Chapter 14 Practice Question Answers
1. Answer: D. In broadest terms, secured claims take priority over unsecured claims, which in turn take priority over interests. Subordinated secured bonds are only subordinate relative to other secured claims. Such bonds still have higher priority than unsecured claims and interests. Therefore, Item III has the highest priority.
Among unsecured claims, administrative expenses of the bankruptcy (Item IV) take priority over wages earned before the bankruptcy filing (Item I). Finally, preferred shareholders have an interest, rather than a claim. Since interests have lower priority than claims, Item II comes last.
2. Answer: B. Sometimes secured lenders make an agreement among themselves as to which of their liens will take priority in case of bankruptcy. This is called an intercreditor agreement (ICA) or an agreement among lenders (AAL).
None of the other responses alter the priority of claims. A debtor appointed as a debtor in possession (DIP) essentially acts as its own bankruptcy trustee. A DIP is permitted to obtain financing to continue operations during bankruptcy, known as DIP financing. A Section 363 sale is a sale of assets by the debtor, with the approval of the bankruptcy court. A stalking horse is a bidder engaged by the debtor for the purpose of ensuring that assets being sold off fetch an adequate price.
3. Answer: D. This is referred to as debtor-in-possession (DIP) financing because the company remains “in possession” of the company’s assets. Section 363 of the bankruptcy code is a sale of assets in a bankruptcy case; it is not a method of financing. While Senseless Risk’s loan may turn out to be pre-liquidation financing if Tenuous ultimately files for Chapter 7 bankruptcy, that is not the common name for such credit arrangements. An event of default is an event specified in a credit agreement that allows the creditor to demand immediate repayment of all or part of the loan balance; it i