What is a Fulcrum Security in Bankruptcy?

by Nicholas Ortiz

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In bankruptcy there is a hierarchy in the right to get paid. Secured creditors come before unsecured creditors who, in turn, come before stockholders. Senior creditors get paid in full before their juniors get anything. In a Chapter 11 bankruptcy scenario, there is usually a tier of creditors that is only partially "in the money." For example, if a debtor's secured debt will be paid in full, but unsecured debt will receive 10 percent on the dollar, the unsecured debt is what is known as the fulcrum security. That is because the unsecured debt is the tier of claims that will likely end owning the reorganized debtor and that will have maximum leverage over approval of the debtor's reorganization plan. Why is this the case?

The reason the only-partially-in-the-money group of claims end up "owning the debtor" is because of something called the absolute priority rule. That rule requires that senior creditors be paid in full before junior claims get anything. If a class of claimants is only being partially paid, then no one else is entitled to receive the stock (i.e. ownership) of the reorganized debtor unless they buy this stock with cash or all classes approve the plan. So the partially-in-the-money group of claims has a presumptive right to the stock of the reorganized debtor.

A fulcrum is a lever. A partially-in-the-money group of claims has leverage over a bankruptcy plan because they are often the only class of claims that has a vote that matters. The existence of a fulcrum security usually means that a senior class of debt is being paid in full. The approval of this senior class is automatic. Any interests junior to the fulcrum will get nothing, and so the rejection of the plan by that class of claims is presumed. Consequently, the fulcrum group is the only one with a vote that matters, and this gives it leverage over plan confirmation. No wonder the this concept has such a prominent plays a key role in distressed company investing.

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