Codifying Bankruptcy Law's Fastpass: New Value and the Absolute Priority Rule

David P. Hamm Jr, Mississippi College School of Law

Abstract

The notion behind the absolute priority rule is not novel to any of us. We all learned at a very young age that if someone is in front of you in line—they get served first. This basic notion of fairness affects our lives in several everyday contexts—including bankruptcy. The people in the “bankruptcy” line are the holders of interests in the debtor. If the interest held by party A is “senior” to that of party B, then party A is in front of party B in line. The absolute priority rule essentially provides that the party A must be paid in full before party B is entitled to anything.

While the absolute priority rule satisfies our basic notion of fairness on the one hand, other considerations have led to a great deal of effort to get around its wooden application. One such consideration is the effect of a fresh contribution of money upon the application of the rule. A wooden application precludes party B—a junior interest holder—from receiving anything before payment in full to party A—the senior interest holder—despite party B making a “fresh contribution.” Such a wooden application leads to inequitable results.

The “new value” exception, or corollary, addresses such inequities by giving party B a FASTPASS. The FASTPASS allows party B to move up in the “bankruptcy” line by allowing party B to retain an equity interest in the bankrupt entity upon a fresh contribution in money or money’s worth. Despite the soundness of the new value exception, its viability is far from certain.

This article argues that the new value exception, or corollary, should be included in the statutory text of §1129(b)(2)(B)(ii) of the Bankruptcy Code of 1978. The inclusion of the new value exception in the text of the Code resolves the uncertainty surrounding its viability and precludes a wooden and inequitable application of the absolute priority rule.