The absolute priority rule sets forth a hierarchical scheme for the distribution of proceeds obtained through liquidating the assets of a debtor. The scheme provides that property of an estate shall be distributed to secured creditors, then to administrative and priority unsecured creditors, then to unsecured creditors, and lastly to equity holders. Under Chapter 11, section 1129(b)(2)(B)(ii) for a dissenting class of impaired creditors, a plan is “fair and equitable” only if the allowed value of such creditors claims are paid in full, or the holder of any claim or equity that is junior to the dissenting creditors will not retain any property under the plan on account of such junior creditors claim. It must be noted that the absolute priority rule applies only to dissenting classes of creditors. If the class consents, the absolute priority rule does not apply, even with respect to the claims of a dissenting creditor in that class. In many cases, the strict application of the absolute priority rule will prevent the confirmation of an otherwise confirmable plan. This is particularly true in chapter 11 cases in which the continued participation of the credit and equity holders is vital to the reorganization. Other parties will try to use gifting as a method for confirming a plan that would otherwise violate the absolute priority rule over objecting classes of creditors. Such a plan may be essential to the debtor’s reorganization, especially if the junior creditors and equity holders are vital for the debtor’s reorganization.
“Gifting,” in the context of bankruptcy, occurs when a senior creditor voluntarily relinquishes a portion of its distribution, provided for in a plan of reorganization, in favor of junior creditors or equity holders. The “gifting doctrine” is a concept that emerged as a result of attempts by creditors and equity holders to circumvent the absolute priority rule. Senior creditors agree to “gift” a portion of their distribution to junior creditors or equity holders in order to streamline the confirmation of reorganization plans and disregard the distribution scheme required by the Bankruptcy Code. While gifting sometimes violates the absolute priority rule, recent case law suggests that there ways to “gift” which are allowable by the courts.