• Caveat Creditor: Courts Split Regarding Abrogation of Absolute Priority Rule for Individual Chapter 11 Debtors
  • June 14, 2013 | Authors: Scott St. Amand; J. Ellsworth Summers
  • Law Firm: Rogers Towers, P.A. - Jacksonville Office
  • Although the 2005 BAPCPA amendments appeared to be a boon for creditors, at least with respect to Chapter 7 claims, individual Chapter 11 debtors immediately seized upon a perceived ambiguity in Congress’ language with regards to cramdown, which may ultimately prove costly for creditors.

    Generally, a plan of reorganization can be confirmed in one of two ways. If § 1129(a) is satisfied, a plan can be confirmed with the consent of each class of creditor. If the debtor does not have the consent of each class of creditor but satisfies the remainder of the paragraphs of § 1129(a), then the bankruptcy court may still confirm the plan, as long as the plan is, among other things, “fair and equitable.” This latter nonconsensual method is commonly referred to as “cramdown.”

    When a plan is crammed down, it is “fair and equitable” so long as it satisfies the Absolute Priority Rule of § 1129(b)(2)(B)(ii) (the “APR”). In other words, a reorganization plan that does not pay an unsecured creditor in full is nevertheless “fair and equitable,” and can be confirmed over the unsecured creditor’s objections, so long as an individual debtor does not retain property - except such property included in the bankruptcy estate under § 1115. This italicized exception, added in 2005 as part of the BAPCPA amendments, has caused a distinct split in courts throughout the country.

    Courts interpreting this new language disagree about the meaning of the phrase “property included in the estate under § 1115,” and thus also disagree as to the extent to which the APR applies to individual debtors after the amendment. A broad interpretation of the amendment would allow an individual debtor’s reorganization plan to be confirmed, while the debtor retains all property and wages acquired both pre-petition and post-petition, even if that plan does not pay an unsecured creditor in full, thus abrogating the APR. A narrow interpretation, on the other hand, would allow the individual debtor to keep only property and wages acquired post-petition.

    A recent case out of the Tenth Circuit surveyed relevant post-BAPCPA decisions and found that only one circuit court (the Ninth) and five bankruptcy courts have adopted the broad interpretation. In contrast, the Fourth and Tenth Circuits and seventeen bankruptcy courts have reached the opposite conclusion, holding that the BAPCPA amendments only exempt from the APR that property which § 1115 adds to an individual estate - not the pre-petition property already defined by § 541.

    Even within individual districts, courts are split. In the 2010 case of In re Gellin, Chief Judge Karen Jennemann of the Middle District of Florida held that “the narrow reading of § 1115 is the best, most likely interpretation of Congress’ intent,” in part because if Congress meant to eliminate the APR for individual debtors, it “could have simply stated that the [APR] is inapplicable when the debtor is an individual.” The appropriate reading, in Chief Judge Jennemann’s opinion, is that such property “included in the estate under § 1115” means only post-petition property added to the estate under § 1115.”

    Conversely, Judge Susan Bucklew of the Middle District of Florida held that the broad reading of § 1115 was appropriate because the statutory language of the amendment is clear and unambiguous. Thus, property of the estate, “for purposes of § 1115, includes property acquired and earnings earned after the debtor files his or her Chapter 11 petition, in addition to property specified in § 541,” which includes property that the debtor owns an interest in at the time of the commencement of the bankruptcy case. The effect of this broad interpretation is that the APR would no longer apply to any property of an individual debtor. Thus, in Judge Bucklew’s opinion, BAPCPA abrogated the APR with respect to individual Chapter 11 debtors.

    Although Judge Bucklew’s holding is certainly not without merit, at least nineteen separate courts have found the language in question to be ambiguous. Nevertheless, creditors and their counsel must be aware that individual Chapter 11 creditors will likely argue in favor of a broad interpretation, because it eliminates the most significant hurdle in the way of confirmation - the APR. If, in fact, the APR was abrogated with respect to individual Chapter 11 debtors, the result would be potentially devastating to unsecured creditors even in the short term.