Fourth Circuit Finds Absolute Priority Rule Applicable to Individual Debtors

Posted by NCBRC - June 15, 2012

The Fourth Circuit Court of Appeals has dealt a blow to debtors on the issue of whether the absolute priority rule applies in individual chapter 11 cases. In re Maharaj, No. 11-1747 (4th Cir. June 14, 2012). The decision turned on the court’s finding that the reference in section 1129(b)(2)(B)(ii) to “property included in the estate under section 1115,” and the words “in addition to” as found in section 1115 were amenable to differing interpretations. Having found the meaning ambiguous, the court went on to base its decision on its view of congressional intent.

Two factors were primary in its conclusion that the absolute priority rule was not abrogated. 1) its interpretation of the overarching purpose behind BAPCPA, and 2) its belief that had Congress intended to abrogate the rule, it would have done so more coherently.

With respect to BAPCPA’s purpose, and despite the fact that its very title purports to be equally geared toward abuse prevention and consumer protection, the court found that its purpose was, in fact, to ensure that consumer debtors pay as much to their creditors as possible. The court quoted In re Gbadebo, 431 B.R. 222, 229 (Bankr. N.D. Cal. 2010), for the conclusion that “[n]o one who reads BAPCPA as a whole can reasonably conclude that it was designed to enhance the individual debtor’s ‘fresh start.’” The court rejected the argument that when Congress enacted the means test  it effectively shunted many debtors who were not eligible for chapter 13 relief and who were no longer eligible for chapter 7 relief into chapter 11. Having thus directed a new class of debtors into this reorganization chapter, it makes no sense for Congress to make it virtually impossible for them to have a plan confirmed under that chapter.

The decision is equally nonsensical with respect to the drafting of the statutes. One could equally argue that “no one who reads BAPCPA as a whole could reasonably conclude” that Congress always expresses its intent in the most efficient and concise way. However, that is what the Court seemed to conclude. It found that had Congress intended to abrogate the absolute priority rule, there were better ways that it could have done it and, therefore, that was not Congress’s intent.

Having concluded that Congress did not intend to afford debtors a greater opportunity to retain their business while repaying their creditors to the best of their ability, the court went on to take a rosy view of creditors. It found that debtors’ relief, denied by Congress, can be found in the generosity of their creditors to agree to a plan that allows the debtor to continue his business even though to do so lessens their recovery.

This issue is currently pending in the Fifth Circuit, In re Lively, No. 12-90014, (debtor lost below) and the Ninth Circuit, P + P, LLC v. Freidman, No. 12-60033, 12-60034, (debtor won below), and the Tenth Circuit, In re Stephens, No. 11-6309 (debtor won below).

Maharaj opinion


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