Individual Chapter 11 Cases under BAPCPA
Editor's Note: See Related Article on p. 10. (Legislative Update) Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) significantly changes chapter 11 cases of individuals. After reviewing how chapter 11 works in an individual's case and how it differs from chapter 13, this article discusses provisions of the new law of particular interest to individual chapter 11 debtors. BAPCPA does not alter many of the fundamental provisions of chapter 11 that make it an unattractive alternative to chapter 13 for an individual desiring to retain exempt property, cram down secured debt and pay unsecured creditors what they would receive in a chapter 7 liquidation case. Thus, almost all individuals seeking rehabilitative relief will continue to file under chapter 13 rather than chapter 11. Nevertheless, an individual's circumstances may require a chapter 11 filing. For example, a debtor may not be eligible for chapter 13 relief under §109(e)1 because of the amount of debts or the lack of regular income. An individual might also desire to maintain control of the liquidation of assets as a debtor-in-possession (DIP), prefer to avoid chapter 13's requirement of prompt filing of a plan, or need more time to pay debts than the 60 months that chapter 13 permits.
Overview of Chapter 11 for Individuals and Comparison to Chapter 13
In some ways, chapter 11 for an individual resembles chapter 13. In both chapters, the plan may bifurcate a secured claim (other than certain residential mortgages and, under BAPCPA in chapter 13 cases, certain purchase money security interests) into secured and unsecured portions. §506(a). The debtor pays the value of the secured portion in deferred cash payments, with appropriate interest. §§1129(b)(2)(A)(i), 1325(a)(5).2 Each chapter's "best interests" test requires payment of unsecured claims, including deficiencies on undersecured claims, at least what would be paid in a chapter 7 liquidation. §§1129(a)(7)(A)(ii), 1325(a)(4). Under either chapter, a plan may not modify a claim secured by the debtor's principal residence (§§1123(b)(5), 1322(b)(2)), other than to cure defaults and reinstate its maturity. §§1124(2), 1322(b)(5). Under BAPCPA, both chapters may require the debtor to commit projected disposable income to make payments under the plan. §§1129(a)(15), 1325(b)(1)(B).
In many respects, however, chapter 11 is dramatically different. Initially, because the chapter 11 debtor is a DIP with the rights and duties of a trustee (§1107(a)), the debtor's engagement of counsel requires court approval. §327(a). Among other things, debtor's counsel must be disinterested and cannot hold or represent any interest adverse to the debtor's estate—concepts that do not apply in chapter 13 cases. Thus, conflicts of interest that may be waivable or permissible under chapter 13 may disqualify a lawyer from representing the debtor in a chapter 11 case.
An individual's filing of a chapter 11 petition has important consequences that a chapter 13 filing does not. Unlike a chapter 13 debtor, a chapter 11 debtor does not have a right to dismiss the case. Compare §1112(b) with §1307(b). Furthermore, the filing of an individual's chapter 11 case creates a new taxable entity, the bankruptcy estate, just like the filing of an individual's chapter 7 case. 26 U.S.C. §1398. If there are post-petition events such as the disposition of an asset through a §363 sale or through foreclosure after lifting of the stay, the estate, not the individual debtor, may incur tax liability at the "married filing separately" rate. Tax considerations relating to a chapter 11 debtor's post-petition earnings are discussed below.
The two chapters treat priority claims differently. Under chapter 11, priority claims other than tax claims must be paid in full, in cash, on the plan's effective date. §1129(a)(9). Thus, a chapter 11 debtor cannot pay a domestic support obligation3 with priority under §507(a)(1) in installments without the claimant's agreement. In contrast, chapter 13 permits payment of all priority claims in deferred cash payments, without interest (§1322(a)(2)), although the debtor may remain liable for interest on debts that are now nondischargeable under BAPCPA's elimination of the "superdischarge." §1328(a). Section 1322(b)(1) permits a chapter 13 plan to provide for payment of interest on nondischargeable claims only if it provides for payment of all unsecured claims in full.
