ACCA Advanced Financial Management (AFM) Practice Exam

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What happens when a company defaults on its debt?

The company is immediately dissolved
The debt holders take ownership of the company's assets
The company is given more time to recover financially
The interest rates on future loans increase

The correct answer is: The debt holders take ownership of the company's assets

When a company defaults on its debt, one of the primary consequences is that debt holders may take ownership of the company's assets. This situation arises as part of the default process, where creditors have rights under the terms of the debt agreement. In the event of default, creditors can initiate legal proceedings to reclaim the assets that serve as collateral for the loans. This could lead to a liquidation of assets to repay the outstanding debts, providing a relatively prioritized path for recovery of the debt owed to them. This option reflects the typical response of creditors according to the established legal frameworks surrounding insolvency and default. These processes enable creditors to seek repayment through ownership or liquidation of a defaulting company’s assets rather than the company being immediately dissolved or merely given more time to recover. While other options may conceptually relate to the aftermath of a default, they don't accurately capture the immediate and formal actions that typically occur when a company cannot meet its debt obligations.