The Sixth Circuit Court of Appeals recently issued an opinion confirming that the absolute priority rule still applies to individual chapter 11 debtors following the 2005 amendments to the Bankruptcy Code. Ice House America, LLC v. Charles Cardin, Appeal No. 13-5764 (6th Cir. May 13, 2014). The Sixth Circuit now joins the Fourth, Fifth and Tenth Circuits in finding that Congress did not intend to abrogate the absolute priority rule in individual chapter 11 cases through its amendments to Sections 1115 and 1129(b)(2)(B)(ii) of the Bankruptcy Code.
The Court began its analysis by noting that prior to the 2005 amendments to the Code, there was no question that the absolute priority rule, as codified in Section 1129(b)(2)(B)(ii), prevented individual chapter 11 debtors from retaining property of the estate acquired as of the commencement of the case unless all creditors were paid in full. In 2005, Congress added Section 1115 to the Code, which expanded the definition of “property of the estate” in chapter 11 individual cases to include property and earnings acquired by the debtor after the commencement of the case. Without an amendment to Section 1129(b)(2)(B)(ii), the Court found that property included in the estate by virtue of Section 1115 would also be subject to the absolute priority rule, meaning that an individual debtor could not retain any non-exempt property, whether acquired before or after the commencement of the case, if a class of creditors did not accept the plan and was not paid in full.
As the Court was well aware, however, Congress did amend Section 1129(b)(2)(B)(ii) in 2005 to address the proper scope of the absolute priority rule in individual chapter 11 cases. Specifically, Congress added the phrase “property included in the estate under Section 1115” to Section 1129(b)(2)(B)(ii), which appears to permit the retention of such property by individual chapter 11 debtors even if all creditors are not paid in full. The debtor argued that the word “included” meant any property mentioned in Section 1115, which would include all property of the estate, even if already part of the estate pursuant to Section 541. The Court rejected that argument, however, after analyzing Congress’s intent in adding the new phrase. To interpret the newly added phrase, the Court focused its attention on the possible definitions for the word “included” and determined that the phrase meant that a “debtor may retain property that [Section 1115] takes into the estate.” The Court described the debtor’s interpretation as a “Rube-Goldberg reading at best” because it would have required a strained reading of the rest of Section 1129(b)(2)(B)(ii). The Court concluded that if Congress intended to completely abrogate the absolute-priority rule for individual chapter 11 debtors, it would have done so with a much simpler amendment to Section 1129(b)(2)(B)(ii). And although the Court recognized that individual chapter 11 debtors are in a tougher position as compared to chapter 13 debtors because of the application of the absolute priority rule, the Court underscored that its task is to “interpret the laws that Congress enacted, not to determine whether they are fair.”
The Court’s ruling adds to the growing weight of authority that the absolute-priority rule still applies to individual chapter 11 debtors after the 2005 amendments to the Bankruptcy Code. All four Circuit Courts of Appeals to take on the issue to date have held that the absolute priority rule was not abrogated in individual chapter 11 cases by Congress’s 2005 amendments to the Code. Even if these rulings are not binding authority in the eight other Circuits, they serve as strong, persuasive authority for the proposition that individual chapter 11 debtors cannot retain non-exempt, pre-petition property pursuant to a chapter 11 plan if the creditors of a non-accepting class are not paid in full.