Chapter 11 Reorganization and the Fair and Equitable Standard: How the Absolute Priority Rule Applies to All Nonprofit Entities

Abstract

In recent years, nonprofit entities increasingly have sought bankruptcy protection. Though the Bankruptcy Code does not prevent nonprofits from reorganizing, Chapter 11 was designed for and applies best to for-profit businesses. This creates challenges for courts evaluating a nonprofit’s reorganization plan. This Article focuses on one crucial aspect of a court’s evaluation — the fair and equitable standard, a necessary, but not sufficient condition of which is satisfaction of the absolute priority rule.

The few courts addressing absolute priority claims in nonprofit reorganizations have held that the rule is categorically inapplicable to nonprofit entities except in limited circumstances. These courts overall failed to consider explicitly whether the nonprofit demonstrated that the plan otherwise satisfied the fair and equitable standard. Thereby, these courts potentially created case law that may be read to provide that a nonprofit’s plan need not allocate all going concern value to creditors until creditors are paid in full, as is required by the absolute priority rule and as is fundamental to the fair and equitable standard. This Article sets forth a theory of how the rule, by way of its history and underlying principles, applies to all nonprofit entities through the fair and equitable standard. Application of these principles will force nonprofits to propose plans that meet one of Chapter 11’s rigorous approval criteria.

Keywords: bankruptcy, absolute priority rule, nonprofit entities, charitable organizations, chapter 11, reorganization