At long last, the United States Supreme Court finally decided an opinion putting to rest the issue of whether the "new value" corollary to the absolute priority rule exists under the Bankruptcy Code. In general, a Chapter 11 plan of reorganization cannot be confirmed over a dissenting class of creditors. A holder of a junior claim to that class cannot receive or retain any property under the plan on account of such junior claim. However, the "new value" corollary to the rule provides that if the equity owners provide new, substantial, necessary and fair infusion of capital into the reorganized debtor which enables it to reorganize, they can obtain an interest in the reorganized debtor, even though a class of creditors remains unpaid. This "new value" rule is not stated specifically in the code, and various federal circuit courts have been in conflict as to whether the new value rule exists and/or whether it applies to a given fact pattern.
In Bank of America National Trust & Saving Assn. v. 203 North LaSalle Street Partnership, decided on May 3, 1999, the United States Supreme Court reversed a previous confirmation of a plan of reorganization, approving of a new value based plan of reorganization.
In La Salle Street, the bank made a loan secured by mortgage on the debtor's interest in an office building, the value of which was less than the balance due the bank. After the debtor defaulted and the bank began a state court foreclosure, the debtor filed a voluntary petition for relief under Chapter 11 of the Bankruptcy Code. The debtor's proposed plan of reorganization provided that the equity owners in the partnership could contribute new value and remain in control of the reorganized entity.
The United States Supreme Court held that the debtor's prebankruptcy equity holders may not, over the objection of a senior class of impaired creditors, contribute new capital and receive an interest in the reorganized entity, when the opportunity is given exclusively to the old equity holders under a plan adopted without consideration of alternatives. The old equity holders are disqualified for participating in such "new value" transactions by section 1129(b)(2)(B)(ii) of the code, which, in the circumstances of this particular case, barred a junior equity interest holder's receipt of any property on account of his prior interest.
Unfortunately, the court did not decide whether the code expressly includes a new value corollary or exception. Thus, although many creditors and debtors alike were waiting for the court to finally decide the issue, it really did not do so expressly. The court found that the drafting history of the absolute priority rule was equivocal but did not convince the court that the provision did not include such a corollary. The court adopted a reading of the words "on account of" with a more common understanding that the phrase means "because of" and, therefore, injected a "causation" element into the analysis. Thus, courts will be required to determine whether the opportunity to contribute new value was "because of" their junior lien and, if so, they may be prohibited from such participation without allowing market forces to play a role in determining whether the new value was new, substantial, necessary and fair.
In essence, the court found that if there is a new value corollary, bankruptcy plans providing junior interest holders with exclusive opportunities free from competition without benefit of market valuation fall within the code's prohibition. In the subject case, the exclusiveness of the opportunity, with its protection against market scrutiny of the stated purchase price, was found to render the partnership's interest extended "on account of" the old equity position and, therefore, subject to an unpaid senior creditor's class objection. The bankruptcy court should allow for some form of market valuation to test the adequacy of the old equity's contribution and reverse the confirmation.
Mr. Ludwig is a Director in the firm's Banking and Financial Institutions, and Bankruptcy and Insolvency Departments, specializing in creditors' rights related ligitation. E-mail: mbl@kpclegal.com.