The New Value Exception to the Absolute Priority Rule in Chapter 11 Cases

ABSOLUTE PRIORITY RULE – 11 U.S.C. 1129(b)(2)(B)(ii) The absolute priority rule generally requires that all unsecured creditors be paid in full before equity security holders are allowed to retain any ownership interest in the debtor. SeeLiberty Nat'l Enters. v. Ambank La Mesa Ltd. P'ship (In re Ambanc La Mesa Ltd. P'ship), 115 F.3d 650, 654 (9th Cir. 1997); In re Bonner Mall P'ship, 2 F.3d 899, 906-07 (9th Cir. 1993). The Absolute Priority Rule is incorporated in § 1129(b)(2)(B) of the Bankruptcy Code, which requires that: "… (i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (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."

There is an exception to this rule, seeBonner Mall,2 F.3d at 906-07, known as the "new value exception." See also In re Shin, 306 B.R. 397, 404 n. 17 (Bankr. D.C. 2004) (relying on West’s Bankruptcy Law Letter (October 2002) “to apply the absolute priority rule to an individual debtor’s wholly exempt property stands the absolute priority rule on its head – affording to unsecured creditors an artificial ‘priority’ in exempt property that unsecured creditors simply do not otherwise possess”); In re Brotby, 303 B.R. 177, 195-96 (9th Cir. BAP 2003) (a contribution from an exempt pension would constitute new value). And see Colliers on Bankruptcy ¶ 1129.03[4][c].

The new value exception to the absolute priority rule allows junior interest holders (e.g. shareholders of a corporate debtor or here the debtor himself) to receive a distribution of property under a plan if they offer "value" to the reorganized debtor that is: (1) new; (2) substantial; (3) money or money's worth; (4) necessary for a successful reorganization; and (5) reasonably equivalent to the value or interest received. Id.at 909.

Whether the absolute priority rule applies in individual cases will soon be adjudicated in David Zachary v. California Bank & Trust in which the Chapter 11 debtors appealed the bankruptcy court's order sustaining the objection of an unsecured creditor to their plan of reorganization. [2:11-bk-42866]