My Brief on Friedman

Friedman v. P&P, LLC (In re Friedman), —- B.R. —- (9th Cir. BAP, March, 2012)

Issue:   Does the absolute priority rule still apply, after BAPCPA, in individual chapter 11 cases?

Holding:   No.

Judges Philip Brant and James Marlar, Tucson, AZ

Jury, Kirscher, Clarkson

Opinion by Scott Clarkson, Dissent by Meredith Jury

The debtors filed chapter 11 to stop a foreclosure sale on real property they owned although not their principle residence.  The debtors filed a plan proposing to pay unsecured creditors $634 per month.  The largest unsecured creditor filed an objection to the plan on various grounds including that the plan violated the absolute priority rule.  The bankruptcy court conducted a hearing on the plan limited to the issue of whether it was unconfirmable because it violated the absolute priority rule.  The court ruled that it did and ordered the debtors to file an amended plan.  The debtors did not do that and the case was converted to chapter 7.  The debtors moved for a stay pending appeal which was granted by the bankruptcy court given the split on the issue.

The BAP reversed, 2-1.  The opinion traces the absolute priority rule back to 1913 and notes it was “eventually codified in 1978” and clearly applied to individuals until BAPCPA.  The analysis starts with the first rule of statutory interpretation that “if the language is plain and ambiguous,” the court must enforce the will of Congress.  Congress modified the code in Section 1129(b)(2)(B)(ii) to state that the plan of an individual debtor who proposes to keep the property in Section 1115 does not violate the absolute priority rule.  Section 1115 provides that property of the estate in an individual chapter 11 “includes” all property set forth in Section 541 plus the debtor’s postpetition earnings.  Therefore, “[a] plain reading of Section 1129(b)(2)(B)(ii) and 1115 together mandates that the absolute priority rule is not applicable in individual chapter 11 debtor cases.”

This result makes sense the opinion says because of other changes made to the code at the same time.  Section 1129(a)(15) was added to give unsecured creditors a veto unless the debtor contributes all of his “projected disposable income,” 1141(d)(5)(A) was added delaying the discharge similar to treatment in chapter 13, and 1127(e) was added permitting modification during the life of the plan “resembling Section 1329(a).  The fact that creditors get to vote in chapter 11s does not change the results.  If the class votes no, the plan cannot be confirmed unless the debtor pays his net income to creditors for five years.

The dissent argues that the word “included” in Section 1115 means property that is “added to” the estate.  Section 541 is already there and “there is no reason for Section 1115 to ‘absorb’ and ‘supersede’ Section 541.”  She complains that the majority ruling means that Section 541 is written out of individual chapter 11 cases as is the right of the unsecured creditors to vote.  She disagrees that Congress intended to make individual chapter 11s the same as chapter 13s.    She says that the absolute priority rule is such a fundamental part of bankruptcy that it should not be interpreted out of the code unless it is clear that that is what Congress intended.

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