Meaning
Exceptions to the absolute priority rule allow existing owners to retain equity if they provide fresh capital. The new value corollary requires that this contribution be new and substantial while also being necessary for the reorganization. It permits founders to maintain a stake in the business even if senior creditors are not paid in full, provided the value of the stake is equivalent to the new investment.
This principle stops applying if the creditors reject the contribution or the court finds the investment insufficient.
Capital Contribution
Owners must put up real money or tangible assets rather than promise future labor or services. This new value corollary ensures that the reorganization is supported by an actual influx of liquidity. The investment must be paid in cash or its equivalent at the time the plan is confirmed.
Equity Retention
Keeping a piece of the company after a bankruptcy filing is usually impossible for old shareholders. By utilizing this exception, founders can stay involved and potentially benefit from the future success of the firm. The amount of equity they keep must be strictly proportional to the amount of money they contribute.
Priority Exception
Creditors often challenge these attempts to bypass the normal order of distribution. They argue that any value in the company should belong to the lenders until their debts are satisfied. The court must decide if the new investment is the best deal available for the estate.
