Fifth Circuit Deals Blow to Individual Debtors in Chapter 11

Posted by NCBRC - June 10, 2013

The Fifth Circuit has joined the Fourth and Tenth Circuits in applying the absolute priority rule to individual debtors in chapter 11 bankruptcy. In re Lively, No. 12-20277 (5th Cir. May 29, 2013). See also In re Stephens, 704 F.3d 1279 (10th Cir. 2013); In re Maharaj, 681 F.3d 558 (4th Cir. 2012). But see In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012) (finding that the rule does not apply to individual debtors). The Fifth Circuit rejected the argument that section 1129(b)(2)(B)(ii) abrogates the rule in the case of individual debtors. That section sets forth an exception to the rule: “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.” Section 1115 provides that property of the estate “includes, in addition to the property specified in section 541 . . . all property . . . that the debtor acquires after commencement of the case.” The court discussed the competing views on this issue. The “narrow” view holds that the post-BAPCPA application of the absolute priority rule to an individual only excepts the debtor’s post-confirmation earnings and property acquisitions. The “broad” view holds that section 1129(b)(2)(B)(ii) refers to all of the debtor’s property under section 1115 including post-petition property and, therefore, abrogates the absolute priority rule in its entirety with respect to individual debtors. The court reconciled its interpretation that section 1115’s “includes, in addition to,” really means “includes only” post-petition property by finding that in amending these sections Congress intended to capture post-petition property which was not previously included in chapter 11 plans, but did not want that property to be subject to the absolute priority rule.

Unfortunately, this ruling will ultimately conflict with one of BAPCPA’s underlying purposes which is to encourage reorganization plans rather than liquidation. Because individual debtors in chapter 11 are typically there because their debt exceeds the limits for chapter 13, it makes more sense to conclude that the two chapters be read in harmony and without application of the absolute priority rule.

Lively opinion


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