A chapter 13 discharge may benefit a debtor more than a chapter 11 discharge. In a chapter 11 case, an individual's discharge itself can be challenged and denied for any of the reasons applicable under §727(a) in a chapter 7 case if the debtor liquidates all or substantially all of the debtor's assets and does not engage in business after the plan's consummation. §1141(d)(3). Furthermore, a chapter 11 discharge does not eliminate any debt excepted from discharge under §523 (§1141(d)(2)). Although BAPCPA significantly reduces the scope of the chapter 13 discharge, some debts excepted under §523 remain dischargeable in chapter 13. For example, a property settlement debt arising under a divorce decree now survives a chapter 7 or 11 discharge under BAPCPA's changes to §523(a)(15), but it is not excepted from a chapter 13 discharge. §1328(a). Similarly, certain nonpecuniary tax penalties and debts incurred to pay a nondischargeable tax, excepted from discharge under §523(a)(7), (14) and (14A), are dischargeable in a chapter 13 case.
The plan confirmation process is far more complex in chapter 11. The fundamental difference, of course, is that creditors with impaired claims are entitled to accept or reject a chapter 11 plan. §1126(a). Before soliciting acceptances, the debtor must prepare and send to creditors a disclosure statement, approved by the bankruptcy court, that contains "adequate information" sufficient to enable creditors to make an informed decision about whether to accept the plan. §1125.
A creditor's affirmative acceptance is usually immaterial to confirmation of a chapter 13 plan. But creditor acceptance is critical in chapter 11 for two principal reasons. First, confirmation requires acceptance by at least one impaired class of creditors,4 with acceptance determined without regard to the claim of any insider. §1129(a)(10).
Second, with regard to each nonaccepting impaired class, the plan must satisfy the cramdown requirements of §1129(b). For secured claims, chapter 11 operates similarly to chapter 13. Cramdown of unsecured claims in chapter 11, however, requires compliance with the "absolute priority rule." §1129(b)(2)(B).
In general, the absolute priority rule prohibits a junior class of claims or interests from receiving or retaining any property under the plan unless claims in a senior dissenting class are paid in full. The rule has been interpreted to preclude confirmation of a plan that provides for the debtor to retain exempt property over the objection of the class of unsecured creditors because the debtor's interest in exempt property is junior to that class. In re Fross, 233 B.R. 176 (B.A.P. 10th Cir. 1999). A contrary view is that the absolute priority rule does not prohibit confirmation of such a plan because the debtor's retention of exempt property occurs by operation of law, not "under the plan." In re Henderson, 321 B.R. 550 (Bankr. M.D. Fla. 2005), aff'd. 2006 WL 1280988 (M.D. Fla. May 9, 2006). The chapter 11 business practitioner immediately thinks of payments by the debtor from post-petition earnings as qualifying for the "new value" exception to the rule even if it is applicable, but the Supreme Court has held that an individual's "sweat equity" does not qualify as "new value." Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988).
Consideration of an oversimplified consumer debt situation illustrates the differences in cramdown in chapter 11 and 13 cases. Assume that a debtor with fully exempt assets owes $15,000 on a car worth $10,000 and has five credit card debts of $4,000 each. The debtor proposes to (1) pay $10,000 on the car debt, with appropriate interest; (2) treat the $5,000 deficiency as an unsecured claim; (3) pay a small percentage of the unsecured claims, no more than the amount required to satisfy the disposable income test; and (4) retain all exempt property. Prior to BAPCPA, courts routinely confirmed such plans in chapter 13 cases; under the §1325(a)(5) "hanging paragraph" added by BAPCPA, the debtor must pay the car debt in full if it is secured by a purchase-money security interest in the car, the debt was incurred within 910 days of filing and the debtor acquired the car for personal use.
Confirmation of the plan in a chapter 11 case depends on how creditors vote. If both the car creditor and the class of unsecured creditors reject the plan, the plan is not confirmable because no impaired class has accepted it. On the other hand, if both the car creditor and the unsecured class accept the plan, it is confirmable because the absolute priority rule applies only if unsecured creditors do not accept the plan.
The plan is also confirmable if the car creditor rejects it but the class of unsecured creditors accepts it. As a secured creditor, the car creditor cannot invoke the absolute priority rule; as an unsecured creditor, the acceptance by the unsecured class eliminates its application because cramdown is not required. §1129(a)(8).
If the car creditor accepts the plan but the unsecured creditors reject it, confirmation will hinge on which of the interpretations of the absolute priority rule discussed above the court adopts.
