Contributed by Elizabeth Hendee
In April, we wrote about Friedman v. P+P, LLC, in which the United States Bankruptcy Appellate Panel of the Ninth Circuit held that the absolute priority rule does not apply to individual debtor chapter 11 cases.  In that post, we noted that this issue has been hotly contested in courts around the country since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) in 2005.  The Tenth Circuit’s recent decision in Dill Oil Co., LLC v. Stephens (In re Stephens) adds fuel to the fire.  In Stephens, the United States Court of Appeals for the Tenth Circuit held that the absolute priority rule does apply to individual chapter 11 cases.
The debtors in Stephens, Arvin and Karen Stephens, owned a chain of gas station convenience stores for which Dill Oil Company, LLC and Nancy Dill were the primary suppliers of gasoline and gas station products.  At the time Arvin and Karen Stephens filed for bankruptcy protection, they were indebted to the Dills for almost $2 million. The Dills were technically secured creditors; they held mortgages on many of the Stephens’s properties, but all of their mortgages were subordinate to other liens.  Accordingly, the Stephens’s chapter 11 plan proposed to treat only approximately $15,000 of the Dills’ nearly $2 million claim as secured.  Pursuant to the plan, the Dills would receive payment equal to approximately 1% of the remainder of their claim.  Payments on the “unsecured” portion of their claim would be spread out over five years.  The plan further provided that the Stephenses would retain possession and control of all of their property.
The Dills did not consent to the proposed treatment of their claim under the plan.  Instead, they objected to the plan as violating the absolute priority rule because the plan proposed that the debtors would retain all of their property.  The bankruptcy court held that the absolute priority rule does not apply to chapter 11 cases in which the debtor is an individual and thus confirmed the plan.  A direct appeal to the Tenth Circuit followed.
Section 1129(b)(2)(B)(ii) of the Bankruptcy Code, known as the absolute priority rule, provides that a plan can be found “fair and equitable” as to a class of unsecured claims (despite a dissenting impaired class) if holders of interests junior to the impaired class do not receive or retain interest in any property under the plan.  The BAPCPA added an exception to this general rule: “in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115 . . . .”  Section 1115 of the Bankruptcy Code expands the definition of property of the estate for individual debtors to include, “in addition to the property specified in section 541,” property and earnings obtained postpetition.
A number of courts, including the bankruptcy court in Stephens and the Ninth Circuit BAP in Friedman, have adopted a “broad view” of the BAPCPA amendment and held that the amendment eliminates the absolute priority rule as applied to an individual debtor’s entire estate.  According to the broad view, section 1115 of the Bankruptcy Code incorporates and supersedes section 541 of the Bankruptcy Code and thus excepts from the absolute priority rule property and earnings obtained postpetition as well as prepetition property referenced in section 541.  If the broad rule applied in this case, the debtors would be able to retain prepetition property, even though a class of impaired creditors had voted against their plan. According to the narrow view, however, section 1115 of the Bankruptcy Code merely supplements, but does not replace, the definition of property of the estate found in section 541 for individual debtors.  Section 1115 of the Bankruptcy Code thus includes in an individual debtor’s estate only property that was not already included by section 541 (i.e., only post-petition property and earnings).
On appeal, the Tenth Circuit’s analysis began with a look at the statutory language.  Proponents of both the broad and narrow views have argued that the plain meaning of section 1115 is “clear” and in favor of their view.  According to the court, this discrepancy in interpreting the “clear” language of section 1115 indicates that the meaning of the statute is, in fact, not “clear.”  The court next turned to legislative history.  Proponents of the broad view argue that the BAPCPA amendments generally model the treatment of individual debtors in chapter 11 after the treatment of chapter 13 debtors.  Chapter 13 of the Bankruptcy Code does not contain an absolute priority rule so, according to the broad view, the rule should not apply to individual chapter 11 debtors either.  Courts adopting the narrow view, on the other hand, reason that the BAPCPA amendments generally favor creditors and impose greater burdens on debtors.  Eliminating the absolute priority rule for chapter 11 debtors would go against this trend.  Further, if Congress had intended to eliminate the absolute priority rule, it likely would have “done so in a far less convoluted way.”
The Tenth Circuit aligned with courts that have adopted the “narrow view” of the BAPCPA amendment, observing that this interpretation is most consistent with pre-BAPCPA law.  The court held that, after examining the different interpretations and the language of the statute itself, either view was plausible.  Without a clear indication that Congress intended to abolish the absolute priority rule with respect to individual debtors and finding that the language in section 1115 and legislative intent behind it were ambiguous, the court would “heed the presumption against implied repeal” and maintain the status quo.  The court reasoned that if Congress intended to repeal the absolute priority rule as to individual chapter 11 debtors, it would have done so expressly.
The Stephens opinion reminds us that the debate over whether the absolute priority rule applies to individual chapter 11 debtors is still alive.  Perhaps Congress, or the Supreme Court, will provide clear guidance on this issue soon.  Until then, at least for individual debtors in the Tenth Circuit, the absolute priority rule still applies.