On May 3, 1999 the United States Supreme Court issued its decision in Bank of America National Trust and Savings Association v. 203 North Lasalle Street Partnership. While expressly reserving judgment on whether the New Value Exception still exists, the Supreme Court defined the benchmark at which it clearly may not be used. This decision will likely have a substantial impact on the form of many Chapter 11 plans and may prove to be the most significant bankruptcy decision of the decade.
Section 1129(2(b)(ii) of the United States Bankruptcy code codified a version of what had developed as the “absolute priority rule.” As codified, the absolute priority rule prevents the cramdown of a plan in which the holders of equity retain any property interest by virtue of their pre-petition interests, over the objection of a dissenting class of impaired unsecured creditors.
However, many courts had held that in those instances where the equity holders inject new value into the reorganized debtor, the equity holders may retain their interest in property of the debtor to the extent that new value is added. This has come to be known as the “New Value Exception” to the absolute priority rule. The circuits had been split as to the impact of the New Value Exception upon the codified absolute priority rule. Recently the Seventh and Ninth circuits had confirmed plans in reliance upon the New Value Exception, while the Second and Fourth circuits had disapproved plans that relied upon the New Value Exception.
The Supreme Court ruled that: “Although the Debtor’s exclusive opportunity to propose a plan under section 1121(b) is not itself ‘property’ within the meaning of subsection (b)(2)(B)(ii), the respondent partnership in this case has taken advantage of this opportunity by proposing a plan under which the benefit of equity ownership may be obtained by no one but the old equity partners . . . . At the moment of the plan’s approval the Debtor’s partners necessarily enjoyed an exclusive opportunity that was in no economic sense distinguishable from the advantage of the exclusively entitled offeror or option holder. This opportunity should, first of all, be treated as an item of property in its own right.”
The Supreme Court has now decided that a plan violates the Absolute Priority Rule if it grants exclusively to prebankruptcy equity holders the opportunity to receive ownership interests in the reorganized debtor, over the objection of an impaired class.