Amendments Affecting Individual Chapter 11 Cases
BAPCPA affects individual chapter 11 cases in three ways. First, several new provisions apply to all individual debtors. Second, some amendments apply in all chapter 11 cases. Third, BAPCPA adds provisions previously applicable only in chapter 13 cases to govern chapter 11 cases of individuals.
Amendments Applicable in All Individual Cases
BAPCPA makes an individual's case under any chapter more difficult; most of the new requirements also apply in chapter 11 cases of individuals. These provisions include the pre-petition credit-briefing requirement for eligibility in §109(h), new limitations on the automatic stay in §362 and the expansion of an individual debtor's duties with regard to disclosure of information and filing of tax returns under §521. An uncodified provision of BAPCPA prohibits confirmation of an individual's chapter 11 or 13 plan "unless requested tax documents have been filed with the court." BAPCPA §1228(b).
If the individual chapter 11 debtor qualifies as an "assisted person" (an individual with primarily consumer debts with nonexempt property less than $150,000, §101(3)), the rules in §§526-528 with regard to "debt relief agencies" are applicable. And if the individual's debts are primarily consumer debts, new rules with regard to notices in §342 apply. Also of significant import is the new first priority for "domestic-support obligations" under §507(a)(1). Unless the holder of such a claim accepts the chapter 11 plan, §1129(a)(9)(B) requires payment in full on the plan's effective date.
Other new provisions in chapter 11 correspond to new rules for individual chapter 7 and 13 cases. For example, the individual chapter 11 debtor must provide notices with regard to domestic-support obligations, §1106(a)(8), identical to those that chapter 7 and 13 trustees must provide. §§704(a)(10), 1302(b)(6). Failure to pay post-petition domestic-support obligations is a ground for dismissal or conversion of the case in both chapters (§§1112(b)(4)(P), §1307(b)(11)); in chapter 11 cases, such failure is also a ground for appointment of a trustee. §1104(a)(3). Similarly, both chapters condition confirmation of a plan on the debtor's payment of post-petition domestic-support obligations. §§1129 (a)(14), 1325(a)(8). As in chapter 7 and 13 cases, entry of the chapter 11 discharge must be delayed if §522(q)(1) may be applicable to the debtor and a proceeding is pending in which the debtor may be found guilty of a crime of the kind described in §522(q)(1)(A) or liable for a debt of the kind described in §522(q)(1)(B). §§707(a)(12), 1141(d)(5)(C), 1328(f).5
New Provisions for All Chapter 11 Cases
A second category of BAPCPA's amendments makes chapter 11 cases more difficult for any debtor. Of concern to individuals are the new provisions for "small-business cases" that apply if a debtor with less than $2 million of debt is engaged in commercial or business activities, unless a creditors' committee has been appointed and is sufficiently active. See §101(51C), (51D). The new small-business rules include additional reporting and filing requirements under §1116, stricter deadlines for the filing and confirmation of a plan under §1121(e) and §1129(e), and potentially more relaxed requirements for a disclosure statement under §1125(f). All chapter 11 debtors must timely pay post-petition taxes applicable to the debtor's business under BAPCPA's amendments to 28 U.S.C. §960.
Other changes of interest to chapter 11 individual debtors include new standards for the appointment of a trustee or examiner or conversion or dismissal of the case under §§1104 and 1112, new rules governing creditors' committees under §1102, new limitations on the exclusivity period for the debtor to file and obtain confirmation of a plan under §1121(d), and revised (and possibly, more flexible) requirements for disclosure statements under §1125. Importantly, the new disclosure statement rules require "a discussion of the potential federal tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case." §1125(a)(1).
New Provisions for Individual Chapter 11 Cases
Amendments in the third group apply only in individual chapter 11 cases. Generally, BAPCPA incorporates provisions previously applicable only in chapter 13 cases into chapter 11 cases of individuals. Although these new provisions were borrowed from chapter 13, they have different effects in chapter 11.
