Album2Last Wednesday, David Cassidy, star of the 1970s “The Partridge Family,” filed an individual Chapter 11 bankruptcy petition in the Southern District of Florida. Perhaps it’s wishful thinking to wonder whether Mr. Cassidy will help resolve the most controversial plan confirmation issue in individual Chapter 11 cases: the “absolute priority rule” (APR). After all, who could have imagined that Anna Nicole Smith (Vickie Lynn Marshall if you’re a scholar) would turn the very serious issue of bankruptcy court jurisdiction upside down (and give grown adults so much to giggle about at bankruptcy conferences). The APR in individual cases is also a serious issue because, arguably, it gets at the right of an individual to reorganize under Chapter 11. Maybe Mr. Cassidy is just the right “test case.” (For now, he’s providing shameless clickbait.)

We’re optimistic that we’ll have plenty of occasions to address the APR. Thus, we’ll limit this post to (1) introducing the APR, (2) framing the split of authority regarding its application, and (3) linking readers to our APR Case Chart. To be sure, this post re-purposes our July 2014 presentation at the ABI’s 19th Annual Southeast Bankruptcy Workshop titled “The Absolute Priority Rule in Individual Chapter 11 Cases.”

Overview of the Absolute Priority Rule

The absolute priority rule (APR) is relevant in Chapter 11 cases where the debtor attempts to “cram down” a Chapter 11 plan over the objection of dissenting unsecured creditors. If the debtor satisfies all of the other confirmation requirements, then a debtor may cram down by satisfying two additional requirements: (1) the plan must not discriminate unfairly against the objecting class of creditors and (2) the plan must be “fair and equitable.” 11 U.S.C. § 1129(b)(1). To be fair and equitable, a plan must satisfy the APR, as codified in § 1129(b)(2)(B)(ii):

With respect to a class of unsecured claims—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.

11 U.S.C. § 1129(b)(2)(B)(ii) (underlined language added with the 2005 BAPCPA amendments). Dating back to the 19th century, the APR was intended to prevent senior creditors and equity holders from imposing unfair terms on unsecured creditors. The case of In re Arnold, 471 B.R. 578 (Bankr. C.D. Cal. 2012) provides a treatise-worthy discussion of the APR’s history in bankruptcy.

Simply put, the APR requires that a dissenting class of unsecured creditors be provided for in full before any junior class can receive or retain any property under a plan. Recent APR developments focus on the impact of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) on the APR in individual Chapter 11 cases. (Yes, we’re almost 10 years into the changes and still struggling to understand some of them.) Specifically, they focus on the impact of (1) the above underlined language and (2) § 1115, added to the Bankruptcy Code in 2005.

Section 1115(a) provides that property of the estate in an individual Chapter 11 includes, in addition to the property specified in § 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.

The language in § 1129(b)(2)(B)(ii) and § 1115 has resulted in a national split of authority on whether the APR still applies in individual Chapter 11 cases. There are two views: the “broad view” and the “narrow view.”

Broad View versus Narrow View

As of the date of this post, the Supreme Court has not weighed-in on whether the APR still applies in individual Chapter 11 cases. In the interim, the broad and narrow views have emerged in the lower courts. Courts adopting the broad view read § 1115 expansively, concluding that the APR does not apply in individual Chapter 11 cases. Courts adopting the narrow view read § 1115 restrictively, concluding that the APR does apply. Although “broad” and “narrow” indicate the result, the approaches vary, even within the two views.

Broad View: The broad view reads the word “includes” [in the newly-added § 1115(a)] and the word “included” [in the phrase, “property of the estate included under section 1115” in the amended § 1129(b)(2)(B)(ii)] together. Reading “included” broadly, the broad view concludes that a debtor’s pre- and post-petition income and property are “included” in the estate by virtue of § 1115. Therefore, all such property is excepted from the APR, such that the APR does not apply in individual Chapter 11 cases. The broad view courts bolster their statutory analysis with a variety of different arguments that draw from the legislative history, their interpretation of Congress’ intent with respect to BAPCPA, the interpretations of other courts that have addressed the issue, and policy considerations. If there is an almost universal theme in the broad view cases, then it is that Congress intended to make Chapter 11 more like Chapter 13 (which has no APR).

The arguments or approaches used to support the broad view include the following:

  1. A determination of whether the statutory language is ambiguous.
  2. Reliance on early treatise coverage regarding the absolute priority rule.
  3. Congress intended to make Chapter 11 more like Chapter 13 for individuals.
  4. The APR is not “sacrosanct”; it has been amended before.
  5. The broad view does not render the BAPCPA changes trivial or purposeless.

Narrow View: Like the broad view, the narrow view reads the word “includes” and the word “included” together. However, it reads “includes” narrowly, concluding that a debtor’s post-petition income and property are the only types of property “included” in the estate by virtue of § 1115. Thus, under the narrow view, the APR still applies to pre-petition (but not post-petition assets) in individual Chapter 11 cases. Like the broad view courts, the narrow view courts bolster their statutory analysis with a variety of different arguments. If there is an almost universal theme in the narrow view cases, then it is the theme that if Congress had wanted to repeal the APR—a “mainstay” of bankruptcy practice for 100+ years—for individual debtors, then it would have done so explicitly and in a far less convoluted fashion.

The arguments or approaches used to support the broad view include the following:

  1. A determination of whether the statutory language is ambiguous.
  2. Grammatical analysis of BAPCPA changes supports narrow view.
  3. Congress did not intend to make Chapter 11 more like Chapter 13 for individuals.
  4. Congress intended to keep the APR the same as it was pre-BAPCPA, and the same for individuals and for entities.
  5. If Congress wanted to repeal the APR in individual cases, then it would have done so explicitly and in a less convoluted fashion.
  6. The broad view violates the prohibition against “repeal by implication.”
  7. The broad view injures creditors while the narrow view strikes a proper balance.
  8. The narrow view does not make the BAPCPA changes trivial.
  9. The narrow view does not make confirmation impossible in individual cases.
  10. Adopting a case comparison, case adoption approach.

Conclusion

The APR Case Chart collects and summarizes the APR cases for individual Chapter 11 debtors. It starts with the 2007 In re Tegeder case and ends with the May 2014 Ice House/Cardin case from the Sixth Circuit. Plan Proponent is not aware of any other Circuit decisions since Ice House/Cardin, but will continue to update the Chart as the issue evolves. For the moment, all of the Circuit Courts (4th, 5th, 6th, and 10th) that have addressed the issue have adopted the “narrow view,” and concluded that the absolute priority rule continues to apply to all property of the debtor except for post-petition income and assets. Additionally, most bankruptcy courts that have addressed the issue, especially recently, have reached the same conclusion.

Although the original broad view cases are not getting any younger, the broad view continues to have an ally in the 2012 Ninth Circuit B.A.P. Friedman case (subject to its extensive and lengthy dissent). Additionally, the 2013 O’Neal and the 2014 Woodward Bankruptcy Court decisions are two of the more rigorous and extensive broad view cases in the broad view “canon” of cases. However, until the momentum shifts, the Supreme Court weighs-in otherwise, or Congress intervenes (if ever), individual Chapter 11 debtors who cannot pay their creditors in full will likely only enjoy Chapter 11 via negotiation and consent.

We’ll be on the lookout for new developments.

Note: The absolute priority rule is not exactly well-settled in corporate Chapter 11 cases either. For example, the “new value” exception to the APR in corporate cases remains a hot topic. Plan Proponent will dig into to that exception in its multi-part series on the confirmation-related recommendations in the ABI Commission Report.