The RX Technical Question Bank: DIP, Fulcrum, LMTs, Valuation

Introduction

The Rx technical question bank is more specialized than the typical M&A technical bank. Beyond the standard valuation and LBO questions, Rx interviews test capital structure analysis, DIP financing mechanics, recovery waterfalls, fulcrum security identification, liability management transactions, and specific Bankruptcy Code provisions. This article provides a comprehensive technical reference covering the major topic areas, with sample questions and answer frameworks that candidates should master before any Rx interview.

The bank is organized into six core topic areas: capital structure and credit, DIP financing, fulcrum security and recovery, LMTs, valuation under distress, and bankruptcy code provisions.

Capital structure questions test whether the candidate can analyze layered debt stacks with appropriate detail.

Q: Walk me through a typical distressed company's capital structure.

A: From senior to junior: revolving credit facility (often ABL collateralized by working capital), first-lien term loan (collateralized by substantially all assets), second-lien term loan (subordinate lien on same collateral), senior unsecured notes, subordinated unsecured notes, mezzanine or PIK debt, preferred equity, and common equity. Each layer has distinct security, intercreditor relationships, covenants, and recovery prospects.

Q: What is the difference between a first-lien and second-lien term loan?

A: Both are typically secured by the same collateral, but the first-lien holders have priority claims to collateral proceeds. The second-lien holders receive collateral distributions only after the first-lien claims are fully satisfied. The two tranches are governed by an intercreditor agreement that defines voting rights, payment waterfalls, and remedy procedures.

Q: What are key credit covenants and what triggers a covenant breach?

A: Two categories: maintenance covenants (tested periodically, like quarterly Debt/EBITDA or fixed charge coverage) and incurrence covenants (tested only when specific actions are taken, like additional debt issuance). A breach triggers an event of default, which can lead to acceleration, cross-default to other debt, and potential bankruptcy filing. The Debt/EBITDA covenant is the most common maintenance covenant.

Q: What is intercreditor priority and how does it work?

A: Intercreditor agreements define the relative rights of different debt tranches with similar security. Common provisions include payment waterfall (who gets paid first from collateral), voting rights (who controls remedy decisions), standstill periods (junior creditors must wait before exercising remedies), and turnover obligations (junior creditors return excess collections to senior creditors).

DIP financing is one of the most-tested Rx topics because of its centrality to Chapter 11 cases.

Q: What is DIP financing and why is it important?

A: Debtor-in-possession financing is post-petition financing under Section 364 of the Bankruptcy Code. It is critical because distressed companies typically cannot raise capital through traditional channels, but the bankruptcy court can grant protections (super-priority status, priming liens) that make lenders comfortable providing capital. Many companies file Chapter 11 specifically to access DIP financing.

Q: What are the typical features of a DIP facility?

A: Super-priority status under Section 364(c)(1), priming liens on existing collateral under Section 364(d), tight covenants on operating performance, milestones tied to case progression (filing certain motions, plan filing, confirmation), upfront fees of 2-3%, pricing of SOFR + 600-1,000 bps typical (extreme cases can exceed 1,000 bps), and case milestone-based draws. DIPs are typically backstopped by an ad hoc lender group.

Q: What is a DIP roll-up and how does it work?

A: A roll-up converts a portion of prepetition debt into the DIP facility, granting that debt the super-priority status it would not have had as prepetition debt. Roll-ups are advantageous for participating lenders (priority improvement) but disadvantageous for non-participating lenders (their claims become structurally subordinate). Roll-ups are common in cases where existing lenders provide the DIP.

Q: What is the difference between a junior DIP and a priming DIP?

A: A junior DIP sits behind existing prepetition liens; the lender takes super-priority status only over administrative and unsecured claims. A priming DIP has super-priority status that ranks ahead of existing prepetition liens; the existing lien-holders are primed and may receive adequate protection (typically senior-debt-style payment guarantees). Priming DIPs require court approval that finds the existing lenders are adequately protected, which is contested in many cases.

Fulcrum analysis is a distinctive Rx skill that doesn't have a clean M&A analog.