Post-petition Property as Property of the Estate
Property acquired by an individual debtor after the filing of the case is not property of the estate under §5416 unless it is property to which the debtor becomes entitled within 180 days after filing as a result of bequest, devise, inheritance, property settlement in a divorce, or as the beneficiary of a life insurance policy or death benefit plan. §541(a)(5).7 In a chapter 13 case, §1306(a)(1) includes post-petition property as property of the estate. Upon conversion to another chapter, however, §348(f) excludes post-petition property from property of the estate in the converted case unless the debtor converted the case in bad faith.8 Under these provisions, prior to BAPCPA, a debtor filing a petition under chapter 7, 11 or 13 could retain post-petition property if the case ended up in chapter 7.
BAPCPA changes this result for chapter 11 debtors. New §1115(a)(1), in language identical to §1306(a)(1), provides that any property of the kind specified in §541 acquired after commencement of the case is property of the chapter 11 estate. Upon conversion from chapter 11 to chapter 7, the post-petition property remains property of the estate, however, because §348(f) applies only upon conversion from chapter 13 to chapter 7.
Two consequences flow from the addition of §1115(a)(1). First, a chapter 11 debtor, unlike the chapter 13 debtor, will not be able to retain post-petition property if the case is converted to chapter 7. Second, the fact that the post-petition property remains property of the estate and available for liquidation in the chapter 7 case means that its value must be taken into account in applying the "best interests" test of §1129(a)(7)(A)(ii), under which creditors must receive at least as much under the plan as they would receive in a chapter 7 liquidation.9
An amendment to the cramdown provisions of §1129(b)(2)(B)(ii) permits the debtor to retain post-petition property under the plan. Nevertheless, the fact that it remains property of the estate in a converted case indicates that its value must be taken into account in applying the best interests test.
Post-petition Earnings as Property of the Estate
Under §541(a)(6), property of the estate does not include an individual's earnings from services performed post-petition. In a chapter 13 case, such earnings are property of the estate under §1306(a)(2). Pre-BAPCPA chapter 11 had no similar provision, and most courts concluded that earnings directly attributable to an individual's post-petition services were not property of the estate in the chapter 11 case.10
New §1115(a)(2), in language identical to §1306(a)(2), now expressly includes post-petition earnings as property of the estate and, as discussed above, §348(f) does not exclude them from a chapter 7 estate upon conversion. Thus, a debtor who is able to establish a savings account from post-petition earnings during a chapter 11 case must turn the funds over to the chapter 7 trustee for distribution to creditors.
The inclusion of post-petition earnings as property of the estate in individual chapter 11 cases raises other issues. As noted earlier, the filing of a chapter 11 petition creates the bankruptcy estate as a separate taxable entity under 26 U.S.C. §1398. Profs. Williams and Todres conclude that under this provision, all of a chapter 11 debtor's post-petition earnings are payable to the chapter 11 estate and reportable by it as its income.11 They suggest that the estate will pay some portion of the earnings it receives to the individual debtor as an administrative expense based on an application by the debtor and that the estate should be able to deduct the amount paid as an administrative expense.12
Chapter 13 does not contemplate judicial supervision of a debtor's use of post-petition earnings prior to confirmation beyond the statutory mandates that the debtor make adequate-protection payments on claims secured by personal property and payments to the trustee as proposed in the plan. §1326(a). Chapter 11 has no specific requirement that adequate protection payments begin (although they may, of course, be required under §363(e)), and no mechanism for pre-confirmation plan payments.
Courts will have to determine whether a chapter 11 debtor, like a chapter 13 debtor, retains control over the use of post-petition earnings prior to confirmation of plan and whether, and to what extent, the chapter 11 filing restricts the debtor's ability to pay post-confirmation living expenses. Chapter 11 debtors, particularly those with above-median incomes, may face challenges to spending for personal expenses that exceed amounts prescribed under the standards applicable for determining projected disposable income in connection with confirmation under §1129(a)(15)(B). This requirement adopts the chapter 13 definition of disposable income which, in turn, incorporates the "means test" standards applicable in chapter 7 cases for above-median income debtors. Perhaps a debtor may avoid limitations on spending with a showing that the plan will provide for full payment of unsecured claims so that the projected disposable-income test will not be applicable (§1129(a)(15)(A)) or with an argument that the test does not become effective until confirmation. The amended statute provides no guidance on these issues.
