The Overstated Absolute Priority Rule
33 Pages Posted: 22 Mar 2015
Date Written: March 20, 2015
The absolute priority rule describes the basic order of payment in bankruptcy. Secured creditors get paid first, unsecured creditors get paid next, and only then do shareholders get paid, if at all.
The rule has obtained a kind of unassailable, near scriptural status in the corporate reorganization literature.
But there is no absolute priority rule of the kind described in the literature under current law. It is not clear there ever has been such a rule. And even if there were, adopting such a rule would be inconsistent with chapter 11, or any other sensible system of reorganization.
In essence, the academic conception of the absolute priority rule in corporate reorganization is based on a world that does not exist. Reorganizing companies are dynamic things, whereas most of the literature assumes a frozen pool of assets, to which the court might oversee an orderly allocation of value.
Reorganization in reality is fundamentally inconsistent with heartfelt fondness for a strict absolute priority rule.
Keywords: Chapter 11, bankruptcy, financial distress, creditor protection, absolute priority rule
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