Fourth Circuit Preserves Absolute Priority Rule Despite Challenge Through BAPCPA

By: Andrew Serrao

St. John’s Law Student

American Bankruptcy Institute Law Review Staff

In the first appellate decision on the issue, the Fourth Circuit in In re Maharaj[1] held that the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) did not abrogate the absolute priority rule’s applicability to individual Chapter 11 debtors.[2] Ganess and Vena Maharaj (the “Debtors”) accumulated a significant amount of debt while owning and operating an auto body repair shop.[3] The Debtors filed a voluntary petition under Chapter 11 in bankruptcy court, and subsequently filed a plan of reorganization (the “Plan”),[4] pursuant to section 1121(a).[5] The Plan provided that the Debtors would continue to own and operate their auto body business, using income from the business to pay general unsecured claims.[6] The Plan also separated creditors into four classes[7]. Class 3 (general unsecured claims) voted to reject the Plan,[8] and the Debtors sought a cram down.[9] If BAPCPA had abrogated the absolute priority rule, the Debtors could have retained their auto body business and crammed down the Plan.[10] However, the Fourth Circuit held that the absolute priority rule had not been abrogated by BAPCPA.[11]

The Fourth Circuit held that neither the statutory language,[12] nor Congressional intent, nor policy considerations favored the Debtors’ interpretation of BAPCPA, and affirmed the bankruptcy court’s denial of plan confirmation. First, the Fourth Circuit examined the relevant statutory language in sections 1129(b)(2)(B)(ii) and 1115, which it concluded were ambiguous.[13] Without clear direction from the statutory language, the Fourth Circuit examined the legislative history.[14] The court noted that Congress must clearly state its intention to repeal the absolute priority rule in individual Chapter 11 cases, or the Debtors’ interpretation of BAPCPA could not be adopted because “[a]s a general matter, [especially in the bankruptcy context,] repeals by implication are not favored, and therefore, the intention of the legislature to repeal must be clear and manifest.”[15] The Fourth Circuit held that Congress failed to make clear any intent in either the relevant statutory language or the inconclusive legislative history to repeal the absolute priority rule.[16] Finally, the Fourth Circuit rejected the Debtors’ policy arguments[17] that the continued application of the absolute priority rule makes plan confirmation very difficult or impossible for individual Chapter 11 debtors, contrary to the goals of Chapter 11.[18] The Fourth Circuit noted that Congress did not express intent to provide greater benefits to debtors by enacting BAPCPA,[19] and that plan confirmation is still possible with the continued application of the absolute priority rule.[20]

Although the Fourth Circuit is the first circuit court to decide this issue, the bankruptcy and district courts have disagreed as to whether BAPCPA abrogated the absolute priority rule. Furthermore, while the Fourth Circuit and some lower courts[21] have taken the view that BAPCPA did not abrogate the absolute priority rule, they have not agreed on the reasons why. For example, the In re Gbadebo[22] court held that the language of section 1129(b)(2)(B)(ii) unambiguously preserved the absolute priority rule, while the Fourth Circuit determined the statutory language was ambiguous. And, as mentioned above, other courts[23] have held that Congress did abrogate the absolute priority rule with the passage of BAPCPA. For example, the court in SPCP Group, LLC. v. Biggins[24] held that the plain meaning of section 1129(b)(2)(B)(ii) abrogated the absolute priority rule. This appears to be a complex issue dividing the courts, and only time will tell if future decisions bring clarity to the status of the absolute priority rule.