An initial question confronting debtor's counsel is whether the debtor must seek prior court approval of the use of post-petition earnings for payment of personal expenses. Section 363(b) requires notice and a hearing for the use of estate property "other than in the ordinary course of business." Debtor's counsel might conclude that this section permits the debtor to continue to pay ordinary living expenses, but counsel for a creditor or subsequent trustee might conclude, to the contrary, that the statute does not apply to permit payment of personal as opposed to business expenses in the ordinary course.
Beyond these pre-confirmation considerations, the inclusion of post-petition earnings as property of the estate changes the analysis of confirmation issues. Under pre-BAPCPA law, a debtor's post-petition earnings were irrelevant to chapter 11 confirmation requirements except to the extent that the debtor had to demonstrate an ability to make payments under the feasibility standards of §1129(a)(11). Under §1123(a)(8) as added by BAPCPA, an individual debtor's plan must provide for payment of earnings as are necessary for execution of the plan. This new provision appears to do little more than expressly state an existing confirmation requirement.
But BAPCPA adds a new confirmation standard for individual cases (§1129(a)(15)) that requires the commitment of projected disposable income, as defined in §1325(b)(2) for chapter 13 purposes, for the longer of five years or the period for which the plan provides for payments if the holder of an allowed unsecured claim objects to confirmation. Unlike the cramdown provisions, which apply only if a class of creditors does not accept the plan, this requirement may be invoked by a single creditor.
In adding this requirement, Congress presumably intended to incorporate the projected disposable-income concept of chapter 13 (which, in turn, is related to the chapter 7 means test of new §707(b)) into chapter 11 for the benefit of unsecured creditors, but it may have missed the mark. Generally, chapter 13 after BAPCPA requires that projected disposable income be paid to holders of allowed unsecured claims. §1325(b)(1)(B). In contrast, §1129 (a)(15) provides only that the amount to be distributed under the chapter 11 plan be not less than the projected disposable income for the required period. Significantly, it does not require that the payments be made to holders of unsecured claims.
Post-Confirmation Modification of the Plan
Related to the provisions dealing with post-petition earnings are new provisions for post-confirmation modification of an individual's confirmed chapter 11 plan. BAPCPA adds a new §1127(e) which, in language identical to §1329(a) prior to its amendment by BAPCPA,13 permits modification of a confirmed chapter 11 plan upon request of the debtor, the trustee, the U.S. Trustee or the holder of an allowed unsecured claim. New §1127(e) permits modification to increase or reduce the amount of payments on claims of a particular class, to extend or reduce the time for payments, or to alter the amount of a distribution on a claim as necessary to take account of payment other than under the plan. Arguably, the chapter 13 provision permits a chapter 13 trustee to modify a plan to increase payments to unsecured creditors based on increased post-confirmation earnings of the debtor, but the statutory language does not necessarily require this result. Chapter 13 cases dealing with this issue will presumably provide guidance for interpretation of the identical language that BAPCPA added for chapter 11 cases.
New Chapter 11 Discharge Rules
BAPCPA does not change §1141 (d)(2), which provides that a chapter 11 discharge in an individual case does not discharge any debt that would be excepted from discharge under §523 in a chapter 7 case, or §1141(d)(3), which denies a discharge to a debtor who would be denied a discharge in a chapter 7 case if the plan provides for the liquidation of all or substantially all of the property of the estate and if the debtor does not engage in business after consummation of the plan.
Under new §1141(d)(5), however, confirmation of an individual's plan no longer results in a chapter 11 discharge, as it does in nonindividual cases. Instead, revised §1141(d)(5)(A) provides that confirmation of an individual's chapter 11 plan, like the confirmation of a chapter 13 plan, does not discharge any debt until the court grants a discharge upon completion of all plan payments. In contrast to chapter 13 provisions, however, the court may order otherwise, for cause. As noted above, discharge may be delayed under §1141(d)(5)(C) if there are §522(q) issues.
BAPCPA provides an exception to the requirement that the debtor complete payments under the plan to receive a discharge, similar to the so-called "hardship discharge" of chapter 13. §1328(b). Under new §1141(d)(5)(B), the court may grant a discharge to a chapter 11 debtor who has not completed payments under the plan if unsecured creditors have received as much as they would have received in a chapter 7 liquidation on that date and modification of the plan under §1127 is not practicable. Unlike the requirements for a chapter 13 hardship discharge, the chapter 11 hardship discharge requirements do not include the requirement that the debtor's failure to complete plan payments be due to circumstances for which the debtor should not justly be held accountable.
