An Insider’s Guide To Evading Absolute Priority?

In Chapter 11 bankruptcy cases, the absolute priority rule requires a debtor's creditors be paid in full before equity investors receive any value. However, existing equity investors occasionally seek to invest new money in the plan of reorganization process and argue that such investment justifies retention of equity in the reorganized company; equity which otherwise would pass to impaired creditors. In 1999, the Supreme Court examined this "new value" argument, holding that valuing a new investment requires competition: if a reorganization plan rewards a new investment with equity in the reorganized company, other potential investors must be allowed to bid to determine the market value of that equity. See Bank of America National Trust & Savings Ass'n v. 203 North LaSalle Street Partnership, 526 U.S. 434 (1999). So long as the equity is valued through an auction and the equity investor pays the market-set rate, the absolute priority rule is not violated.