Legal Definitions - fair-and-equitable requirement

The fair-and-equitable requirement is a standard used in U.S. bankruptcy law, specifically within Chapter 11 reorganization cases. It comes into play when a company or individual proposes a reorganization plan that some creditors or owners (referred to as "classes of interests") do not agree to. When a bankruptcy court approves such a plan despite the objections of certain parties, it's often called a "cramdown" plan.

For a cramdown plan to be approved, the court must ensure that it is "fair and equitable" to all classes of creditors and owners who have not accepted it. This means the plan must adequately provide for these non-consenting parties, typically by adhering to principles like the "absolute priority rule." This rule generally dictates that no junior class of creditors or owners can receive any payment or property under the plan until all more senior classes are paid in full, unless the senior classes explicitly agree to a different arrangement.

In addition to being fair and equitable, a cramdown plan must also be accepted by at least one class of creditors whose rights are "impaired" (meaning their legal, equitable, or contractual rights are altered by the plan), and it must not unfairly discriminate among other impaired classes that have not accepted the plan.

Here are some examples illustrating the fair-and-equitable requirement:

• Corporate Reorganization: "Tech Innovations Inc." files for Chapter 11 bankruptcy. Its proposed reorganization plan offers to pay its senior secured lenders 75% of their outstanding debt and its unsecured bondholders 15% of their claims. However, the plan also allows the current shareholders (who are the most junior class of interest) to retain a 10% ownership stake in the reorganized company. If the senior secured lenders or unsecured bondholders object to this plan, the bankruptcy court would apply the fair-and-equitable requirement. The court would likely find the plan *not* fair and equitable because the shareholders are retaining value while more senior classes of creditors are not being paid in full and have not consented to this arrangement. The absolute priority rule would be violated.

• Real Estate Development: A real estate developer, "Urban Sprawl LLC," files for Chapter 11. The developer's plan proposes to pay its primary bank lender (whose loan is secured by the property) in full over a longer period. However, it offers its construction contractors (who hold valid mechanic's liens, also a secured class) only 60 cents on the dollar for their claims. Simultaneously, the plan allows the original owners of Urban Sprawl LLC to retain their full equity interest in the reorganized company. If the construction contractors object to receiving only a partial payment while the owners (a junior equity class) retain their interest, the court would scrutinize the plan under the fair-and-equitable requirement. The court would likely reject the plan as not fair and equitable because a junior class (owners) is receiving value while a senior secured class (contractors) is not being paid in full and has not agreed to this treatment.

• Small Business Bankruptcy: "Main Street Eatery," a restaurant chain, enters Chapter 11. Its proposed plan offers to pay its primary food suppliers (unsecured creditors) 20% of their outstanding invoices and its utility companies (also unsecured creditors) 50% of their outstanding bills. The plan also includes a provision for the original owner to retain full ownership and continue operating the business. If the food suppliers object to receiving a significantly lower percentage than the utility companies, and the owner retains equity while neither class is paid in full, the court would evaluate the plan under the fair-and-equitable requirement. The court might find the plan unfairly discriminatory between the two unsecured classes, or not fair and equitable if the owner retains equity without the full consent of the unpaid creditors.