BAPCPA Eliminates the Absolute Priority Rule for Individual Chapter 11 Debtors

Posted: 5 years 21 weeks ago

By: Christina Kormylo
St. John's Law Student
American Bankruptcy Institute Law Review Staff
 
The addition of section 1115 to the Bankruptcy Code by the 2005 BAPCPA amendments created an exception to the “absolute priority rule” for individual Chapter 11 debtors according to the bankruptcy court in In re Tegeder.[1]   In Tegeder, the general unsecured creditor class did not accept the Chapter 11 plan proposed by an individual debtor who was engaged in business, thereby triggering the “cram down” provisions of 11 U.S.C. § 1129(b).[2]  Although all other requirements for plan confirmation under section 1129(a) were met, the U.S. Trustee argued that the debtor, as a holder of interests junior to the dissenting class, could not retain any property pursuant to the absolute priority rule of section 1129(b)(2)(B)(ii).[3]  The absolute priority rule, as amended by BAPCPA, states, “the holder of any claim or interest that is junior to the claims of such class will not receive or retain . . . 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.”[4]  Addressing the effect of the cross-reference to section 1115, the Tegeder court held that the absolute priority rule does not prevent a plan’s confirmation where both pre- and post-petition assets are retained by an individual debtor.[5]  The court explained that the 2005 BAPCPA amendment and the addition of section 1115 created an exception to the rule, allowing an individual debtor to retain property included in the estate.[6]

The intent of this new provision was to waive the absolute priority requirements imposed by section 1129(b)(2)(B)(ii) and permit an individual debtor to retain property included in the estate under section 1115.[7]  Although not clearly worded, section 1115 clearly includes post-petition property and also refers to pre-petition property that becomes property of the estate under section 541.[8]  Thus, the court reasoned that the debtor’s retention of pre-petition property is permitted.[9]  A narrower interpretation would cause the amendment to have little impact.[10]  Other courts have reached similar conclusions.  The bankruptcy court in In re Roedemeier explained that sections 1115 and 1129(b)(2)(B)(ii) should be construed broadly to cover property brought into the estate by both sections 1115(a) and 541.[11]  The court in In re Bullard similarly held, based on section 1129(b)(2)(B)(ii), that a reorganization plan could be confirmed despite the debtor’s retention of post-petition income and property.[12]  Bullard acknowledged that its interpretation alters the absolute priority rule, a fundamental principle of reorganization law.[13]
 
The absolute priority rule itself predates the Bankruptcy Code.[14]  The rule is central to the law of reorganization as it is the source of both substantive rights and procedural protections for reorganization participants, and was intended to give unsecured creditors bargaining power.[15]  Under the “cram down” provisions of 11 U.S.C § 1129(b), a reorganization plan can be confirmed despite an impaired class’ rejection of it.[16]  However, a plan must not discriminate unfairly, and must be fair and equitable.[17]  In order to be fair and equitable, unsecured claims must be paid in full, or the absolute priority rule must be met.[18]  As a result of BAPCPA’s 2005 amendments, property acquired after the commencement of a case is considered property of the estate.[19]  The early interpretations of section 1115 by the bankruptcy courts have eliminated the absolute priority rule for individual debtors and permitted them to retain property even over the objection of unpaid unsecured creditors.[20]  Therefore, a single phrase added to the end of section 1129(b)(2)(B)(ii) by the BAPCPA amendments appears to have eliminated a creditor’s ability to challenge the reorganization plan of a debtor who seeks to retain property after confirmation of the plan.[21]  That protection appears to have been replaced by the new “disposable income” requirement of section 1129(a)(15).[22]

[1] 369 B.R. 477, 478 (Bankr. D. Neb. 2007).

[2] Id. at 478, 479.

[3] Id. at 479.

[4] Id. (quoting 11 U.S.C. § 1129(b)(2)(B)(ii) (2006)).

[5] Id. at 478.

[6] Id. at 479–80.

[7] 6 Norton Bankr. L. & Prac. 3d § 106:1 (2008); 6 Norton Bankr. L. & Prac. 3d § 113:21 (2008).

[8] 6 Norton Bankr. L. & Prac. 3d § 106:1 (2008); 6 Norton Bankr. L. & Prac. 3d § 113:21 (2008) (citing In re Goldstein, 385 B.R. 496, 498–99 (Bankr. C.D. Cal. 2007)).

[9] See In re Tegeder, 369 B.R. at 478.

[10] 6 Norton Bankr. L. & Prac. 3d § 106:1 (2008).

[11] In re Roedemeier, 374 B.R. 264, 276 (Bankr. D. Kan. 2007).

[12] 358 B.R. 541, 544 (Bankr. D. Conn. 2007).                                       

[13] Id. at 543 (citing Northwest Bank Worthington v. Alhers, 485 U.S. 197 (1988)).

[14] In re Armstrong World Indus., Inc., 432 F.3d 507, 512 (3d Cir. 2005).

[15] See In re Armstrong World Indus., Inc., 432 F.3d at 514–15 (citing H.R. Rep. No. 95-595, at 416); 6 Norton Bankr. L. & Prac. 3d § 113:21 (2008); Douglas G. Baird, The Elements of Bankruptcy 81–82 (Rev. ed., The Foundation Press, Inc. 1993).

[16] See In re Tegeder, 369 B.R. at 479; 7 Collier on Bankruptcy, ¶ 1129, at 1129.04 (Alan N. Resnick et al. eds., 15th ed. rev. 2006) (explaining a confirmation can be “crammed down” throat of dissenting class when requirements of 1129(b) are met) (quoting New English Coal & Coke Co. v. Rutland R. Co., 143 F.2d 179, 189 (2d Cir. 1944) where phrase first used by court).  

[17] See 11 U.S.C. § 1129(b)(1).

[18] See, e.g., Group of Institutional Investors v. Chicago, M., St. P. & Pac. R.R., 318 U.S. 523, 564-66 (1943) (analyzing “fair and equitable” as composed of absolute priority rule that no creditor paid more than owed and explaining senior creditor entitled to be paid or allocated value from debtor, not paid in full, before that paid to junior class); In re Tegeder, 369 B.R. at 479.

[19] See Donald R. Lassman, Individual Chapter 11s Really Do Work, 27 Am. Bank. Inst. J. 18, 65 (2008).

[20] See 6 Norton Bankr. L. & Prac. 3d § 106:1 (2008); 3 Bankr. Practice Handbook § 14:152 n. 1 (2006).

[21] See Donald R. Lassman, Individual Chapter 11s Really Do Work, 27 Am. Bank. Inst. J. 18, 68 (2008).

[22] See 11 U.S.C. § 1129(a)(15).