By Bruce Grohsgal (Delaware Law School Widener University)
Bankruptcy’s absolute priority rule arose to prevent insiders from using their control over a distressed enterprise to obtain a greater share of estate value than parties who had a higher distributional priority but were not “in on the deal.” The Supreme Court again considered this issue in Jevic in 2017, when it held that a chapter 11 case-ending settlement called a “structured dismissal” must comply with the same absolute priority rule that applies to the similarly case-ending confirmation of a chapter 11 cramdown plan.
The Jevic Court explicitly left open, though, the extent to which a pre-plan settlement or court-ordered “first-day” distribution in chapter 11 may deviate from the absolute priority rule. It suggested only that a court approving these pre-plan distributions must show some respect for – or a “proper solicitude” to – the statutory distributional priorities.
I propose in this paper that, for a proposed pre-plan, priority-skipping settlement with an insider, secured lender or other party who exercises some control over the debtor, the absolute priority rule is sufficiently respected when a bankruptcy court subjects to an auction the claim proposed to be settled.
I further contend that a market test for a “first-day” distribution to a critical vendor, employee or other creditor that is challenged as priority-skipping will be limited to whether the debtor sought and failed to obtain in the market the same good, service, or credit from an alternative supplier on the same or better terms than those proposed in the first-day motion.