The Toronto Skaters Company currently has one issue of debt outstanding.Toronto Skaters has decided to borrow more money by issuing new debt with a higher priority in the event of bankruptcy.This could result in a violation of which type of covenant on the original debt?
A) Standard negative pledge
B) Cross-default clause
C) The new issue will not violate any covenant as there are never covenants when a firm has only one issue of debt
D) This type of transaction is illegal

Question

Quizplus · Accepted Answer

A standard negative pledge covenant prohibits the borrower from granting security over assets that are not already secured by the lender. By issuing new debt with a higher priority, Toronto Skaters would be granting security over assets that are not already secured by the original lender, which could violate the negative pledge covenant. Cross-default clauses relate to default on other debts, so this is not relevant in this scenario. The statement about there never being covenants when a firm has only one issue of debt is false, as covenants can still be present in such a situation. The transaction itself is not necessarily illegal, but violating a covenant could trigger default and other negative consequences for the borrower.

The Toronto Skaters Company Currently Has One Issue of Debt