Has the Absolute Priority Rule Died For Individual Chapter 11 Cases?

Posted by on Apr 10, 2012 in Chapter 11 Bankruptcy Issues | 1 comment

People typically think “LA Dodgers Bankruptcy” or “Lehman Brothers” or “General Motors Bankruptcy” when hearing the term Chapter 11 bankruptcy. But Chapter 11 bankruptcy also applies to people, individuals who are sole proprietors or wage earners with either secured debt or unsecured debt above and beyond what is allowable in a chapter 13 context. For such individuals who are contemplating repayment of debt within bankruptcy, an individual chapter 11 may be the only option.

Recently, the 9th Circuit Bankruptcy Appellate Panel decided in In Re Friedman (March 19, 2012), that the absolute priority rule does not apply in an individual chapter 11 case. Why the distinction?  Well, 1129(b)(2)(B)(ii) says that for a class of unsecured claimants that “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.”  This means the absolute priority rule comes into play if there is 1 impaired class of claims that does not accept the plan.   Otherwise, that means a chapter 11 plan will not be crammed down on unsecured creditors unless stockholders/the individual debtor get nothing under the plan.  The reason for this absolute priority rule is to promote fairness.

In Friedman, the court mentioned using “common sense”  in determining whether the absolute priority rule applies in individual cases.   The court found that it had to first look at the language within the bankrutpcy code to determine whether the absolute priority rule applies.  The court found nothing contrary to hold that the absolute priority rule apply in individual cases based on the language of the applicable statutes.   It also found it incongruous that a chapter 11 individual debtor had to submit equivalent value of 5 years of disposable income under 1129(a)(15) yet have the absolute priority rule still apply.  Moreover, the court noted the semblance of newly added statutes for chapter 11 cases that closely mirrored chapter 13 rules for individual cases.

A dissent was filed by Riverside Bankruptcy Judge Meredith Jury in which Judge Jury disagreed with both the holding and the analysis.  Not only does Judge Jury believe that the absolute priority rule is alive and well in individual chapter 11 cases, she finds that the majority lost sight of the fundamental purpose behind chapter 11.  Judge Jury then doved into an analysis of relevant 9th Circuit case law to support her conclusions while specifically addressing the majority’s analysis as well as NACBA’s amicus brief.

The Friedman court concluded with this thought: “When decicisions have gone further than exercising a plain reading of the statute, they have entered into speculative analyses that are fatally flawed.”  Thus, at least for now, the 9th Circuit BAP has concluded the absolute priority rule does not apply – however it is unclear whether 9th Circuit Bankruptcy Judges are even bound by BAP opinions so the magnitude of this case has yet to be determined.   Stay tuned.

 

 

 

 

 

 

 

 

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