DOES THE ABSOLUTE PRIORITY RULE APPLY TO INDIVIDUAL CHAPTER 11 DEBTORS?Published on by: Ian M. Falcone
DOES THE ABSOLUTE PRIORITY RULE APPLY TO INDIVIDUAL CHAPTER 11 DEBTORS?
The Absolute Priority Rule refers
to the confirmation requirement of 11 U.S.C. 1129(b)(2)(B)(ii) which states:
. . . (b) (2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
. . . (B) With respect to a class of unsecured claims -
(ii) the holder of any claim or interest that is junior to the
claims of such class will not receive or retain under the plan on account of
such junior claim or interest any property, except that in a case in which the
debtor is an individual, the debtor may retain property included in the estate
under section 1115, subject to the requirements of subsection (a)(14) of this
section.
It can be thought of as a fountain that contains
a series of cups. The second cup does
not get any water until the first cup is completely full. The third cup does not get any water until
the first and second cups are completely full, and so on. In other words, unless the plan is confirmed
through acceptance by every impaired class, each class of creditors must be
paid 100% of their claims before the next class can receive any money. In corporate cases, this typically results in
the equity holders (shareholders) losing their ownership interest with new
stock being issued and purchased by new shareholders contributing “new value”
in order to obtain their shares.[1] Unfortunately,
this concept does not translate well into the individual Chapter 11 case. Must an individual repurchase all of his
assets? If so, where do the funds come
from? Certainly, not from the estate
itself. If the Absolute Priority Rule
applies, is a 100% plan the only option to attain confirmation? In order to answer some of these questions,
we must first understand the definition of estate property in a Chapter 11
case.
11
U.S.C. 541, which applies to all chapters of the Bankruptcy Code, states:
(a) The commencement of a case under section 301, 302, or 303 of
this title creates an estate. Such estate is comprised of all the following
property, wherever located and by whomever held:
(1) Except as provided in
subsections (b) and (c)(2) of this section, all legal or equitable interests of
the debtor in property as of the commencement of the case.
(2) All interests of the debtor and
the debtor’s spouse in community property as of the commencement of the case
that is—
(B) liable for an
allowable claim against the debtor, or for both an allowable claim against the
debtor and an allowable claim against the debtor’s spouse, to the extent that
such interest is so liable.
(3) Any interest in property that
the trustee recovers under section 329
(b), 363
(n), 543,
550, 553, or 723 of this title.
(4) Any interest in property
preserved for the benefit of or ordered transferred to the estate under section
510 (c) or 551 of this title.
(5) Any interest in property that
would have been property of the estate if such interest had been an interest of
the debtor on the date of the filing of the petition, and that the debtor
acquires or becomes entitled to acquire within 180 days after such date—
(B) as a result of a
property settlement agreement with the debtor’s spouse, or of an interlocutory
or final divorce decree; or
(6) Proceeds, product, offspring,
rents, or profits of or from property of the estate, except such as are
earnings from services performed by an individual debtor after the commencement
of the case.
Thus, with the exceptions of “after-acquired”
property referenced in subparagraph 5, the estate consists of as virtually all
property owned by the debtor at the time of filing. In essence, a photograph of the debtor’s
assets is taken upon the commencement of the case; if it is in the picture, it
is part of the estate.
However, when BAPCPA was passed in 2005, the
definition of estate was changed with regard to an individual Chapter 11 case[2]. 11 U.S.C. 1115 now reads:
(a) In a case in which the debtor is an
individual, property of the estate includes, in addition to the property specified
in section 541—
(1)
all property of the kind specified in section 541
that the debtor acquires after the commencement of the case but before the case
is closed, dismissed, or converted to a case under chapter 7, 12, or 13,
whichever occurs first; and
(2)
earnings from services performed by the debtor after the commencement of the
case but before the case is closed, dismissed, or converted to a case under
chapter 7, 12, or 13, whichever occurs first.
Thus, the property in an individual Chapter 11
case includes all the property listed in Section 541 plus assets
acquired after filing and all income earned during the pendency of the case.
After reading these two subsections in
conjunction with one and other, one would think that 1129(b)(2)(B)(ii) is
clear, “in a case in which the debtor is an individual, the debtor may retain
property included in the estate under section 1115, subject to the requirements
of subsection (a)(14) of this section.”
One would be very wrong. It is
the cross-referencing contained in 11 U.S.C. 1115(a)(1) that seems to cause
problems when determining whether the Absolute Priority Rule remains in effect
for individuals.
Courts are split.[3] Those that believe that Congress eliminated
the Absolute Priority Rule when it added 1129(b)(2(B)(ii) adhere to what is
commonly called the “broad view” and those court that believe that the Absolute
Priority Rule is alive and well in individual cases follow the “narrow view.”
Under the “broad view”, the term “property
included in the estate under section 1115”[4] is read to include the
property described in Section 541.
Section 1115’s
identification of estate property consists of the property contained in §541 and
the two post-petition acquired assets - newly acquired property and
income. The so-called disputes over what
“included” means in §1129(b)(2)(B)(ii) and “in addition to” in §1115 arise from
misinterpretation of the words.
“Included” is not a word of limitation.
To limit the scope of estate property in §1129 and 1115 would require
the statute to read “included, except for the property set out in Section 541”
(in the case of §1129(b)(2)(B)(ii)), and “in addition to, but not inclusive of
the property described in Section 541” (in the case of §1115).
A plain reading
of §§1129(B)(2)(B)(ii) and §1115 together mandates that the absolute priority
rule in not applicable in individual chapter 11 debtor cases. Accord SPCP
Group, LLC v. Biggins, ___ B.R. ___, 2011 WL 4389841, at *3-5 (M.D. Fla.