Chapter 11 is even more difficult for individuals after the BAPCPA amendments than it was before. Post-petition earnings are now property of the estate, and creditors may insist that debtors commit their projected disposable income to make plan payments for at least five years unless full payment occurs earlier. Consequently, debtors face judicial supervision of their post-petition incomes with potential adverse impact on their lifestyles. Moreover, the absolute priority rule may bar confirmation of a plan for the debtor to retain assets without full payment of claims. Chapter 11's usefulness for individuals may thus be limited to permitting a debtor time to liquidate assets to pay creditors in full, to propose a plan for full payment over time, or to attempt to convince creditors that accepting a plan for some reduced payment is better than liquidation under chapter 7.
1 References are to the Bankruptcy Code, title 11 of the U.S. Code.
2 BAPCPA does not change valuation of collateral in chapter 11 cases as it does in chapter 13 cases. The new requirement in §506(a)(2) for use of replacement value with respect to personal property securing an allowed claim applies only in chapter 7 and 13 cases. The so-called "hanging paragraph" of §1325(a) that eliminates §506(a) bifurcation in chapter 13 cases with regard to claims secured by certain types of collateral has no counterpart in chapter 11.
3 "Domestic support obligation" is a new term defined in §101(14A). In general, it broadly encompasses a debtor's obligations for alimony, maintenance or support to a spouse, former spouse or child of the debtor.
4 A class accepts a plan if the plan is accepted by creditors holding at least two-thirds in amount and a majority in number of the claims held by creditors in the class who vote. §1126(c).
5 Generally, §522(q) limits exemptions in certain property to $125,000 if the debtor has been involved in certain criminal activity or owes debts arising from violation of securities laws or criminal, intentional or willful or reckless conduct resulting in serious physical injury or death to another. How and whether the statute accomplishes its objectives is beyond the scope of this discussion. Suffice it to say that the same issues exist in all chapters.
6 The question does not arise in the case of an entity because anything the entity acquires after the filing of the petition must of necessity come from assets that existed when the petition was filed. As such, any acquisition of post-petition property must be proceeds of property of the estate that is included as property of the estate under §541(a)(6).
7 Property that a debtor acquires post-petition that is not property of the estate must be distinguished from post-petition income, rent or other proceeds that are property of the estate under §541(a)(6). Thus, a car that the debtor buys with cash from his exempt savings account is not property of the estate, whereas interest on a nonexempt savings account is property of the estate.
8 This type of post-petition property differs from proceeds of property of the estate, which have always been included as property of the estate under §541(a)(6).
9 Because the post-petition property would not be an asset of the chapter 13 debtor's estate if it were liquidated on the confirmation date, the issue does not arise in a chapter 13 case. See §1325(a)(4).
10 Williams, Jack F. and Todres, Jacob L., "Tax Consequences of Post-Petition Income as Property of the Estate in an Individual Debtor Chapter 11 Case and Tax Disclosure in Chapter 11," 13 Am. Bankr. Inst. Law Rev. 701, 702-11 (2005) (collecting cases). The article summarizes the pre-BAPCPA state of the law as follows, id. at 705 (footnotes omitted): Before enactment of the 2005 Act, courts had taken three different positions on whether an individual chapter 11 debtor's post-petition earnings should be included in the bankruptcy estate: (1) that all income flowing to an individual debtor in a chapter 11 case becomes property of the estate under §541(a)(7) pending confirmation of a plan, just as such property does in a corporate or partnership chapter 11 case—that is, that the §541(a)(6) carve-out does not apply; (2) that all post-petition earnings by an individual chapter 11 debtor are excluded from the estate by §541(a)(6); and (3) that the debtor's post-petition income should be split under §541(a)(6) based on how the income was generated, with the portion linked to services actually performed by the debtor carved out of the estate.
11 Id. at 717.
12 Id. at 717-22.
13 BAPCPA amended §1329(a) to add an additional subsection (4) to permit a reduction in amounts to be paid if the debtor acquires health insurance under certain circumstances. The chapter 11 provision does not include this additional ground for modification of the plan.