Congress didn't repeal the so-called absolute priority rule for individuals in Chapter 11 when it amended the Bankruptcy Code in 2005, a district judge in Philadelphia ruled.
The issue has divided federal courts. Three circuit courts of appeal and 17 bankruptcy courts follow the narrow view holding that absolute priority survives in individuals’ Chapter 11s. One bankruptcy appellate panel, one district court and seven bankruptcy courts read the amendments broadly and contend that the absolute priority rule no longer applies to individuals in Chapter 11, according to U.S. District Judge Timothy J. Savage in Philadelphia.
The result reached by Savage and the appeals courts is unfavorable to owners of small businesses in Chapter 11. If there is even one creditor with a large enough claim opposing the plan so creditors don’t approve it by required majorities, the bankrupt can’t use the so-called cramdown process to win confirmation. As a result, a small-business owner can be forced to liquidate or sell the business, even if the plan might have paid more than liquidation.
The case turns on language added in 2005 to Section 1129(b)(2)(B)(ii) of the Bankruptcy Code and Section 1115 which was entirely new. The majority take the view that the plain meaning of the two statutes together only allows an individual using cramdown to keep property obtained after filing bankruptcy.
Savage found the language unambiguous. Even if it weren’t, he nonetheless subscribed to the narrow view. He said there is nothing in the statute or legislative history to indicate that Congress intended to abrogate absolute priority for individuals.
Because repeal by implication is “disfavored,” Savage concluded that absolute priority remains because nothing in the statute shows an intention to repeal the rule that existed before 2005.
The most recent appeals court decision on the issue came down in May from the circuit court in New Orleans in a case called Lively.
The case is Brown v. Ferroni, 13-cv-06460, U.S. District Court, Eastern District of Pennsylvania (Philadelphia).