What is an Absolute Priority
Absolute priority is a rule that stipulates the order of payment in the event of corporate liquidation among creditors and shareholders. The absolute priority rule is used in corporate bankruptcies to decide what portion of payment will be received by which participants. Debts to creditors will be paid first and shareholders divide what remains. Absolute priority also applies to individuals, who face liquidation of their assets to settle claims. Secured always takes precedence over unsecured claims.
Regarding the estate of a deceased person, the absolute priority rule will ensure payment of outstanding debts before the distribution to beneficiaries.
Also known as "liquidation preference."
BREAKING DOWN Absolute Priority
Under Section 1129(b)(2) of the U.S. Bankruptcy Code, a liquidation plan must be "fair and equitable" to creditors. Setting aside certain provisions to handle back wages and benefits and tax claims, absolute priority specifies the pecking order to carry out the directive for fair and equitable treatment. Senior creditors are paid in full before junior creditors unless the senior creditors consent to subordinate some of their claims to unsecured creditors. After the claims of junior creditors are satisfied, any remaining funds or assets are handed over to equity holders.
In estate cases, if the resources of the estate are insufficient to pay off the debts, assets will need to be liquidated to handle the obligations.
Courts Intervene to Affirm Absolute Priority
In some litigated cases, courts have had to affirm the absolute priority rule. Such cases involved cooperation between certain creditors and debtors who sought to exclude sets of other claimants from liquidation proceeds. The courts hearing these cases deemed that secured creditors must be paid first, then unsecured creditors, and finally equity holders if any assets remain. Unless extraordinary circumstances exist or if secured creditors consent otherwise, no prearrangements are allowed to break this sequence.