Fourth Circuit: Absolute Priority Rule Lives

By Robyn Hagan Cain on June 15, 2012 | Last updated on March 21, 2019

The Fourth Circuit Court of Appeals ruled on Thursday that the absolute priority rule still applies to individual debtors in possession filing for bankruptcy under Chapter 11.

This is a significant decision, because the Fourth Circuit is the first appellate court to consider the issue since the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

The absolute priority rule applies when an unsecured creditor objects to a "cramdown" plan. It requires that unsecured creditors receive full payment before the debtor retains property of the bankruptcy estate.

The Supreme Court articulated the earliest version of the absolute priority rule in response to widespread collusion in the context of railroad reorganizations. The rule was codified in the Bankruptcy Reform Act of 1978, and remained unchanged until BAPCPA was passed in 2005.

Prior to 2005, the absolute priority rule was simply that, if the proposed plan allowed the debtor to retain property, any dissenting creditors must be paid in full in order for the plan to be "crammed down."

The Code, after BAPCPA, now states that to be fair and equitable, a proposed plan must provide that "the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115," subject to certain requirements.

A significant split of authorities has developed nationally among the bankruptcy courts regarding the effect of the BAPCPA amendments on the absolute priority rule when the Chapter 11 debtor is an individual.

Some courts have adopted the "broad view" that Congress intended to include the entirety of the bankruptcy estate as property that the individual debtor may retain, thus effectively abrogating the absolute priority rule in Chapter 11 for individual debtors. (A federal judge in Tampa notabley adopted this view last year, reports Thomson Reuters News & Insight.)

Other courts, adopting the "narrow view," have held that Congress did not intend such a sweeping change to Chapter 11, and that the BAPCPA amendments merely have the effect of allowing individual Chapter 11 debtors to retain property and earnings acquired after the commencement of the case that would otherwise be excluded.

The Fourth Circuit Court of Appeals took the latter view, finding that Congress did not intend to abrogate the absolute priority rule.

But instead of telling lawyers and lower courts, "Look to the plain language of the statute," the Fourth Circuit conceded that BAPCPA is anything but plain, and open to more than one "cogent interpretation."

(Side Bar: Because, "Guys, this law is totally ambiguous" is what everyone wants to hear from a federal appellate court.)

Despite the ambiguities and the multiple, reasonable interpretations, the Fourth Circuit concluded that BAPCPA preserved the absolute priority rule.

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