Question

2. Provide a brief explanation of the “Absolute Priority Rule” and its significance designing a restructuring plan for a company in financial distress.

Answer 1

2. In the event of the liquidation of the company, the Absolute Priority Rule states which participant will receive how much money. Between the shareholders and creditors, the creditors have priority over the assets of the company. After a company files for bankruptcy, this rule states the shareholders will be paid only afters settling the dues of the creditors.

In case of creditors too, the secured creditors gets priority in claims over the unsecured ones.

It designs a restructuring plan that is fair and just to all. This rule sets up a pecking order where the senior claims of creditors are settled before junior claims , the creditors are settled before the shareholders. The shareholders are paid off, with what is left over. The restructuring plan also prohibits paying a class of creditors more than what they owe.

Unless extraordinary circumstances exist or if secured creditors consent otherwise, no prearrangements are allowed to break this sequence.