What is the Absolute Priority Rule?

The absolute priority rule, also known as "liquidation preference", is a rule that specifies the order in which creditors and shareholders stand to be compensated in case the company undergoes liquidation. Absolute priority rules typically prioritize a creditor's claim over a shareholders claim. Furthermore, secured claims are invariably prioritized over unsecured claims.

How Does the Absolute Priority Rule Work?

Section 1129(b)(2) of the U.S. Bankruptcy Code protects creditors interest by making it obligatory for liquidation plans to be non-partisan and non-discriminatory towards creditors. The absolute priority rule draws up the following hierarchy :

• The senior class of creditors is paid first and in full.
• Claims of junior creditors are fulfilled.
• Claims of equity holders are serviced.

There are also rare situations where secured creditors have consented to permuting this hierarchy. There also exists a common law exception to the absolute priority rule. It is known as the New Value Exception, and is variously referred to as the New Value Doctrine and the New Value Corollary. 

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