Claims & Interest Absolute Priority Rule New Value Exception

Claims and interests are classified in order to allow treatment which recognizes differences in the rights of creditors and to treat these according to the facts of the case. Similar claims and interests are given similar nondiscriminatory treatment which follows sound business reasoning. However, some discrimination is permitted if it is based on sound business reasoning, is done in good faith, and the debtor could not reorganize without it, and if the degree of discrimination is related to the rational for the disparate treatment. Discrimination may be necessary to create an impaired consenting class.

StopCartoon01The holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property. 1129(b)(2)(B)
In 2005 the BPCPA amendment to the bankruptcy added the phrase except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115. Thus in individual chapter 11 cases a debtor may retain property acquired after the bankruptcy was filed even if the unsecured creditors did not receive payment in full. Note that his exception to the absolute priority rule only applies to property acquired after the bankruptcy was filed and not to property owned by the debtor at the time of the filing.

The objection of an impaired senior class does not bar junior claim holders from receiving or retaining property interests in the debtor after reorganization, if they contribute new capital in money or money’s worth, reasonably equivalent to the property’s value, and necessary for successful reorganization of the restructured enterprise. Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 118, 60 S.Ct. 1, 84 L.Ed. 110 (1939) The reasoning was that the junior creditors were not receiving something for their junior claim while the senior claims were not being paid in full, they were in reality just participating in a newly capitalized reorganized enterprise into which they had infused capital equal in value to their interest in that reorganized enterprise. This holding has been narrowly interpreted and is available only if as strong showing of unusual circumstances is shown and is necessary for the reorganization. In re Dow Corning Corp., 244 B.R. at 747, citing In re Potasky 222 B.R. 826. The Potasky analysis utilized a 3 part test: (1) That the suit against the non-debtor was, in essence, a suit against the debtor or will deplete assets of the estate;(2) The non-debtor contributed substantial assets to the debtor’s estate as part of the debtor’s plan of reorganization; and(3) The injunction is essential to reorganization. Without the injunction the entire reorganization plan would unravel. The Potasky went on to state: In those cases where the courts found that unusual circumstances were present, the injunctions served either to marshal assets of the debtor’s estate or to channel the claims of creditors to assets of that estate. The existence of these assets, however, depended upon the action of a third party non-debtor. By permanently enjoining suits against these third party non-debtors, the courts created a legal environment that enabled the non-debtor to take the necessary steps which would lead to the creation of assets for the debtor’s estate.

Call Attorney C. Stephen Gurdin Jr. at his Gurdin Law Wilkes-Barre Scranton Pennsylvania area office today, 570.826.0481.