The purpose of the restrictive debt covenant that requires that subsequent borrowing be subordinated to the original loan is to
A) ensure that certain key employees are maintained.
B) limit the amount of fixed-payment obligations.
C) ensure a cash shortage does not cause an inability to meet current obligations.
D) protect the lender by maintaining its position in the priority of claims in the event of liquidation.

Question

Quizplus · Accepted Answer

The purpose of a subordination clause in a restrictive debt covenant is to protect the lender by maintaining its position in the priority of claims in the event of liquidation. It means that if the company defaults on its debt, the lender with the subordinated loan will not be paid until the original loan is paid off first. This reduces the lender's risk and protects its investment.

The Purpose of the Restrictive Debt Covenant That Requires That