Quick answer: The absolute priority rule lives in 11 U.S.C. Section 1129(b)(2)(B)(ii). In a Chapter 11 cramdown over a dissenting impaired unsecured class, no junior class - including equity owners - may keep any property under the plan unless that senior class is paid in full. It is the rule that can wipe out old ownership. It applies only in cramdown, has a narrow "new value" exception, and does not apply in Subchapter V.
What the Rule Actually Says
The absolute priority rule is one half of the "fair and equitable" standard that a plan must meet to be crammed down over a dissenting impaired unsecured class. Section 1129(b)(2)(B) gives two ways to be fair and equitable to such a class:
Either (i) the class receives property of a present value equal to the allowed amount of its claims (paid in full), or (ii) the holder of any claim or interest junior to that class will not receive or retain any property under the plan on account of that junior claim or interest.
Clause (ii) is the absolute priority rule. The logic is a strict waterfall: value flows down the priority ladder, and a junior class cannot jump ahead of a senior class that is not being paid in full. Because equity sits at the bottom of the ladder, the rule's most common real-world effect is to strip old owners of their interest when unsecured creditors above them are not paid in full and have not consented.
When the Rule Bites - Only in Cramdown
The absolute priority rule is not a general confirmation requirement. It is part of the cramdown standard in Section 1129(b), which applies only when a plan cannot satisfy Section 1129(a)(8) because an impaired class has rejected it.
| Path to confirmation | Does the rule apply? |
|---|---|
| Consensual - every impaired class accepts (1129(a)) | No. The rule never comes into play. |
| Cramdown over a dissenting impaired unsecured class (1129(b)) | Yes. The plan must satisfy the absolute priority rule as to that class. |
This is why consent is so valuable to old equity. If the owners can persuade the impaired unsecured class to accept the plan - often by offering a better recovery - confirmation proceeds under 1129(a) and the absolute priority rule never applies. The rule is the stick that drives the negotiation; consent is the way around it.
The New Value Exception
Courts have long recognized a corollary that lets old equity retain an interest despite the absolute priority rule: the new value exception (sometimes called the new value corollary). Old equity may keep a stake if it contributes new capital that meets all of these tests:
- New - genuinely new money or money's worth, not a recycling of existing interests.
- Substantial - meaningful in relation to the value retained, not token.
- Money or money's worth - cash or its equivalent, not a promise of future services or "sweat equity."
- Necessary - needed for a successful reorganization.
- Reasonably equivalent - proportionate to the value or interest the equity holder retains.
The exception is narrow and contested. Where old equity proposes to retain ownership through new value, the opportunity to participate generally must be tested by the market - through competing plans or an auction - rather than handed to the owners on an exclusive basis. A new-value plan that gives old equity an exclusive, unmarketed right to buy back the company invites serious objection.
The Individual Chapter 11 Debate
Whether the absolute priority rule applies to individual Chapter 11 debtors is genuinely unsettled. BAPCPA amended Section 1129(b)(2)(B)(ii) to add that, in a case where the debtor is an individual, the debtor may retain property included in the estate under Section 1115 - which sweeps in the individual debtor's post-petition earnings and acquired property. Courts read that amendment two ways:
| View | Reading |
|---|---|
| Broad view | The amendment abolishes the absolute priority rule for individual debtors entirely - an individual may retain pre-petition property too. |
| Narrow view | The amendment carves out only Section 1115 property (post-petition earnings and acquisitions); the absolute priority rule still applies to the individual's pre-petition property. |
The split has not been resolved uniformly, so the answer for an individual Chapter 11 debtor depends on the controlling authority in the district. For small business owners, this debate is one reason Subchapter V - which removes the absolute priority rule altogether - is often the more attractive path.
Subchapter V Removes the Rule
The single most consequential difference between a traditional Chapter 11 cramdown and a Subchapter V cramdown is the absolute priority rule. Subchapter V does not apply it. Under Section 1191(b), a small business debtor can confirm a plan over creditor objection and keep ownership without paying unsecured creditors in full, as long as the plan commits the debtor's projected disposable income for three to five years and is otherwise fair and equitable.
For the owner of a viable small business, that difference is decisive: in traditional Chapter 11 the absolute priority rule can force the owner to either pay unsecured creditors in full or surrender the company; in Subchapter V the owner keeps the business and pays disposable income over the commitment period instead.