Alerts

A Secured Creditor May Carve Out A Portion Of Its Collateral For The Exclusive Benefit Of Unsecured Creditors Without Violating The Absolute Priority Rule

July 17, 2006

The United States Bankruptcy Court for the District of Delaware (the "Bankruptcy Court") recently held that the Third Circuit's decision in In re Armstrong World Indus., Inc., 432 F.3d 507 (3d. Cir. 2005) does not prohibit secured creditors from carving out a portion of their collateral for the exclusive benefit of a lower priority class.  In Armstrong, the Third Circuit had affirmed the district court's reversal of an order confirming Armstrong's reorganization plan, which provided under certain circumstances for one class of unsecured creditors to receive and automatically transfer new warrants to a holder of equity interests without first providing for full recovery to another (pari passu) class of unsecured creditors that rejected the plan.  The Third Circuit held that the plan's distribution scheme violated the absolute priority rule set forth in 11 U.S.C. § 1129(b)(2), and rejected the notion that creditors are generally free to do whatever they wish with the cash or other property they receive from a debtor.