You Just Can't Give it Away

Companies in Chapter 11 may have capital structures consisting of multiple tiers of debt and equity that have competing priorities of payment vis-'-vis the company and its assets. The claims and interests of these competing stakeholders may be resolved in a Chapter 11 plan. To emerge from Chapter 11, the company must obtain approval of a plan that deals with all creditor claims and equity interests in accordance with the (sometimes complicated) rules contained in the Bankruptcy Code. In an effort to achieve an agreed-upon Chapter 11 plan, some creditors may give up (or gift) a portion of the recovery to which they would otherwise be entitled to another class of creditors or equity holders.

The proposition that a creditor can do whatever it wants with its recovery from a Chapter 11 debtor may seem to be a fundamental right. In the context of confirmation of a Chapter 11 plan, that right may not be unqualified and may, in fact, violate well-established bankruptcy principles. One such principle that applies only in the context of non-consensual confirmation of a Chapter 11 plan — or “cram-down” — is commonly referred to as the “absolute priority rule,” a pre-Bankruptcy Code maxim that established a strict hierarchy of payment among claims of differing priorities. The rule's continued vitality and application under the current statutory scheme was the subject of a notable ruling recently handed down by a Delaware district court in In re Armstrong World Industries, Inc., 320 B.R. 523 (D. Del. 2005).