In a case of first impression before the 9th Circuit, on January 28, 2016, the Court held that the Absolute Priority Rule applies in all chapter 11 cases, even if the debtor is an individual. In re Zachary. In relevant part, the Absolute Priority Rule (Rule) provides that a dissenting class of unsecured creditors must be provided for in full before the debtor can receive or retain any property under a reorganization plan. Through the Zachary decision, the 9th Circuit has answered the question: what property can the individual debtor retain and not pay to creditors, without running afoul of the Absolute Priority Rule? The answer is -- only property acquired by the debtor after his or her bankruptcy petition was filed.
Through the enactment of BAPCPA in 2005, Congress added section 1115 of the Bankruptcy Code. This section provides that in an individual chapter 11 case, "property of the estate" includes, in addition to the prepetition assets that traditionally constitute estate property, assets and earnings acquired after the case was filed. Congress also amended the Absolute Priority Rule itself (§1129(b)(2)(B)(ii)) to exclude – in an individual chapter 11 – property which would otherwise be included under section 1115. The question before the Court was whether this exception was intended to apply to all "property of the estate," thus abrogating the Rule altogether, or whether Congress intended only to except that which was added through section 1115 – post-petition property. Relying on the plain language and history of the statutory revisions, the 9th Circuit found that the Rule remained in effect as to any property owned by the debtor at the commencement of the case, meaning that in order for an individual debtor to retain any such property, it must satisfy the requirements of the Rule.
In Zachary, the husband and wife debtors were seeking to retain full ownership of the husband's business, their home, and their Lake Tahoe rental property. In turn, their chapter 11 Plan provided that our client, which held a claim on account of a $2.0 million guaranty, would be paid only $5,000. The bankruptcy court found that this violated the Absolute Priority Rule and denied confirmation of the Plan.
The debtors sought leave to appeal directly to the 9th Circuit, which was granted. Prior to this 9th Circuit decision, four other circuits weighed in on the issue and all agreed that BAPCPA did not repeal the Absolute Priority Rule as to individual chapter 11 debtors. However, in the 9th Circuit, the rogue contrary decision has been the Friedman case, decided by the Bankruptcy Appellate Panel. At oral argument, the court made clear that it is not bound by decisions of other circuits or decisions by an Article I court (i.e., the bankruptcy court and the BAP). Through this opinion, the 9th Circuit has now expressly overruled Friedman.
The Court noted that the debtors' reading of the BAPCPA amendments would require the Court to find an implied repeal of an over 100-year-old rule. The Court dismissed this out of hand, referring to numerous decisions which have held that Congress would not repeal a statute "in the most oblique way possible, and yet omit any mention of this remedy from the legislative history." Debtors also contended that fairness and equity weighed in favor of finding repeal. In response, the Court stated "our task is not to balance the equities, however, but to interpret the Bankruptcy Code."
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