Does the Absolute Priority Rule Apply to Individual Debtors

By: Colin Coburn

St. John’s Law Student

American Bankruptcy Law Review Staff

 

The Arizona Bankruptcy Court recently held, in In re Sample, that the absolute priority rule does not apply to individual debtors because it was bound by the Ninth Circuit Bankruptcy Appellate Panel’s decision in P + P LLC v. Friedman (In re Friedman).[1]  Section 1129(b)(2)(B)(ii) of the Bankruptcy Code defines the absolute priority rule,[2] which mandates that under a chapter 11 plan of reorganization, a dissenting class of unsecured creditors must be paid in full before the holder of any junior claim or interest receives or retains any property on account of such junior claim or interest.[3]  In In re Friedman, the court stated that Congress, in passing BAPCPA, intended Chapter 11 individual bankruptcy to resemble Chapter 13 bankruptcy.[4]  In Friedman the court held that §1129(a)(15)(B),[5] replaced §1129(b)(2)(B)(ii) in cases involving individual debtors, thereby abrogating the absolute priority rule in individual chapter 11 cases.  Section 1129(a)(15)(B) states that a court can only confirm an individual debtor’s plan, to which an unsecured creditor objects, when, “the value of the property to be distributed . . . is not less than the projected disposable income of the debtor” for the first 5 years after payments begin.[6]  The Friedman court reasoned that this fact, combined with the plain meaning of sections 541, 1115, and 1129(b)(2)(B)(ii), dictated that the absolute priority rule does not apply to individual debtors.[7]  The Sample court disagreed with the reasoning of the Friedman opinion, but held that it was bound to follow that holding.[8]

The Friedman court adopted the broad view in the debate over whether individuals are exempt from the absolute priority rule.[9]   Courts which express this view, believe that the absolute priority rule does not apply to individual debtors because Congress, when it passed BAPCA, changed §1129(b)(2)(B)(ii) to include a cross-reference to §1115 which itself cross-references §541.[10]  Therefore, these courts conclude, Congress intended to eliminate the absolute priority rule for individual debtors by exempting all of the debtor’s property.[11]  This view is not shared by many courts, which have adopted the narrow view.[12]  Courts subscribing to the narrow view argue that if Congress had intended to eliminate the absolute priority rule in individual bankruptcies, it would have done so explicitly.[13]  Courts adopting this view maintain that the absolute priority rule was essentially unaffected by BAPCPA, and, as a result, it still applies to individual debtors.[14]  Within the Ninth Circuit, courts have failed to reach a consensus on which view should be controlling.[15] 

In re Sample is a further muddying of the waters in the debate over how the absolute priority rule should apply to individual debtors.  Under the “broad view,” an individual debtor can “cram down” a plan of reorganization over an objecting class of creditors.  This makes it easier for an individual to confirm a Chapter 11 plan of reorganization because the confirmation cannot be delayed by one dissenting class of creditors.  In contrast, the “narrow view” makes it more difficult to confirm a Chapter 11 plan of reorganization.  Under the “narrow view,” the debtor is not able to “cram down” a plan on a dissenting class of creditors.  Therefore, a debtor needs every class of creditors to agree to a plan.  This gives creditors much more leverage over the debtor.  The ruling in Sample benefits individual debtors by making it easier for individual debtors to confirm chapter 11 plans in Arizona. 

 


[1] In re Sample, No. 2:10-38373-DPC, 2013 WL 375795, at *1 (Bankr. D. Ariz. 2013).

[2] 11 U.S.C. §1129(b)(2)(B)(2) (“With respect to unsecured creditors . . . 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.”)

[3] Bank of Am. Nat’l Trust & Sav. Ass’n v. 203 N. LaSalle St. P’ship, 526 U.S. 434, 441-42.

[4] P + P LLC v. Friedman (In re Friedman), 466 B.R. 471, 483 (B.A.P. 9th Cir. 2012)

[5] Id. at 484.

[6] 11 U.S.C. §1129(a)(15)(B).

[7] In re Friedman, 466 B.R. at 483.

[8] In re Sample, at *2 (holding that BAP decisions should be binding as long as there is not a conflicting opinion from the Arizona District Court).

[9] In re Friedman, 466 B.R. at 484.

[10] In re Maharaj, 681 F.3d 558, 563 (4th Cir. 2012).

[11] Id.

[12] See In re Stephens, 704 F.3d 1279 (10th Cir. 2013); see also In re Maharaj, 681 F.3d 558.

[13] In re Stephens, 704 F.3d at 1286 (refusing to hold that Congress intended to impliedly repeal the absolute priority rule); In re Maharaj, 681 F.3d at 575 (holding that “[t]he dramatic nature of such a departure from longstanding pre-BAPCPA law, the ambiguous language of the statutes, and the total lack of any indication in the legislative history of such an intent, lead us to conclude that Congress intended to and did preserve the absolute priority rule.”)

[14] In re Maharaj, 681 F.3d at 575.

[15] Compare In re Arnold, 471 B.R. 578, 607 (Bankr. C.D. Cal. 2012) (holding that a reading of the applicable statutes leads to the conclusion that the absolute priority rule does apply to individual debtors, and that only post-petition property is protected), with In re Friedman and In re Sample.