I. Explanation of absolute priority rule Consumer debtors that do not qualify for protection under Chapter 7 or Chapter 13 of the Bankruptcy Code, are left with filing under Chapter 11, where they will come face-to-face with the absolute priority rule (the “APR”). The APR is a cornerstone of bankruptcy law. It was first developed by the Supreme Court in the late nineteenth-century to deal with widespread collusion in railroad reorganizations. To prevent unfair deals between senior creditors and equity holders, the Court held that “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”[1] Simply stated, the APR establishes a hierarchy of rights in bankruptcy proceedings, commencing with secured creditors at the top of the heap and ending with equity holders (or the debtor when the case involves an individual) at the bottom. This rule recognizes that equity holders, or debtors, have less rights and entitlement to recovery of a bankrupt enterprise’s assets because they stood to reap the most if the entity succeeded. It also recognizes that equity-holders generally control the allocation of value and absent limitations, they would unfairly allocate a disproportionate share to themselves. “This rule assured those who did business with the corporation that if the business were dissolved the creditors would be paid before the insiders would recover their investments. In case of collapse, the creditors could count on payment in full before equity collected anything from the business assets.”[2] Individuals debtors may find problematic their efforts to satisfy the APR because a Chapter 11 plan cannot be confirmed over the objection of a dissenting class of creditors if value is being allocated to the debtor, unless secured creditors and unsecured creditors are paid in full (see below discussion on the requirements for full payment), or the Plan meets the stringent “new value” test.[3] On a practical level, an individual debtor cannot retain any property in a Chapter 11,[4] unless all senior creditors are paid in full, including over an extended time period; all impaired classes accept the plan; or the debtor contributes what is known as “new value” in exchange for retaining its equity interests. [5] II. How the rule applies in chapter 11 The APR evolved beyond a judicially created doctrine when Congress codified it as part of the Bankruptcy Code in 1978.[6] To confirm a Chapter 11 plan, all impaired classes must accept the plan.[7] However, a court may still confirm the plan (i.e., through a “cramdown”) if an impaired class rejects it, but only if the plan is otherwise “fair and equitable” within the meaning of the Bankruptcy Code, or, in some cases, the debtor contributes “new value” in accordance with that exception to the APR, and satisfies certain other criteria enumerated in §§1129(a)(1) through (a)(14).[8] To be fair and equitable, a plan must provide property of a value, as of the effective date of the plan, equal to the allowed amount of a creditor’s claim or it must satisfy the APR. A plan can satisfy the APR if value is allocated in accordance with the APR – e.g., if unsecured creditors are not paid in full, the debtor receives no property. Full payment to senior classes does not necessarily require a single payment of the full amount owed and does not have to be immediate or in accordance with existing debt instruments (except for loans on an individual’s principal residence, which cannot be modified), so long as the payment stream is accompanied with an appropriate interest rate and is otherwise “fair and equitable.” Thus, the deferred cash payments can be structured in many ways, so long as the restructured terms are “fair and equitable” in the view of the Court. This makes the cramdown of a Chapter 11 plan difficult for individual debtors that have a lot of debt and limited means to repay that debt.[9] III. After BAPCPA a minority of lower courts have held that the APR no longer applies in individual chapter 11 cases. In 1988, the Supreme Court unanimously held the APR applied in individual Chapter 11 cases.[10] However, the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”) that was enacted in 2005, led some courts to question whether the APR was still applicable in individual Chapter 11 cases.[11] BAPCPA modified §1129(b)(2)(B)(ii) and added §1115. The interaction between these two provisions has generated some decisions holding that the APR no longer applies when the debtor is an individual, although the majority view, which is followed by five Circuit Courts, holds otherwise – i.e., the APR still applies and was not abrogated by BAPCPA. Section 1129(b)(2)(B)(ii) provides 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 sub…
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