United States: Fifth Circuit Applies Absolute Priority Rule In Individual Chapter 11 Cases

On May 29, 2013, the Fifth Circuit Court of Appeals issued its decision in In re Lively, affirming an order on appeal from the U.S. Bankruptcy Court for the Eastern District of Texas and holding that the absolute priority rule, 11 U.S.C. § 1129(b)(2)(B)(ii), as amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), applies in individual chapter 11 cases.¹ The ruling resolves a question of first impression in the Fifth Circuit, taking the "majority view" approach on a controversial issue that bankruptcy courts have grappled with of late.²

In In re Lively, the individual debtor's chapter 13 case was converted to a chapter 11 when a creditor's claim caused the debtor's scheduled debts to exceed the statutory limit for chapter 13 cases.³ Proceeding with a chapter 11 plan, the debtor proposed to retain all of his property while paying unsecured creditors a small amount that exceeded the liquidation value of his assets.⁴ Although no competing plans or objections to confirmation were filed, the bankruptcy court cited its "mandatory and independent duty" to determine whether the "cramdown" requirements of 11 U.S.C. § 1129(b) were met after a majority of the class of unsecured creditors voted to reject the plan.⁵ At the confirmation hearing, the bankruptcy court preliminarily announced its intention to deny plan confirmation for violating the absolute priority rule and invited the parties to submit briefs on this issue.⁶ Only one brief was filed: The debtor filed a brief in support of his argument that BAPCPA abrogated the absolute priority rule for individual chapter 11 cases.⁷ The debtor adopted the "broad view" espoused by several courts, arguing that the language of § 1129(b) (2) (B)(ii) provides that an individual chapter 11 debtor may retain "all property" that is included within the definition of property of the estate under 11 U.S.C. § 1115.⁸ The debtor further argued that the "narrow view," interpreting § 1129(b)(2) (B) (ii) as excepting property "included in" or "added to" the estate under § 1115, renders the exception trivial.⁹ The bankruptcy court disagreed.¹⁰

The bankruptcy court first noted that the plan failed to satisfy the requirements of 11 U.S.C. § 1129(b)(2)(B)(i) because it did not provide for payments equal to the allowed amount of the claims of the impaired dissenting classes of unsecured creditors.¹¹ Accordingly, the bankruptcy court proceeded to examine § 1129(b) (2) (B) (ii) to determine whether confirmation was warranted. The bankruptcy court cited to the language added to § 1129(b) (2) (B)(ii) by BAPCPA, noting the split of authority regarding what property is included in the estate under § 1115.¹² Finding that the plain language of § 1115 is unambiguous and that the exception fits coherently and consistently into the overall scheme of reorganization under chapter 11, the bankruptcy court ruled that the absolute priority rule applies in individual chapter 11 cases, held that the debtor's plan did not satisfy § 1129(b)(2)(B)(ii) and denied confirmation.¹³ Thereafter, and recognizing no controlling decisions by the Fifth Circuit Court of Appeals or by the U.S. Supreme Court, the bankruptcy court certified its order denying confirmation to the Fifth Circuit.¹⁴

The Fifth Circuit Court of Appeals promptly accepted the certification, stating that the issue of whether BAPCPA abrogated the absolute priority rule has been arising with some frequency in the Fifth Circuit and has been the subject of conflicting bankruptcy court opinions.¹⁵ Reviewing the issue de novo, the court began its analysis by citing the language of § 1129(b)(2)(B) and examining the debtor's argument that the language added to § 1129(b)(2)(B)(ii) at the time of the 2005 amendments to the Bankruptcy Code provided his exemption from the statute entirely.¹⁶ Because the language added to § 1129(b)(2)(B)(ii) speaks to retention of property included in the estate under § 1115, the court further reviewed § 1115 (also added during the 2005 amendments) against the debtor's question, "What does the provision mean when it allows an individual debtor to retain property included in the debtor's estate under § 1115?,"¹⁷ thus framing the crux of the BAPCPA-revised absolute priority rule.

The court recognized that the cases interpreting BAPCPA's modification of the absolute priority rule fall into one of two camps: the "narrow view," which contends that the absolute priority rule was amended so that individual debtors could exclude from its reach only their post-petition earnings and post-petition property acquisitions (only property that was not already included in the estate under § 541),¹⁸ and the "broad view," which contends that the exception's reference to the property "included in" the individual debtor's estate under § 1115 subsumes or supersedes the § 541 definition completely, thus effectively abrogating the absolute priority rule.¹⁹

Focusing on the language of the statute in the context of the Bankruptcy Code, the Fifth Circuit adopted the "narrow view" as unambiguous and correct, and ruled that the exception to the absolute priority rule "plainly covers only the individual debtor's post-petition earnings and post-petition acquired property."²⁰ The court's plain reading of § 1129(b)(2)(B)(ii) in light of § 1115 included its view that both provisions were adopted via the BAPCPA amendments in order to manage individual debtor reorganization, in some respects, more like chapter 13 cases.²¹ Noting that before the BAPCPA amendments individual chapter 11 debtors were only required to devote assets that were property of the estate at the time of the petition in order to comply with the absolute priority rule, the court observed that Congress remedied this potential inequity of chapter 11 by adding to the § 541 definition the individual's post-petition earnings and property acquisitions through § 1115.²² The Fifth Circuit cited to the recent decision in In re Kamell²³ for support of its position that under this new statutory scheme, Congress had to modify § 1129(b)(2)(B)(ii) so that a debtor would not be burdened with pledging all post-petition property to satisfy creditors' claims.²⁴ The court concluded that this "most natural reading of the amendments renders no Code provision superfluous and reveals a reasonable purpose."²⁵

