Business Law Newsletter
The LaSalle Decision and Limiting the Application of the New Value Exception
In the 1999 case, Bank of America National Trust and Savings Association (LaSalle), the U.S. Supreme Court issued a landmark ruling regarding the effect and application of the “new value exception” to the “absolute priority rule.”
The new value exception has traditionally permitted junior creditors to receive value from a debtor in a Chapter 11 business reorganization plan contrary to the mandates of the Absolute Priority Rule. This has generally been the result where the junior creditors have contributed new money toward the debtor’s reorganized business.
The Facts of the LaSalle Case
In LaSalle, the bank had made a loan to the debtor, a real estate partnership. The debtor defaulted on the loan and filed for Chapter 11 bankruptcy to prevent the bank from selling the debtor’s interest in a Chicago office building (under the automatic stay). The debtor’s plan for reorganization proposed that its former shareholders would contribute new money toward the reorganization, in exchange for ownership in the reorganized business. Under the plan, the old shareholders were the only ones who could contribute to the reorganized business.
The Open Market Auction Requirement
The Supreme Court held that, if the new value exception exists at all, it does not apply to allow junior equity holders to receive value from a debtor’s reorganization plan (without the consent of senior creditors), if creditors, other than the equity holders are not permitted to contribute to the debtor’s new reorganized business. Rather, Chapter 11 debtors must put their new reorganized business up for auction on the open market in order for a bankruptcy court to confirm a reorganization plan that allows equity holders to receive any value.
LaSalle Limited to Violations of the Absolute Priority Rule
Despite the LaSalle ban on equity holder exclusivity, the ruling is limited to those cases that violate the absolute priority rule, which requires senior classes of creditors to be paid in full ahead of junior classes of creditors, in order for a bankruptcy court to confirm a Chapter 11 business reorganization plan. Under the absolute priority rule, if a senior class of creditors does not accept a debtor’s plan, the court will nonetheless confirm the plan if the senior class of creditors is paid in full ahead of all other creditors. There is no violation of the Absolute Priority Rule where:
- The plan is approved by all creditors classes
- The plan calls for the debtor’s assets to be sold to a third party, rather than to former equity holders
Succinctly, LaSalle will not apply to prevent the exclusive contributions of equity holders toward a debtor’s reorganized business in exchange for ownership of that business, if there has been no violation of the absolute priority rule.
© 2019 NextClient.com, Inc. All rights reserved.