Bankruptcy issue to be resolved by court Absolute priority gives creditors right to veto reorganization plans; Supreme Court


WASHINGTON -- The Supreme Court agreed yesterday to settle one of the most hotly debated issues in bankruptcy: the power of creditors with high-priority claims to veto company reorganization plans that let shareholders retain their ownership by putting new capital into the firm.

Lower federal courts are split on whether the "absolute priority" rule that benefits creditors should always govern the reorganization of bankrupt firms.

Some courts recognize an exception that allows those with an ownership interest to retain that interest by supplying new funds -- though not enough to ensure that senior creditors are paid in full. The justices said they would decide whether that exception still exists, in the wake of Congress' 1978 decision to write the "absolute priority" rule into law.

Four years ago, the Supreme Court stepped in to resolve that question. But that case was settled out of court before a decision could be made. Since then, the conflict among lower courts on the issue has deepened. Academics are also split; two authors of a leading bankruptcy textbook themselves disagree.

Bank of America National Trust and Savings Association, which is facing the prospect of recovering only 16 percent of a $38 million debt from a failed Chicago real estate partnership, objects to the reorganization plan and contends that its veto should block the reorganization. Lower courts have rejected that view.

The case involves a partnership that owns 15 floors of a skyscraper in the downtown Chicago business district -- 203 North LaSalle Street Partnership. When the partnership failed to pay its mortgage to Bank of America, the bank sought to foreclose, and the partnership filed for bankruptcy.

Ex-partners added capital

Its reorganization plan allowed the former partners to put up new capital -- about $4.1 million -- to help assure the reorganized company's survival. The partners were allowed to retain their ownership interest, though they ranked lower in priority to Bank of America's claim. Bank of America is the partnership's largest creditor.

Ruling expected in 1999

Without the exception to the absolute priority rule, the partners could not have kept their interest unless Bank of America were assured that it would be paid in full.

A Supreme Court ruling on the issue is expected next year.

Pub Date: 5/05/98

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