additional indebtedness (that would be in the negative covenants section).
I'm using a silly example, but the point is that the answer to your question is yes. You could technically have a piece of debt that had a lien on some asset of the company, but was subordinated to another piece of paper that didn't (you could draft it to say that until the senior unsecured debt was paid in full, the subordinated debt would turnover any form of consideration). Also just to be clear, when you talk about subordination, you need to subordinate yourself to a specific obligation or obligations.
That's all very unlikely though obviously. Who are the people who take security interests? Banks obviously, but generally, it's people who are willing to accept a lower interest rate in order to have a higher chance of receiving par when the company goes belly up. People who take subordinated paper are the opposite, so it's unlikely that you would have a lender who would take a security interest but then subordinate themselves to another obligation.
agree with the above. No senior lender is ever going to be cool with taking on more risk with (most likely) less return. This would be reflected in the negative covenant section under liens in the credit agreement. There might be a lien bucket, but bolier plate language normally only permits liens on things like rent and accounts payable.
In some rare cases, a borrower could assume debt of another company without paying it off/refinancing. In which case , anything could happen. But again, most lenders would demand (and I've never even checked a credit agreement because its so axiomatic) that their senior facilites are at least in line with all other obligations aka pari passu.
If secured, there is collateral. Recourse to the collateral (security) is exclusive to the secured party(ies) upon default, typically this manifests in a failure to make payment. For example, you can mortgage your house and borrow money to start a meth lab unsecured. When your meth lab gets busted, the mortgage lender gets your house and the unsecureds get dick.
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