Owners of Chapter 11 bankruptcy debtors have long devised schemes to try to hold on to their ownership interests while stiffing the debtors’ creditors. In the past, owners attempted to do this by proposing reorganization plans that paid creditors only a portion of what they are owed while selling all of the equity in the reorganized debtor to the owner for a nominal new investment.

In its 1999 decision, Bank of America National Trust & Savings Ass’n v. 203 North LaSalle Street Partnership, the U.S. Supreme Court rebuffed this strategy by ruling that such reorganization plans must allow other potential investors to compete with the owner to obtain the equity in the reorganized debtor by making higher bids than the owner.

After the Supreme Court’s ruling, owners tried to evade the required competitive process by arranging for other persons closely related to them (“insiders”) to make the nominal new investment to obtain the equity in the reorganized debtor.

But in Castleton Plaza, LP, the U.S. Court of Appeals for the Seventh Circuit recently ruled that the owners cannot evade the required competitive process so easily. Whether reorganization plans propose to sell the equity in the reorganized debtor to the owner or to persons closely related to the owner, creditors may require that they (and other potential investors) be allowed to compete for the equity through higher bids. Moreover, creditors may compete for the equity by credit bidding the value of their existing loans instead of having to make an actual cash payment.