Creditors, who have waited patiently (and with great anticipation) for the United States Supreme Court's decision on the "new value exception" to the absolute priority rule in the North LaSalle Street case, were rewarded (somewhat) by a ruling that struck down the efforts of the partners of a debtor in a single asset real estate case to control the reorganization and plan process by asserting an exclusive right to contribute new value to the debtor in exchange for an equity ownership interest in the reorganized debtor. Absent a determination of the market value of equity being retained by the partners, the Debtor's plan failed to satisfy the absolute priority rule.
In Bank of America National Trust and Savings Association v. 203 North LaSalle Street Partnership (May 3, 1999), the Supreme Court ruled that a debtor's pre-bankruptcy equity holders could not maintain an exclusive right to contribute new capital over the objection of a senior class of creditors (who were not paid in full on their claims). Under Section 1129(b)(2)(B)(ii), which describes the absolute priority rule, a plan cannot permit a junior interest holder to receive or retain any property on account of his/her pre-bankruptcy interest unless all senior classes of creditors have been paid in full on their allowed claims.
In North LaSalle Street, the debtor's partners agreed to contribute a stream of cash with a present value of $4.1 million in exchange for 100% of the equity of the reorganized debtor, but the Supreme Court found the plan was defective since it failed to provide any other parties with the opportunity to compete for the equity interest. The Supreme Court simply found that the debtor's partners took unfair advantage of the exclusive period to propose a plan that benefited the partners at the expense of other creditors. The absence of competition for the equity (also viewed as a lack of a market testing of the equity) caused the debtor's plan to fall short of the requirements of Section 1129(b)(2)(B)(ii).
However, the Supreme Court's ruling provided no clear resolution of whether a "new value exception" still exists. It merely held that the debtor's plan violated the absolute priority rule by providing the partners with an exclusive right on account of their pre-bankruptcy equity interest to the detriment of senior classes of creditors. The Supreme Court did not rule out the possibility of a "cramdown" of senior creditors if the new value satisfied some form of market test. Currently, the Seventh and Ninth Circuits have recognized the "new value exception" but the Second and Fourth Circuits have specifically disallowed the exception in single-asset cases.
The North LaSalle Street case does not detail the factors that would satisfy the Court's market value concerns, but it does provide secured creditors with enhanced power to block confirmation of debtor's plan. It may also burden all creditors (secured or unsecured) with the obligation of greater participation in the reorganization process to ensure market value contribution by a debtor's partners.