Absolute Priority Rule

The Absolute Priority Rule is a Chapter 11 bankrupty rule that provides that senior crediors must be fully paid before any junior creditors and stockholders receive any payments.

Reference Desk

11 U. S. C. § 1129(b)(2)(B)(ii)

the 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, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section.
Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1998)

As the Court of Appeals stated, the absolute priority rule “provides that a dissenting class of unsecured creditors must be provided for in full before any junior class can receive or retain any property [under a reorganization] plan.” 794 F. 2d, at 401. The rule had its genesis in judicial construction of the undefined requirement of the early bankruptcy statute that reorganization plans be “fair and equitable.” See Northern Pacific R. Co. v. Boyd, 228 U. S. 482, 504-505 (1913); Louisville Trust Co. v. Louisville, N. A. & C. R. Co., 174 U. S. 674, 684 (1899). The rule has since gained express statutory force, and was incorporated into Chapter 11 of the Bankruptcy Code adopted in 1978. See 11 U. S. C. § 1129(b)(2)(B)(ii) (1982 ed., Supp. IV). Under current law, no Chapter 11 reorganization plan can be confirmed over the creditors’ legitimate objections (absent certain conditions not relevant here) if it fails to comply with the absolute priority rule.

There is little doubt that a reorganization plan in which respondents retain an equity interest in the farm is contrary to the absolute priority rule.[2] The Court of Appeals did not 203*203 suggest otherwise in ruling for respondents, but found that such a plan could be confirmed over petitioners’ objections because of an “exception” or “modification” to the absolute priority rule recognized in this Court’s cases.

The Court of Appeals relied on the following dicta in Case v. Los Angeles Lumber Products Co., supra, at 121-122:

“It is, of course, clear that there are circumstances under which stockholders may participate in a plan of reorganization of an insolvent debtor. . . .

“[W]e believe that to accord `the creditor of his full right of priority against the corporate assets’ where the debtor is insolvent, the stockholder’s participation must be based on a contribution in money or money’s worth, reasonably equivalent in view of all the circumstances to the participation of the stockholder.”

The Court of Appeals found this language applicable to this case, concluding that respondents’ future contributions of “labor, experience, and expertise” in running the farm — because they have “value” and are “measurable” — are “money or money’s worth” within the meaning of Los Angeles Lumber. 794 F. 2d, at 402. We disagree.[3]

204*204 Los Angeles Lumber itself rejected an analogous proposition, finding that the promise of the existing shareholders to pledge their “financial standing and influence in the community” and their “continuity of management” to the reorganized enterprise was “[in]adequate consideration” that could not possibly be deemed “money’s worth.” 308 U. S., at 122. No doubt, the efforts promised by the Los Angeles Lumber equity holders — like those of respondents — had “value” and would have been of some benefit to any reorganized enterprise. But ultimately, as the Court said in Los Angeles Lumber, “[t]hey reflect merely vague hopes or possibilities.” Id., at 122-123. The same is true of respondents’ pledge of future labor and management skills.

Viewed from the time of approval of the plan, respondents’ promise of future services is intangible, inalienable, and, in all likelihood, unenforceable. It “has no place in the asset column of the balance sheet of the new [entity].” Los Angeles Lumber, 308 U. S., at 122-123. Unlike “money or money’s worth,” a promise of future services cannot be exchanged in any market for something of value to the creditors today. In fact, no decision of this Court or any Court of Appeals, other than the decision below, has ever found a promise to contribute future labor, management, or expertise sufficient to qualify for the Los Angeles Lumberexception to the absolute priority rule.[4] In short, there is no 205*205 way to distinguish between the promises respondents proffer here and those of the shareholders in Los Angeles Lumber; neither is an adequate contribution to escape the absolute priority rule.

Respondents suggest that, even if their proposed contributions to the reorganized farm do not fit within the Los Angeles Lumber dicta, they do satisfy some broader exception to the absolute priority rule. Brief for Respondents 23-24. But no such broader exception exists. Even if Congress meant to retain the Los Angeles Lumber exception to the absolute priority rule when it codified the rule in Chapter 11 — a proposition that can be debated, see n. 3, supra — it is clear that Congress had no intention to expand that exception any further. When considering adoption of the current Code, Congress received a proposal by the Bankruptcy Commission to modify the absolute priority rule to permit equity holders to participate in a reorganized enterprise based on their contribution of “continued management . . . essential to the business” or other participation beyond “money or money’s worth.” See H. R. Doc. No. 93-137, pt. 1, pp. 258-259 (1973). This proposal — quite similar to the Court of Appeals’ holding in this case — prompted adverse reactions from numerous sources.[5] Congress ultimately rejected the proposed liberalization of 206*206 the absolute priority rule and adopted the codification of the rule now found in 11 U. S. C. § 1129(b)(2)(B)(ii) (1982 ed. and Supp. IV). “This [section] codifies the absolute priority rule from the dissenting class on down.” See H. R. Rep. No. 95-595, p. 413 (1977). We think the statutory language and the legislative history of § 1129(b) clearly bar any expansion of any exception to the absolute priority rule beyond that recognized in our cases at the time Congress enacted the 1978 Bankruptcy Code.

In sum, we find no support in the Code or our previous decisions for the Court of Appeals’ application of the absolute priority rule in this case. We conclude that the rule applies here, and respondents’ promise of future labor warrants no exception to its operation.

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