The court further reasoned that even if the statutory language was ambiguous, the narrow view must prevail because "the opposite interpretation leads to a repeal by implication of the absolute priority rule."²⁶ Construing that the "broad view" results in a complete abrogation of the absolute priority rule for debtors, the court stated that the minority view was unacceptable as a matter of statutory construction, reasoning that such an interpretation would be a "startling and most indirect way for Congress to have effected partial implicit repeal of the very provision that the section amended."²⁷ Therefore, the Fifth Circuit's decision in In re Lively joins the recent decisions of the Tenth Circuit²⁸ and the Fourth Circuit²⁹ in holding that the absolute priority rule, as amended by the BAPCPA, applies in chapter 11 individual cases. abi

Reprinted with permission from the ABI Journal, Vol. XXXII, No. 7, August 2013.

Footnotes

1 In re Lively, No. 12-20277, 2013 WL 2347045 at *1 (5th Cir. May 29, 2013).

2 Cases adopting the "majority view" or "narrow view" interpreting §§ 1129(b)(2)(B)(ii) and 1115 to except property added to the bankruptcy estate, and thereby holding the absolute priority rule applicable, include In re Maharaj, 449 B.R. 484 (Bankr. E.D. Va. 2011); In re Kamell, 451 B.R. 505 (Bankr. C.D. Cal. 2011); In re Borton, No. 09-00196-TLM, 2011 Bankr. LEXIS, at *1 (Bankr. D. Idaho Nov. 9, 2011); In re Gelin, 437 B.R. 435 (Bankr. M.D. Fla. 2010); In re Gbadebo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); In re Karlovich, 456 B.R. 677 (Bankr. S.D. Cal. 2010). Cases adopting the "minority view" or "broad view" interpreting §§ 1129(b)(2)(B)(ii) and 1115 to except all property of the bankruptcy estate, and thereby holding the absolute priority rule inapplicable, include In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012); In re Shat, 424 B.R. 854 (Bankr. D. Nev. 2010); In re Johnson, 402 B.R. 851 (Bankr. N.D. Ind. 2009); and In re Roedemeier, 374 B.R. 264 (Bankr. D. Neb. 2007).

3 See In re Lively, 466 B.R. 897, 898 (Bankr. S.D. Tex. 2011).

4 See id. at 898-99.

5 See id. at 899.

6 See id. at 897.

7 See id. at 898.

8 See id. at 901.

9 See id. at 902.

10 See id.

11 Id. at 900. 11 U.S.C. § 1129 provides:

(b)(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(B) With respect to a class of unsecured claims €"

(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim.

In In re Lively, the debtor admitted that his plan did not provide for payments equal to the allowed amount of the claims of the impaired dissenting classes of unsecured creditors, instead relying on the exception under (ii) for confirmation.

12 In re Lively, 466 B.R. 897 at 898. 11 U.S.C. § 1129(b)(2)(B)(ii) provides:

(b)(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

(B) With respect to a class of unsecured claims €"

(ii) 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. (emphasis added to denote BAPCPA amendment).

13 See In re Lively, 466 B.R. at 901-03.

14 See In re Lively, 467 B.R. 884, 884 (Bankr. S.D. Tex. 2012).

15 In re Lively, 2013 WL 2347045, at *2.

16 2013 WL 2347045, at *2. See id. at *2-3.

17 See id. at *3. 11 U.S.C. § 1115 provides:

Property of the estate.

(a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 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.

(b) Except as provided in section 1104 or a confirmed plan or order confirming a plan, the debtor shall remain in possession of all property of the estate.

18 See id. at *2 (citing In re Maharaj, 449 B.R. 484 (Bankr. E.D. Va. 2011); In re Gelin, 437 B.R. 435 (Bankr. M.D. Fla. 2010); In re Gbadebo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); and In re Karlovich, 456 B.R. 677 (Bankr. S.D. Cal. 2010), as cases adopting the "narrow view").

19 See id. (citing In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012); In re Shat, 424 B.R. 854 (Bankr. D. Nev. 2010); and In re Roedemeier, 374 B.R. 264 (Bankr. D. Neb. 2007), as cases adopting "broad view").

20 Id.

21 See id.

22 See id. Prior to BAPCPA, § 1129(b)(2)(B)(ii) provided that "the holder of a claim or interest that is junior to the claims of such [impaired dissenting] class will not receive or retain under the plan on account of such junior claim or interest any property."

23 451 B.R. 505, 511 (Bankr. C.D. Cal. 2011).

24 Id. at *3. In re Kamell, 451 B.R. 505, 511 (Bankr. C.D. Cal. 2011) (holding that "the property included in the estate under § 1115 includes all post-petition earnings, not limited by deduction for monthly expenses [as in chapter 13] ... [s]o, if the absolute priority rule persisted after BAPCPA, it would have prevented the debtor from keeping any of his post-petition earnings as the price for cram down; thus enters the necessary amelioration in § 1129(b)(2)(B)(ii).... But this is as far as one needs to go to make sense of the new statutory scheme").

25 Id.

26 Id. The court cited to Nat'l Ass'n of Home Builders v. Defenders of Wildlife, 55 U.S. 644, 662 (2007), in support of its position that "[r]epeals by implication are disfavored and will not be presumed unless the legislature's intent is clear and manifest."

27 Id. The court further cited to Hamilton v. Lanning, 130 S. Ct. 2464, 2473 (2010), quoting that "we will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure."

28 In re Stephens, 704 F.3d 1279 (10th Cir. 2013).

29 In re Maharaj, 681 F.3d 558 (4th Cir. 2012).

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