The U.S. Bankruptcy Code contains carefully created priority rules that dictate the order in which claims are entitled to be paid. For example, secured creditors have the right to be paid from the proceeds of their collateral, and claims incurred during bankruptcy generally must be paid ahead of all other creditors. Prepetition, general unsecured creditors, although not at the very bottom of the ladder, typically cannot be paid until secured, administrative and priority creditors are paid first. As a result, it is often difficult to enlist the support of unsecured creditors during the case when there are no funds to pay them. To solve this dilemma, bankruptcy professionals have devised a number of schemes to side-step the strict bankruptcy waterfall payment rules that otherwise would control. The U.S. Court of Appeals for the Third Circuit decision in In re ICL Holding, 802 F.3d 547 (3d Cir. Del. 2015), aff’g sub nom United States v. LCI Holding (In re LCI Holding), 519 B.R. 461 (D. Del., 2014), represents one of the more creative workarounds to date.
In ICL Holding, a Section 363 sale of substantially all of the debtors’ assets was approved despite being predicated upon a settlement in which the secured lender/purchaser gifted funds to general unsecured creditors, while the claims of more senior creditors went unpaid, and further, paid certain administrative claims, while not providing for others. On its face, this settlement arguably afforded payment in violation of the priority of payment procedures established under the Bankruptcy Code. For example, the settlement appears to conflict with the “absolute priority rule,” which is the rule of “vertical equity” prohibiting payment of junior creditors until more senior creditors are paid or allocated value in full. In addition, it appears to run counter to the “horizontal equity” required under the Bankruptcy Code, which requires that creditors of the same priority receive proportionally equal distributions of estate property.
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