Individual Chapter 11 Cases and The Absolute Priority Rule

Posted by on Jan 19, 2012 in Chapter 11 Bankruptcy Issues | 1 comment

Individual Chapter 11 Cases are unique – these are cases where employed individuals or wage earning spouses file chapter 11 where they do not otherwise qualify for ch7, ch13, or where those chapters of bankruptcy are not in their best interest.  In such cases, the only alternative may be a chapter 11 individual case filing.   These individual chapter 11 cases are more than just large chapter 13’s, but they are not true ch11 cases in the corporate sense (ie. LA Dodger’s Bankruptcy).

One of the more problematic aspects of an individual chapter 11 case has to do with what is called the absolute priorty rule.  In a Chapter 11 case, this is the rule that says no junior class of claims or interests may receive anything of value from the estate unless a more senior nonaccepting class of unsecured claims or interests is paid in full. 11 U.S.C. § 1129(b)(2)(B) and (C).   In other words, this means a debtor cannot retain any property in a chapter 11 case unless creditors are paid in full per the absolute priorty rule unless there is a consenting class of creditors (leading to a whole other set of rules – see Sections 1124-1126 of the US Bankrutpcy Code).

Currently, courts around the country are at odds as to whether or not this absolute priorty rule applies to chapter 11 individual debtors.  Although 1129(b)(2)(B) seems to say that the absolute priority rule does not apply in individual cases and such individuals may retain property of the estate pursuant to Section 1115, courts have held otherwise.  This whole debate leads to an analysis of statutory construction over how to properly read Sections 1115 and 1129(b)(2)(B), believe it or not.

This issue is currently on appeal across the country and NACBA (the National Assoc. of Consumer BK Attorneys) is taking the reigns to combat this issue across bankruptcy courts and circuit courts across the country.  In California specifically, there are a handful of cases in which courts have found that the absolute priority rule does apply to individual chapter 11 cases.   At least one of these cases is also on appeal and we will have to wait and see how it is resolved in California.

Until then, do not assume that the absolute priority rule will not apply to your chapter 11 individual case.

 

 

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