News from NACBA: Absolute Priority Rule applies to individual debtors.

Absolute Priority Rule Found to Apply to Individual Debtor

The Tenth Circuit joined the Fourth Circuit in finding that BAPCPA did not abrogate the absolute priority rule with respect to individual debtors in chapter 11 bankruptcy. In re Stephens, No. 11-6309 (10th Cir. Jan. 15, 2013) (agreeing with In re Maharaj, 681 F.3d 558 (4th Cir. 2012)).

Turning first to the language of the relevant provisions, the court launched its decision from an initial finding of statutory ambiguity in sections 1129 and 1115. Section 1129(b)(2)(B)(ii) delineates an exception to the absolute priority rule by providing that an individual “debtor may retain property” included in section 1115. Section 1115 provides that property of the estate “includes, in addition to property specified in section 541”all property of the kind specified in section 541 that the debtor acquires after commencement of the case but before the case is closed. Addressing these provisions, the Tenth Circuit divided the decisions of other courts into the “narrow view,” under which only property acquired after commencement of the case is excluded from the absolute priority rule, and the “broad view,” espoused by the debtor, under which all property described by section 541 as well asafter-acquired property are excepted from application of the rule. The court found that the existence of disagreement among courts as to the meaning of these provisions renders the texts ambiguous.

The court then turned to legislative history and congressional intent noting that, like the relevant statutory language, courts have disagreed as to meaning. The court was persuaded that Congress did not intend to abrogate the absolute priority rule, in part, by the fact that in a listing of debtor benefits found in BAPCPA’s legislative history, abrogation of the rule was absent. Additionally, the court found that there was insufficient textual evidence of clear congressional intent to repeal the rule with respect to individual debtors.

The court rejected NACBA’s argument that Congress’s inclusion of language in section 1129(b)(2)(B)(ii) addressing individual debtors as an exception to the rule, as well as its use of broad and inclusive language in section 1115 to define the relevant property, were clear indications that Congress intended to exclude individual debtors from application of the absolute priority rule. Both Stephens and Maharaj essentially deleted the language, “includes, in addition to the property specified in section 541,” from the interpretation of section 1115 by finding that only property acquired after commencement of the case was removed from the constraints of the absolute priority rule.

NACBA filed an amicus brief in this case and continues to fight this battle in other courts. The issue is currently pending in the cases of In re Lively, No. 12-20277 (5th Cir.); Lindsey v. Pinnacle Nat’l Bank, No. 12-6362 (6th Cir.); and Arnold v. U.S. Trustee, No 12-57265 (9th Cir.).

NACBA Amicus Opposes “Carve-Out” Agreement

NACBA has filed an amicus brief in the Fourth Circuit case of In re Reeves,No. 12-2127. In that case the trustee, claiming authority under section 724(b), sought to sell the debtor’s fully encumbered residential property to give effect to an agreement the trustee had entered into with the IRS, a lienholder, under which the IRS agreed to “carve out” a portion of its share of the proceeds from any sale of the property. That portion would then go toward administrative costs and unsecured creditors.

In its brief, NACBA argues first that pursuant to its plain text, and supported by its legislative history, section 724(b) does not empower the trustee to sell estate property. Rather, it prioritizes payment of certain claims over payment of tax liens that would otherwise be paid first. The trustee’s authority to sell estate property arises solely from section 363 and is subject to that provision’s carefully crafted limitations. Second, NACBA argues that even if there was a statutory basis for the trustee to sell the property, he could not do so here where the property is fully encumbered and the estate, therefore, lacks equity in it. Where property is of no value to the estate beyond compensating the trustee, it should be abandoned pursuant to section 554 rather than sold pursuant to section 363. Furthermore, where standard traditional treatment of the liens would result in negligible value to the estate thereby precluding sale by the trustee, there is no authority for the trustee and a creditor to conspire to circumvent the Code by creating a “carve out” agreement. A chapter 7 trustee is not a liquidating agent for a creditor as that role would contravene the trustee’s position as representative of the estate for the benefit of unsecured creditors.

Upcoming Argument:

In re Bullard, No. 12-54 (B.A.P. 1st Cir.)

Issue: Whether bankruptcy court erred in denying confirmation of “hybrid” plan under which lien would be bifurcated into an unsecured portion to be paid through the plan and a secured portion to be paid outside the plan and extending beyond the term of the plan.

Argument date: January 28, 2013

NACBA filed an amicus brief.