Absolute Priority, Cramdown and Plan Confirmation

A company emerging from bankruptcy proposes a plan: secured lenders get paid in full, unsecured bondholders get 40 cents on the dollar in new stock, and existing shareholders keep 10% of the reorganized company. The bondholders vote no — they think shareholders shouldn't get anything until they themselves are paid in full. Can the company force the plan through anyway? Sometimes yes, through a court process called a cramdown, but only if the plan respects a strict rule about who has to be paid before whom.

That rule is the absolute priority rule: in a Chapter 11 reorganization, a junior class of claims (like equity) cannot receive or retain any value under the plan unless every more senior class (secured debt, then unsecured debt) is paid in full first, or that senior class consents to being treated otherwise.

How plan confirmation actually works

1. Classification. Claims and interests are grouped into classes by their legal priority — secured debt, then various tiers of unsecured debt, then preferred and common equity.
2. Voting. Each class votes on the proposed plan. A class is "impaired" if the plan doesn't pay it in full, and impaired classes get a vote; a class is deemed to accept if it gets two-thirds in dollar amount and more than half in number of voting members to say yes.
3. Cramdown, if a class votes no. If at least one impaired class votes yes, the court can still confirm the plan over a dissenting class's objection — but only if the plan is "fair and equitable" to that dissenting class, which for absolute priority means: dissenting secured creditors must be paid the value of their collateral, and dissenting unsecured creditors must be paid in full (or receive their claim's full value) before anyone junior to them gets anything at all.
4. The common workaround: negotiated deviation. In practice, senior classes often voluntarily agree to let equity or junior creditors retain a small stake anyway (sometimes justified as compensation for a "new value" contribution or to avoid delay and litigation costs), which absolute priority permits only because the senior class itself consented.

Worked example

A company in Chapter 11 has $600 million of total enterprise value to distribute. It owes $400 million to secured lenders, $350 million to unsecured bondholders, and has existing equity worth nothing on paper. The plan proposes giving equity holders 5% of the reorganized company's stock, and the unsecured bondholders' class votes to reject the plan.

1. Pay secured lenders first. $400$ of the $600$ million goes to secured lenders, paid in full: $600 - 400 = 200$ million remains for everyone junior.
2. Unsecured bondholders' claim. They are owed $350 million but only $200 million remains — under absolute priority, since this class rejected the plan, they must receive the full $200 million of remaining value (still short of their $350 million claim) before equity can receive anything.
3. Result under cramdown. Because paying equity holders even 5% would mean giving value to a junior class while the senior, dissenting unsecured class isn't paid in full, the court cannot cram down this plan as proposed — the 5% equity allocation has to be stripped out (or the unsecured class's recovery raised to the full $200 million with equity getting zero) before the plan can be confirmed over the bondholders' objection.

What this means in practice

Distressed-debt investors read a proposed reorganization plan primarily through this waterfall: who's impaired, who's voting no, and whether the proposed recoveries actually respect absolute priority, because a plan that skips it invites a cramdown fight that can add months and legal costs to a case. In real negotiations, senior creditors sometimes accept giving equity a small slice anyway — not because absolute priority doesn't apply, but because litigating a cramdown fight is expensive enough that a modest concession is cheaper than winning the legal argument.