Wilmington and Philadelphia partner Andy Kassner and associate Joe Argentina co-wrote an article for The Legal Intelligencer titled, “Absolute Priority Rule Absolutely Applies to Insiders.”

The article discusses the recent ruling in In re Castleton Plaza, LP, in which the Seventh Circuit Court of Appeals was tasked with deciding whether the wife of a debtor’s equity owner – an insider – could purchase the new equity (and control of the company) without competitive bidding over the objection of the creditor that held 99 percent of the debt of the debtor.

The Seventh Circuit noted that bankruptcy courts have disagreed on whether competition is essential when a plan of reorganization gives an insider an option to purchase equity in exchange for new value.  The bankruptcy court in this case concluded that competition was not needed because the absolute priority rule prevents benefits from flowing to “the holder of any claim” junior to impaired creditor’s claim. 

The Seventh Circuit disagreed, however, and stated:  “A new value plan bestowing equity on an investor’s spouse can be just as effective at evading the absolute priority rule as a new-value plan bestowing equity on the original investor.” Their reasoning was that value to the owner’s spouse constituted value to the owner.

Andy and Joe said the case reminded them of the old saying, “If it seems too good to be true, it probably is.” 

They say that while non-bankruptcy practitioners (and many lenders’ counsel) often advise their clients that bankruptcy courts favor reorganization and provide the debtor every opportunity to restructure its affairs, “this decision demonstrates [that] if such an outcome is to occur without the assent of creditors, it should be the result of a competitive process that maximizes value.”

Source: The Legal Intelligencer