The 2nd U.S. Circuit Court of Appeals recently held that the “gifting” of recoveries from senior creditors to either junior creditors or shareholders, over the objection of an intermediate creditor class, is impermissible under Chapter 11 of the Bankruptcy Code. “Gifting” provides a mechanism whereby parties may settle disputes and senior creditors may obtain support for a plan of reorganization from junior claimholders or interest-holders via a payment from the senior creditors’ recovery.
Gifting has become a controversial practice — not surprisingly — in light of the Bankruptcy Code’s absolute priority rule, which aims to protect intermediate creditors from the potential collusion of senior creditors and junior claimholders or interest-holders. Generally, the absolute priority rule establishes a “waterfall” scheme of payments to all classes of creditors and equity holders: It precludes payment to a junior class of creditors or equity holders until all senior classes have been paid in full on their claims. In its Feb. 7 opinion in Dish Network Corp. v. DBSD North America Inc. ( In re DBSD North America Inc. ), the 2nd Circuit held that gifting is impermissible because it violates the absolute priority rule.
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