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The Absolute Priority Rule

By Daniel A. Lowenthal

Debtors in bankruptcy cases have long sought to make distributions to old equity without running afoul of the absolute priority rule. Time and again, debtors' efforts to leave old equity with value in a reorganized entity have been challenged in the appellate courts, and often in the Supreme Court.

A proposed distribution to old equity in the complex Armstrong World Industries (AWI) case was struck down recently by the U.S. Court of Appeals for the Third Circuit Court. In re Armstrong World Indus., Inc., 432 F.3d 507 (3rd Cir. 2005). The Third Circuit ruled that the receipt by old equity of a distribution of warrants that, pursuant to the terms of the reorganization plan, were to be transferred to, but waived by, asbestos claimants violated the absolute priority rule since the unsecured creditors, whose claims were impaired, had objected to the plan. The Third Circuit's decision sets forth a cogent analysis of the absolute priority rule in the context of the facts in AWI.

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