Sept.21, 2011) (declined to follow In re Gelin, 437 B.R. 435 (Bankr.M.D.
Fla.2010), which followed the narrow view based on an ambiguity analysis); In
re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007) (following a plain meaning
analysis); In re Shat, 424 B.R.854 (Bankr. D. Nev. 2010) (following the broad
view based upon an ambiguity analysis).
In re Friedman 466 BR 471 (9th
Cir. BAP 2012).
Under the “narrow view”, the term “property
included in the estate under section 1115”[5] refers only to the two
categories of after-acquired property.[6]
In our view, the context demonstrates that Congress
intended §1115 to add property to the estate already established by §541. This position is supported by the Sixth
Circuit’s holding in In re Seafort,
669 F.3rd 992 (6th Cir. 2012) in which the court
interpreted §1306(a) - the parallel Chapter 13 provision to §1115. The Sixth Circuit interpreted the statute as
follows: “Section 1306(a) expressly incorporates §541. Read together, §541 fixes property of the
estate as of the date of filing, while §1396 adds to the “property of the
estate” property interests which arise post-petition” Seafort
669 F.3d at 667
Oddly, despite
the fact that most courts have conducted similar analyses and concluded that
the relevant language in BAPCPA is unambiguous, as indicated above, they have
reached different conclusions regarding the “plain” meaning of the statute.[7] At present, the “broad view” has been adopted
by the Bankruptcy Panel for the Ninth Circuit and five bankruptcy courts, while
the “narrow view” has been adopted by the Fourth Circuit and seventeen
bankruptcy courts.
Those
adopting the “broad view” emphasize the similarity between the concepts and
language applicable to an individual Chapter 11 debtor and the concepts and
language applicable to a Chapter 13 debtor, which has no absolute priority
rule.[8] Proponents of the “narrow view” are concerned
that had Congress intended to abolish the Absolute Priority Rule, “it would
have done so in a far less convoluted way.”
In re Maharaj 681 F. 3d at
565-66.[9]
Unfortunately,
for now, it appears that we will have to wait until this issue is resolved by
further legislative amendment or review by the U.S. Supreme Court. In the meantime, the only way to guarantee
confirmation of an individual Chapter 11 case is by acceptance of all impaired
classes or payment of 100% to the unsecured class.[10]
[1] Bank of America v. 203 N. La Salle Street
Partnership, 526 U.S. 434, 119 S. Ct. 1411 (1999)
[2]
BAPCPA also knows as the Bankruptcy
Abuse Prevention and Consumer Protection Act of 2005 became effective on
October 17, 2005.
[3] In re Maharaj.
11-1747, 2012 WL 2153066 (4th Cir. June 14, 2012) (“A
significant split of authorities has developed nationally among the bankruptcy
courts regarding the effect of the BAPCPA amendments on the absolute priority
rule when the Chapter 11 debtor is an individual.”)
[4] 11
U.S.C. 1129(b)(2)(B)(ii)
[5] 11
U.S.C. 1129(b)(2)(B)(ii)
[6] In re Maharaj. 11-1747, 2012 WL 2153066
(4th Cir. June 14, 2012)
[7]
In re
Stephens 794 F.3d 1279 (10th
Cir. 2013) (“Although a
number of courts have held this language to be unambiguous, they have reached
starkly different conclusions regarding the “plain” meaning. Compare SPCP Grp.,
LLC v. Biggins, 465 B.R. 316, 322 (M.D. Fla. 2011) (“The plain reading of this
statute” is that § 1115 “includes . . . property specified in section 541.”),
with In re Steedley, No. 09-50654, 2010 WL 3528599, at *2 (Bankr. S.D. Ga. Aug.
27, 2010) (“Nothing in the plain language of § 1115 suggests that it subsumes §
541.”). The very existence of this dichotomy seems indicative of the text’s
ambiguity. Indeed, several courts have recognized that §§ 1115 and
1129(b)(2)(B)(ii) are susceptible to two different yet plausible
interpretations. See, e.g., In re Maharaj, 681 F.3d 558, 569 (4th Cir. 2012);
In re Lindsey, 453 B.R. 886, 903 (Bankr. E.D. Tenn. 2011).”)
[8]
Advocates of the broad view emphasize that the BAPCPA
amendments evince an intent to model Chapter 11 on Chapter 13, which has no
absolute priority rule. See In re Friedman, 466 B.R. at 483; In re Shat, 424
B.R. at 868. In support, they cite a number of provisions that are essentially
copied from Chapter 13. See, e.g., In re Roedemeier, 374 B.R. 264, 275–76
(Bankr. D. Kan. 2007). Further, proponents of the broad view emphasize that
abolishing the APR with respect to individual debtors does not leave unsecured
creditors without any power or protection. Instead, unsecured creditors can
rely on the safeguards of § 1129(a)(15)’s disposable income test, see In re
Shat, 424 B.R. at 863–64, and § 1129(a)(7)’s “best interests” test, see Amicus
Br. of Nat’l Ass’n of Consumer Bankr. Attorneys at 6.
[9]
In re Stephens 794 F.3d 1279 (10th
Cir. 2013) (“Advocates for the narrow view argue
that, had Congress intended such a drastic change, it surely would have
included the amendment in its list of debtor protections. See In re Maharaj,
681 F.3d at 572. Instead, the amendments are best understood as preserving the
status quo. See, e.g., id. at 569–70 (noting that the exemption of
post-petition property and earnings ensures that the APR operates as it did
prior to BAPCPA’s passage).”)
[10]
New value that comes from an outside source and waiver of exemptions may be
additional alternatives.
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