Absolute Priority: Definition, Application, and Legal Implications

Absolute priority, commonly known as the “liquidation preference,” is a principle dictating the order of payment among creditors and shareholders in the event of corporate liquidation or estate settlement. It establishes a hierarchy for distributing assets to ensure that creditors are prioritized over shareholders.

In corporate bankruptcies, absolute priority is governed by Section 1129(b)(2) of the U.S. Bankruptcy Code. A liquidation plan must adhere to the principle of being “fair and equitable” to creditors. Senior creditors, such as secured creditors, are entitled to full repayment before junior creditors, including unsecured creditors, receive any funds. Equity holders, such as shareholders, are last in line to receive payment, and they only receive distributions if assets remain after satisfying all creditor claims.

In estate settlements, the absolute priority rule ensures that outstanding debts of the deceased are paid before distributing assets to beneficiaries. If the estate lacks sufficient resources to cover debts, assets may be liquidated to satisfy creditors’ claims. Similar to corporate bankruptcies, secured creditors hold precedence over unsecured creditors, and equity holders receive distributions, if any, after satisfying creditor claims.

Absolute priority is essential for maintaining fairness and equity in bankruptcy proceedings and estate settlements. By establishing a clear payment hierarchy, it ensures that creditors are appropriately compensated for their claims before shareholders receive any distributions. This principle promotes transparency, predictability, and adherence to legal obligations in financial transactions and legal proceedings.

In most cases, absolute priority governs the distribution of assets in bankruptcy proceedings. However, there may be exceptions or challenges raised by stakeholders, which could lead to deviations from the standard hierarchy of payment. Courts ultimately determine the application of absolute priority based on the specific circumstances of each case.

Shareholders typically receive distributions only after all creditor claims have been satisfied. If there are remaining assets after paying creditors, shareholders may receive distributions proportional to their ownership interests. However, in cases where creditor claims exhaust all available assets, shareholders may not receive any distributions.

Secured creditors, such as lenders with collateralized loans, are accorded priority in bankruptcy proceedings. They have a legal right to claim assets securing their loans before unsecured creditors or equity holders receive any distributions. This priority status helps protect secured creditors’ interests and enhances their chances of recovering debts owed to them.

While absolute priority is a fundamental principle in bankruptcy law, there may be circumstances where stakeholders negotiate modifications or waivers to accommodate restructuring plans or settlement agreements. However, any deviations from absolute priority must be approved by the court and deemed fair and equitable to all affected parties involved in the proceedings.