Absolute Priority Rule
The Absolute Priority Rule is the Chapter 11 principle reflected in Bankruptcy Code Section 1129(b) that, in specified cramdown circumstances, prevents a junior class from receiving or retaining property on account of its junior claim or interest when a senior dissenting class is not paid in full.
The rule is part of cramdown, not every Chapter 11 plan
Section 1129(b) becomes relevant when an impaired class has not accepted the plan and the proponent seeks confirmation anyway.
A consensual plan can distribute value differently because accepting classes can agree to treatment that would not be imposed over their objection.
Unsecured creditors and equity sit in a priority sequence
If an impaired unsecured class rejects and is not paid in full, junior claims or interests generally cannot receive property on account of that junior position.
Existing common equity is usually the clearest junior interest, but the analysis can involve multiple creditor and equity tiers.
Valuation determines whether the rule is actually implicated
Suppose enterprise value is high enough to pay the dissenting unsecured class in full. Junior equity can then receive residual value without violating that class's priority.
If enterprise value is lower, the same equity distribution can become impermissible. Priority disputes are therefore often valuation disputes in disguise.
The phrase does not eliminate every form of junior participation
The statutory language focuses on property received or retained on account of the junior claim or interest.
Complex plans can raise questions involving new capital, gifting, settlements or separate consideration. Those issues require case-specific legal analysis rather than a blanket slogan.
The rule can be tested with a simple value waterfall
Assume reorganized enterprise value is $700 million. Secured debt and priority claims consume $300 million, leaving $400 million for unsecured creditors and equity.
If unsecured claims total $500 million, that class is not being paid in full. Existing equity therefore sits below a class with a $100 million shortfall.
If old shareholders are allowed to retain $50 million of stock solely because they owned the prepetition equity, the plan can face an absolute-priority objection from the dissenting unsecured class.
Raise enterprise value to $850 million and the analysis changes: after the same $300 million of senior claims, $550 million remains—enough to pay the $500 million unsecured class in full and leave $50 million of residual value for equity.
Priority did not change. Valuation changed whether junior value existed at all.
Common mistakes
Assuming absolute priority applies to every confirmed plan It is principally a cramdown concept.
Assuming equity can never receive value Senior treatment and consent matter.
Ignoring valuation Whether a senior class is paid in full depends on what the distributed property is worth.
Example
A company has $400 million of unsecured claims and existing common equity. The unsecured class rejects a plan that gives it only $250 million of value while allowing old shareholders to retain stock solely because they were shareholders. Unless a valid exception or different legal basis applies, that junior retention can conflict with the absolute-priority requirement.
Example
A company has $400 million of unsecured claims and existing common equity. The unsecured class rejects a plan that gives it only $250 million of value while allowing old shareholders to retain stock solely because they were shareholders. Unless a valid exception or different legal basis applies, that junior retention can conflict with the absolute-priority requirement.
Professional note
Do not reduce absolute priority to 'equity always gets zero in bankruptcy.' Junior stakeholders can receive value when senior classes are paid in full, consent, gift value in legally permissible circumstances, or receive value for a reason other than retaining their junior claim or interest.
Related terms
- Recovery Rate
Recovery Rate is the value a creditor receives or is expected to receive after a default, restructuring or bankruptcy, expressed as a percentage of the creditor's allowed or affected claim.
- Reorganization Value
Reorganization Value is the value attributed to a company or its assets upon emergence from a bankruptcy reorganization, used in plan valuation, creditor recoveries and, when applicable, fresh-start accounting.
- Cramdown
Cramdown is the Chapter 11 mechanism under Bankruptcy Code Section 1129(b) that can allow a court to confirm a plan despite rejection by an impaired class, if the statutory confirmation requirements are satisfied and the plan does not discriminate unfairly and is fair and equitable with respect to the rejecting class.
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