Modeling Chapter 11 Recovery Waterfalls

Modeling Chapter 11 Recovery Waterfalls

Builds recovery waterfall models that distribute enterprise value across claim classes following absolute priority, estimating cents-on-the-dollar recovery for each creditor tier under a plan of reorganization or liquidation scenario.

When To Use

• Estimating creditor recoveries under a proposed Chapter 11 plan of reorganization
• Comparing reorganization vs. Chapter 7 liquidation outcomes (the "best interests" test)
• Pricing distressed debt by modeling recovery at various enterprise value assumptions
• Evaluating the fulcrum security (the class where value breaks)
• Supporting disclosure statement preparation or plan confirmation arguments
• Stress-testing recovery sensitivity to valuation, claim amounts, or priority disputes

Inputs To Gather

• Claims register / proof-of-claim summary: All filed claims by class — secured, priority, general unsecured, subordinated, equity interests. Include disputed or contingent claims with estimated allowed amounts.
• Collateral valuations: Appraised or estimated values for each collateral pool securing a secured claim (real property, equipment, receivables, IP). Distinguish between going-concern and orderly-liquidation values.
• Enterprise or asset value range: Low / base / high valuation scenarios. Source from DCF, comparable transactions, or liquidation analysis as appropriate.
• DIP facility and administrative claims: DIP loan balances, accrued professional fees (debtors' counsel, UCC counsel, financial advisors), U.S. Trustee fees, cure costs.
• Plan treatment terms: Any negotiated recoveries, equity tips, gifting structures, or class-skipping provisions in the proposed plan [VERIFY — plan terms are case-specific].
• Intercompany claims and structural seniority: Entity-level debt placement if multi-entity debtor group; substantive consolidation status.
• Executory contract / lease cure amounts: Assumed or rejected contracts and corresponding cure or rejection damage claims.

Workflow

1. Map the priority stack

   • Order all claims by Bankruptcy Code priority: § 507 priority claims (admin expenses, wage claims, tax claims), then secured claims (to extent of collateral value), general unsecured, subordinated, equity.
   • For secured creditors, bifurcate under § 506(a): secured portion (up to collateral value) and deficiency claim (unsecured).
   • Identify any intercreditor subordination agreements that contractually re-order the statutory waterfall [VERIFY — subordination terms vary by agreement].

2. Build the waterfall schedule

   • Row structure: one row per claim class, ordered by priority.
   • Column structure: claim amount | cumulative claims | available value | distribution | recovery %.
   • Distribute available value top-down: each class receives the lesser of its allowed claim or remaining distributable value before the next class is paid.
   • For classes receiving partial recovery, calculate pro-rata distribution across claimants within the class.

3. Model secured claim recoveries separately

   • Each secured class waterfall runs against its specific collateral pool, not the general estate.
   • Apply adequate protection payments already made during the case as offsets.
   • If collateral value exceeds the secured claim, the surplus flows back to the general estate.

4. Run valuation scenarios

   • Build at least three scenarios (low / base / high enterprise value) to show how recovery shifts across classes.
   • Identify the fulcrum security — the most senior class that receives less than full recovery. This is the class with the greatest negotiating leverage and option value.
   • Calculate breakeven enterprise value for each class to achieve par recovery.

5. Incorporate plan-specific adjustments

   • Equity tips or carve-outs negotiated for junior classes despite absolute priority.
   • Convenience class thresholds (small claims paid in full to reduce administrative cost).
   • Rights offerings, backstop commitments, or new-money investment tranches that affect distributable value.
   • Tax attributes (NOLs, § 382 limitations) that affect post-emergence equity value [VERIFY — NOL availability depends on ownership change analysis].

6. Perform the best-interests test

   • Build a parallel Chapter 7 liquidation waterfall using orderly-liquidation collateral values and estimated Chapter 7 trustee fees / wind-down costs.
   • Compare class-by-class: each class must receive at least as much under the plan as it would in liquidation.

Output

• Recovery waterfall table: Claim class | Allowed claim amount | Distribution amount | Recovery % — across all scenarios.
• Fulcrum security identification: State which class is the fulcrum and at what enterprise value the fulcrum shifts.
• Sensitivity matrix: Recovery by class across a range of enterprise values (e.g., $50M increments).
• Best-interests comparison: Side-by-side plan vs. liquidation recovery for each class.
• Key assumptions summary: Valuation methodology, disputed claim treatment, subordination mechanics, and plan-specific adjustments applied.

Quality Checks

• Waterfall distributions must sum exactly to total distributable value — no leakage or rounding gaps.
• No junior class receives any distribution while a senior class is impaired (unless an equity tip or gift is explicitly modeled and labeled).
• Secured claim bifurcation matches collateral valuations; deficiency claims flow correctly to the unsecured pool.
• Administrative and priority claims are fully satisfied before any distribution to general unsecured creditors [VERIFY — confirm no § 1129(a)(9) waiver].
• Recovery percentages are bounded 0–100% per class; cross-check that weighted average recovery across all claims equals total distributable value / total allowed claims.
• Scenario outputs move directionally as expected — higher enterprise value should weakly increase recovery for each class.
• All disputed, contingent, or unliquidated claims are flagged with estimated allowed amounts and marked [VERIFY].