Q: What is the fulcrum security?

A: The fulcrum security is the most senior class of debt that does not receive full recovery in a restructuring. It is critical because the fulcrum security typically converts to post-emergence equity in plans of reorganization. Distressed investors target the fulcrum security because it offers both downside protection (debt instrument) and upside participation (potential equity conversion).

Q: How do you identify the fulcrum security?

A: First, estimate enterprise value under going-concern and liquidation premises. Second, walk through the capital structure from most senior to most junior, allocating value at each level. The fulcrum security is the class where allocated value exceeds zero but is less than the claim amount. The classes above the fulcrum receive 100% recovery; the classes below the fulcrum typically receive zero.

Q: Walk me through how recovery would change if EV doubles.

A: As EV increases, the fulcrum security moves down the capital structure. Senior classes still receive 100%; the previous fulcrum security may now receive 100% with the new fulcrum being a more junior class. At sufficiently high EV, even subordinated classes can receive partial or full recovery, though this is rare in distressed cases by definition.

Q: What is a credit bid and how does it affect the waterfall?

A: Under Section 363(k), secured creditors can bid the face amount of their claims in a Section 363 sale. If the credit bid wins, the secured creditor acquires the assets without paying cash; the unsecured deficiency claim and other classes receive distribution from any cash component plus other estate assets. Credit bidding is a powerful tool that allows secured creditors to acquire collateral without external financing.

LMT questions test understanding of out-of-court restructuring and the post-Serta legal landscape.

Q: What is an uptier exchange and how does it work?

A: An uptier exchange involves a borrower issuing new senior debt in exchange for existing debt held by participating lenders, with the new debt structured to have priming priority over remaining non-participating debt. The non-participating lenders are effectively subordinated. Uptier exchanges rely on credit agreement provisions (sacred rights, open market purchase exceptions) that vary by document.

Q: What was the December 2024 Serta ruling and why does it matter?

A: The Fifth Circuit ruled that Serta's 2020 uptier exchange violated the credit agreement's pro-rata sharing requirement because the transaction did not qualify as an "open market purchase." The ruling cast doubt on the open-market-purchase exception that had powered many uptier exchanges, triggering the post-Serta market shift toward consensual structures backed by cooperation agreements.

Q: What is a cooperation agreement?

A: A pre-LMT contract among holders of a debt tranche that binds participants to act collectively, share information, and refuse non-pro-rata transactions absent unanimous consent. Cooperation agreements emerged as a defensive response to non-consensual LMTs and have become standard in the post-Serta market, with over 70% of 2025 LMTs incorporating cooperation frameworks.

Q: What is a drop-down financing?

A: A transaction where a borrower transfers valuable assets (often unrestricted subsidiaries) outside the existing collateral pool, then issues new debt secured by those transferred assets. The new debt has priority over existing debt with respect to the transferred collateral. The J.Crew "trapdoor" structure was the original drop-down example.

Q: What is a double-dip transaction?

A: A structure where new lenders receive both a direct claim on the borrower and an indirect claim through guarantees or pledges from affiliates, allowing the new debt to "double dip" into recovery sources. Double-dips can produce higher effective recoveries than would otherwise be available given the underlying capital structure.

Distressed valuation extends standard valuation methods with specific adjustments.

Q: How do you value a distressed company?

A: Three primary methods: DCF with elevated discount rates (18-30% all-in for distressed), comparable companies (with adjustments for distressed multiples vs healthy peers), and precedent transactions (focusing on similar restructuring outcomes). The choice depends on data availability and the specific company's situation. Best practice combines all three with explicit weighting.

Q: What is the difference between going-concern and liquidation valuation?

A: Going-concern valuation assumes the business continues operating as an integrated entity, with value derived from future cash flows. Liquidation valuation assumes the assets are sold individually and proceeds distributed; values are typically substantially lower (often 30-50% of going-concern). The Section 1129(a)(7) best-interests test requires plan recoveries to exceed liquidation values.

Q: How does Section 506(a) bifurcation work?

