Absolute Priority Rule

The standard priority order in bankruptcy is: (1) Super-priority claims (DIP financing, administrative expenses), (2) Secured creditors (to the extent of their collateral value), (3) Priority unsecured claims (employee wages up to a cap, certain tax claims), (4) General unsecured claims (bonds, trade payables, deficiency claims from under-secured lenders), (5) Subordinated claims (contractually subordinated debt), (6) Preferred equity, (7) Common equity. Each class must be paid 100 cents on the dollar before the next class receives anything.

The class that straddles the breakpoint — partially paid but not fully satisfied — is the fulcrum security. This class is the most important in any restructuring negotiation because it converts the 'shortfall' into ownership of the reorganized company. For example, if enterprise value covers all secured debt but only 60% of unsecured bonds, the unsecured bonds are the fulcrum security. They will likely receive new equity in the reorganized entity, while old equity is cancelled. Identifying the fulcrum security is the core skill tested in restructuring interviews.

In practice, strict APR is often negotiated around. Gifting: senior creditors voluntarily share value with junior classes to secure their plan votes and avoid litigation delays. New value exception: equity holders may retain ownership by contributing new capital. 363 sales: when assets are sold rather than reorganized, the APR governs distribution of sale proceeds. Cramdown requires the plan to be 'fair and equitable,' which is defined by adherence to APR — the court will not confirm a cramdown plan that violates absolute priority.