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Sixth Circuit Ruling Regarding the Absolute Priority Rule in Chapter 11 Cases

Posted By USFN, Thursday, June 5, 2014
Updated: Tuesday, October 13, 2015

June 5, 2014

 

by Melissa Byrd
Trott & Trott, P.C. – USFN Member (Michigan)

In an important decision affecting secured creditors that are the subject of cramdown in Chapter 11 cases, the Sixth Circuit Court of Appeals recently issued an opinion holding that “the absolute priority rule continues to apply to pre-petition property of individual debtors in Chapter 11 cases.” Ice House Am., LLC v. Cardin, 2014 U.S. App. LEXIS 8882 at *13 (6th Cir. 2014).

To confirm a Chapter 11 plan of reorganization, a debtor must meet the requirements of 11 U.S.C. § 1129(a). A Chapter 11 plan, however, may be confirmed even if it does not comply with § 1129(a)(8)(A), through the “cramdown” provision, “if the plan does not discriminate unfairly, and is fair and equitable” to creditors who have not accepted the plan. Section 1129(b)(2) sets out the requirements for a plan to be considered “fair and equitable,” which includes satisfaction of the “absolute priority rule” found in § 1129(b)(2)(B)(ii), that provides in relevant part:


For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:

* * *
(B) with respect to a class of unsecured claims –

* * *

(ii) 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 the requirements of subsection (a)(14) of this section. [emphasis added].

 

The absolute priority rule requires that every unsecured creditor must be paid in full prior to the debtor retaining any property under the plan.

In the Ice House Am. case, the debtor and creditor agreed that the absolute priority rule was not satisfied under the proposed plan; however, the debtor argued that it does not apply to individual debtors. The creditor and the United States Trustee objected to the plan for violation of the absolute priority rule. The bankruptcy court overruled the objections and held that the absolute priority rule was abrogated in individual cases when the Bankruptcy Code was amended in 2005. On appeal, the district court certified the question for direct appeal to the Sixth Circuit, which was granted. Ice House Am. v. Cardin, at *5.

In deciding whether the absolute priority rule still applied to individual debtors, the Sixth Circuit focused on the word “included” in the italicized portion of the statute. The court found that by looking at the definition of the word ‘included,’ “… it is only that property — property acquired after the commencement of the case, rather than property acquired before then — that the ‘debtor may retain’ when his unsecured creditors are not fully paid,” and reversed and remanded the decision to the bankruptcy court for further proceedings. Ice House Am. v. Cardin at *10, 13, citing 11 U.S.C. § 1129(b)(2)(B)(ii).

The Sixth Circuit, in deciding that the absolute priority rule continues to apply to pre-petition property of the individual debtors in Chapter 11 cases, joins the Fourth Circuit (In re Maharaj, 681 F.3d 558, 565 (4th Cir. 2012)), Fifth Circuit (In re Lively, 717 F.3d 406, 410 (5th Cir. 2013)), and Tenth Circuit (In re Stephens, 704 F.3d. 1279, 1287 (10th Cir. 2013)) in reaching the same interpretation. Ice House Am. v. Cardin, at *13. (The Sixth Circuit is comprised of Kentucky, Michigan, Ohio, and Tennessee.)

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