A: Section 506(a) splits an undersecured claim (collateral value less than face amount) into two pieces: a secured claim equal to collateral value and an unsecured deficiency claim for the remaining amount. The secured claim has priority equal to other secured claims; the deficiency claim drops to general unsecured.

Q: What is the absolute priority rule?

A: Section 1129(b)(2) requires that no junior class receive value while a senior class is impaired and dissenting. In practice, this means equity typically receives nothing in distressed cases where unsecured creditors do not receive full recovery. Exceptions include the "new value" doctrine and consensual deviations through "gifting" structures.

Specific Bankruptcy Code section knowledge is increasingly tested in Rx interviews.

Q: What is Section 363?

A: The provision governing sales of property of the estate. Section 363(b) authorizes sales outside the ordinary course of business with court approval. Section 363(f) provides "free-and-clear" sales (lien interests attach to proceeds). Section 363(k) provides credit bidding. Section 363(m) protects good-faith purchasers from appellate reversal.

Q: What is Section 1129(a)(7) and why does it matter?

A: The "best-interests test" requires that each impaired creditor receive at least what it would receive in a hypothetical Chapter 7 liquidation. This protects dissenting creditors from being forced to accept less than liquidation value and effectively sets a floor on plan recoveries.

Q: What is the automatic stay under Section 362?

A: An automatic injunction that halts virtually all collection actions against the debtor when the petition is filed. Creditors cannot foreclose, accelerate, file new lawsuits, or take other collection actions without bankruptcy court permission. The stay is one of the most important features of Chapter 11.

Q: What did Harrington v. Purdue Pharma hold?

A: The June 2024 Supreme Court 5-4 decision held that the Bankruptcy Code does not authorize nonconsensual third-party releases. The ruling reshapes mass tort cases by requiring opt-in consent rather than imposed releases. Post-Purdue, mass tort plans must use consensual structures with claimant supermajority support.

Plan confirmation mechanics receive heavy testing in senior-banker interviews.

Q: What are the requirements for plan confirmation?

A: Section 1129(a) lists sixteen requirements including: classification of claims under Section 1122, plan voted on by impaired classes (Section 1129(a)(8)), best-interests test (Section 1129(a)(7) requiring at-least-liquidation-value recovery), feasibility (Section 1129(a)(11) requiring the plan is not likely to be followed by liquidation or further reorganization), good faith filing (Section 1129(a)(3)), and full payment of administrative claims and priority taxes.

Q: What is cramdown?

A: Section 1129(b) allows confirmation over a dissenting class if the plan is "fair and equitable" to that class and does not "discriminate unfairly." For unsecured classes, the fair-and-equitable test requires either full payment or no junior class receiving value (the absolute priority rule). For secured classes, the test requires retention of liens plus deferred payments equal to the secured claim, sale of collateral with the lien attaching to proceeds, or realization of the indubitable equivalent of the claim.

Q: What is the new value exception?

A: A judicial doctrine (not codified) recognizing that equity holders can retain or receive equity if they contribute new money or money's worth that is necessary, substantial, in money or money's worth, and reasonably equivalent to what equity is receiving. The new value exception is contested and has been narrowly applied in modern cases.

Bankruptcy litigation questions test whether candidates understand contested case dynamics.

Q: What is an adversary proceeding?

A: A formal lawsuit filed within a bankruptcy case to resolve specific disputes (preference claims, fraudulent transfer claims, lien priority disputes, plan confirmation objections). Adversary proceedings are governed by the Federal Rules of Bankruptcy Procedure and follow procedures similar to standard federal civil litigation but within the bankruptcy court's jurisdiction.

Q: What is a preference claim?

A: Under Section 547, a trustee or debtor-in-possession can recover transfers made within 90 days before bankruptcy (one year for insiders) that allowed the recipient to receive more than it would in a Chapter 7 liquidation. Preference claims are common litigation in restructurings and often produce meaningful estate recoveries.

Q: What is a fraudulent transfer claim?

A: Under Section 548 (and applicable state law), the trustee can void transfers made with actual intent to defraud creditors or for less than reasonably equivalent value while the debtor was insolvent. The look-back period is 2 years under federal law, longer under some state statutes. Fraudulent transfer claims often arise in cases involving leveraged buyouts and pre-bankruptcy asset transfers.

