Suppose B.O. Drug Co. decides to reorganize under Chapter 11. Generally, senior claims are honored in full before various other claims receive anything. Assume that the going concern value of B.O. Drug Co. is $3 million and that its balance sheet is as shown:

The firm has proposed the following reorganization plan:

The firm also has proposed a distribution of new securities under a new claim with this reorganization plan:

However, it will be difficult for the firm to convince secured creditors (mortgage bonds) to accept unsecured debentures of equal face value. In addition, the corporation may wish to allow the old stockholders to retain some participation in the firm. Needless to say, this would be a violation of the absolute priority rule, and the holders of the debentures would not be happy.

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Assets Liabilities Mortgage bonds Subordinated debentures Stockholders' equity $3,000,000 1,500,000 2,500,000 - 1,000,000