Fifth Circuit – Absolute Priority Rule

Written by: Robert DeMarco
The Fifth Circuit has confirmed that the absolute priority rule remains intact for an individual filing a chapter 11 bankruptcy petition.  Judge Edith Jones, writing for the Court, in In re Lively, 12-20277, 2013 WL 2347045 (5th Cir. May 29, 2013), concluded that section 1129(b)(2)(B), as amended by the Bankruptcy Abuse Prevention & Consumer Protection Act of 2005 (Pub.L. No. 109-8, 119 Stat. 23 (2005)) applies to individual debtor cases.
The scenario that Philip Lively [“Lively”] faced is nothing remarkable. To the contrary, it is rather commonplace.  Lively initially filed a chapter 13 bankruptcy petition.  However, Lively’s bankruptcy case had to be converted to on under chapter 11 once it was learned that the debtor’s claims exceeded the chapter 13 debt ceiling.  See 11 U.S.C. § 109(e).
Lively proposed a chapter 11 plan that permitted him to retain all of his property, including the beneficial interest in a mortgage and none railroad tank cars that were being leased.  The unsecured creditors’ class voted against confirmation, thereby putting into play the question of whether the absolute priority rule applies to an individual chapter 11 debtor.

The absolute priority rule provides that a Chapter 11 reorganization plan is “fair and equitable” with respect to a dissenting class of unsecured claims, if
(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; or
(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.

In re Lively, 12-20277, 2013 WL 2347045, pages 1-2 (5th Cir. May 29, 2013) (citations omitted) (emphasis in original).  There was no dispute that the subject chapter 11 bankruptcy plan failed to comply with the absolute priority rule.  Instead, Lively relied upon the minority position which, in reliance upon the above italicized language, holds that individuals are exempt from the rule’s application.
Judge Jones, in discussing why Lively’s position was in error, stated thusly:

Before the BAPCPA amendments, however, an individual Chapter 11 debtor would only have to satisfy the absolute priority rule with assets that were “property of the estate” at the date of filing for relief; the individual debtor’s personal post-petition earnings were not subject to liability to satisfy his creditors. In § 1115, Congress remedied this potential inequity in Chapter 11 by adding to the § 541 definition the individual debtor’s post-petition earnings and property acquisitions.

Id. at page 2.  The Court then continued, quoting from In re Kanell, 451 B.R. 505, 511 (Bankr. C.D.Cal. 2011):

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.

Id. at page 3.
Be it good news or bad news, the issue is now resolved.  An individual chapter 11 debtor, like any other chapter 11 debtor, must comply with the absolute priority rule in the Fifth Circuit.
DATED:  May 31, 2013