Several specialized topics increasingly appear in Rx interviews:

Q: What is a stalking horse bidder and what protections does it receive?

A: A pre-selected buyer in a Section 363 sale process who agrees to a baseline purchase price subject to higher and better offers at auction. The stalking horse receives bid protections including a break-up fee (typically 2-3% of purchase price) and expense reimbursement, designed to compensate for setting the floor and conducting initial diligence.

Q: What is the Texas Two-Step?

A: A bankruptcy structuring technique using Texas state-law divisive merger to separate a company into two pieces, with mass tort liability assigned to one piece (which immediately files Chapter 11) and operating assets to the other (which continues outside bankruptcy). The structure has been challenged as bad-faith filing in J&J's LTL Management cases (dismissed by the Third Circuit in January 2023 and on refilings) and 3M's Aearo Technologies case.

Q: What is fresh-start accounting?

A: Under ASC 852, qualifying companies emerging from Chapter 11 must remeasure their assets and liabilities at fair value as of the emergence date, effectively resetting the balance sheet. Fresh-start accounting requires meeting two conditions: holders of voting shares before emergence receive less than 50% of voting shares post-emergence, and reorganization value (post-emergence enterprise value) is less than total post-emergence liabilities plus allowed claims.

Out-of-court topics test understanding of the alternatives to Chapter 11.

Q: What are the major out-of-court restructuring tools?

A: Five primary tools: amendments and waivers (negotiated covenant relief from existing lenders), forbearance agreements (lender commitments not to exercise remedies for a defined period), distressed exchange offers (offering new debt with modified terms in exchange for existing debt), debt-for-equity swaps (creditors exchange debt for equity in the restructured entity), and new money rescue financing (additional debt or preferred equity to address near-term liquidity).

Q: When does a company go out-of-court versus Chapter 11?

A: Out-of-court works when there are relatively few creditors, the operating issues are addressable through capital structure changes, and creditors can be coordinated efficiently. Chapter 11 becomes necessary when the creditor pool is too dispersed for consensual negotiation, when the company needs the protections of the automatic stay, when DIP financing is required, or when assumption/rejection of executory contracts is needed.

Q: What is consent solicitation in distressed exchange offers?

A: A process of soliciting bondholder consent to amend indenture provisions (typically removing covenants or releasing collateral) as part of a distressed exchange offer. Consent solicitations require specific majority thresholds (often two-thirds in face amount) and are governed by the Trust Indenture Act, which prohibits non-consensual modifications of payment terms.

A condensed reference of the most-tested Bankruptcy Code sections:

Effective preparation involves several specific steps:

Master the structural answers first. Before drilling into specific Section numbers and case names, ensure the structural answers (capital structure walkthrough, recovery waterfall, DIP mechanics, fulcrum identification) are fluent.

Layer in specific provisions. After the structural answers are solid, add specific Section references and code provisions. Bankruptcy Code knowledge differentiates strong from average Rx candidates.

Practice with current cases. For each technical concept, anchor the answer in a current case. DIP financing answers should reference First Brands' $4.4 billion structure; Section 363 answers should reference Joann's auction process; LMT answers should reference Serta and Mitel.

Mock interview extensively. The technical bank is best mastered through repetition with feedback. Mock interviews with peers, friends, or paid coaches identify weaknesses that self-study often misses.

Read recent legal commentary. Mayer Brown, Kirkland & Ellis, Weil, and Davis Polk all publish substantive commentary on bankruptcy developments. Reading these regularly builds the legal-doctrine awareness that distinguishes strong Rx candidates.

The Rx interview process is rigorous, but the technical bank is finite and learnable. Candidates who systematically work through these topics with depth, current-case anchoring, and consistent mock interview practice consistently outperform candidates who rely on broad IB preparation alone. With this technical foundation plus the behavioral preparation in earlier articles in this section, candidates have everything needed to land top Rx offers and ultimately the buy-side seats that the Rx pathway opens.