Brown v. Ferroni (In re Brown)

• Decision Date: 24 February 2014
• Docket Number: Bankruptcy No. 12–14058.,Civil Action No. 13–6460.
• Citation: 505 B.R. 638
• Parties: In re Steven BROWN and Linda Brown, Debtors. Brown, et al., Appellants v. Ferroni, et al., Appellees.
• Court: U.S. District Court — Eastern District of Pennsylvania

505 B.R. 638

In re Steven BROWN and Linda Brown, Debtors.

Brown, et al., Appellants

v.Ferroni, et al., Appellees.

Civil Action No. 13–6460.

Bankruptcy No. 12–14058.

United States District Court,

E.D. Pennsylvania.

Feb. 24, 2014.

Allen B. Dubroff, Philadelphia, PA, for Appellants.

MEMORANDUM OPINION

SAVAGE, District Judge.

The issue in this bankruptcy appeal, which has not been decided by the Third Circuit and has divided other courts, is whether the Bankruptcy Abuse and Prevention and Consumer Protection Act (“BAPCPA”) abrogated the absolute priority rule in individual Chapter 11 cases. Stated differently for purposes of this case, the question is whether an individual Chapter 11 debtor must satisfy the absolute priority rule when an impaired unsecured creditor objects to the proposed reorganization plan.

The absolute priority rule, codified at 11 U.S.C. § 1129(b)(2)(B)(ii), provides that each class of unsecured creditors must be paid in full before the debtor can retain any property as part of a reorganization plan. See Bank of America Nat'l Trust and Sav. Ass'n v. 203 North LaSalle P'ship, 526 U.S. 434, 441–42, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999). The provision was amended and a new section, § 1115, was added in 2005 by BAPCPA. It is the added language that has created the split among the courts that have interpreted the absolute priority rule in individual debtor Chapter 11 cases after BAPCPA was enacted. That newly-added language is “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.” 11 U.S.C. § 1129(b)(2)(B)(ii).

After a thorough, thoughtful and well-reasoned analysis, Bankruptcy Judge Bruce Fox held that the absolute priority rule's application in individual Chapter 11 cases was not affected by the 2005 amendments to the Bankruptcy Code. After reviewing the bankruptcy court's legal determination de novo, In re American Pad & Paper Co., 478 F.3d 546, 551 (3d Cir.2007) (citing In re United Healthcare Sys., Inc., 396 F.3d 247, 249 (3d Cir.2005)), we agree. Therefore, because the debtors acknowledge that they cannot present a plan that satisfies the absolute priority rule, we shall affirm the Bankruptcy Court's order dismissing the case.

Facts

The facts and the procedural history are thoroughly detailed in the Bankruptcy Court's memorandum opinion. In re Brown, 498 B.R. 486, 489–92 (Bankr.E.D.Pa.2013). On appeal, the relevant facts are not in dispute.

On April 25, 2012, the debtors, Steven and Linda Brown, filed a joint voluntary bankruptcy petition under Chapter 11 of the Bankruptcy Code. Steven Brown, an architect, runs a construction and design business through three entities, Design Associates, Inc., Design Build, LLC, and Build US, LLC. Linda Brown is a homemaker and a volunteer special education teacher. The debtors proposed to reorganize using Steven Brown's income from his businesses. In re Brown, 498 B.R. at 489.

On July 19, 2012, Mario Ferroni, one of the Browns' creditors, filed a motion to dismiss the case based on the debtors' failure to file a plan and/or show their ability to reorganize.¹ On March 20, 2013, the Browns proposed a Chapter 11 plan, which was rejected on July 23, 2013. The following day, the Browns filed a second plan. The amended plan proposed that all allowed unsecured claims, including Ferroni's, be placed in class 6.² The debtors proposed to pay $15,000 per year to this class, to be distributed pro rata. The interests of the debtors were placed in class 7 of the proposed plan and provided for their treatment as follows:

On the Effective Date and except as otherwise set forth in this Plan, the Reorganized Debtors shall be vested with all assets that comprise the Debtors' estates, free and clear of all Claims, liens, charges, encumbrances, rights and Interests of creditors and equity security holders. As of the Effective Date, the Reorganized Debtors may operate their business and use, acquire and dispose of property and settle and compromise Claims or Interests without supervision of the Bankruptcy Court free of any restrictions of the Bankruptcy Code other than as expressly set forth in the Plan or the Confirmation Order.

In re Brown, 498 B.R. at 491 (citing Ex. T–3, at 10 (¶ 7.1)). In short, the amended plan proposed that the Browns would retain all of their exempt and non-exempt assets, including Steven Brown's interest in his three businesses, while paying the unsecured creditors $75,000 over five years at the rate of $15,000 per year.

On August 15, 2013, at the hearing on Ferroni's motion to dismiss, the debtors acknowledged that Ferroni's unsecured claim of $489,000 would not and could not be paid in full. They also recognized that Ferroni would not vote in favor of the plan or any plan they could afford to fund. Id. at 491–92.

A plan may not be confirmed unless, among other things, it is accepted by a majority of each class of claims that is impaired by the plan. 11 U.S.C. § 1129(a)(8)(A). To be accepted, a plan needs a favorable vote of at least two-thirds in dollar value of the claims of eligible votes cast in the class. Id. § 1126(c).³ Because Ferroni's claim exceeds the one-third threshold, he holds a “blocking position” pursuant to § 1126(c), ⁴ that is, without his consent, the plan cannot be approved. Accordingly, it is undisputed that without Ferroni's acquiescence, the proposed plan cannot be confirmed.

Ferroni objected to the amended plan, arguing that the Browns' plan violated the absolute priority rule.⁵ The Browns countered that the rule was abrogated by the 2005 amendments to the Bankruptcy Code.⁶ At the same time, they conceded that if the rule was not abrogated, their plan could not be confirmed.⁷

On September 26, 2013, Judge Fox entered an order dismissing the case because the absolute priority rule stood in the way of confirmation.⁸ The Browns timely appealed.

On appeal, the Browns argue that we should adopt the “admittedly, minority” position and hold that the absolute priority rule, as amended by BAPCPA, allows individual debtors to retain pre-petition property over creditor objections. ⁹ In response, Ferroni argues that the plan cannot be confirmed because it is not fair and equitable to the creditors as required under § 1129(b)(2)(B)(ii).¹⁰ Ferroni points out that the three circuit courts of appeal that have considered the issue have held that the BAPCPA amendments did not abrogate the absolute priority rule in individual debtor cases. ¹¹

Discussion

Before a plan of reorganization in a Chapter 11 case can be confirmed, it must meet the requirements set forth in 11 U.S.C. § 1129(a). One of the requirements is that the plan must be acceptable to each impaired class of creditors. 11 U.S.C. § 1129(a)(8)(A). Notwithstanding this creditor-acceptance requirement, the plan can be “crammed down” over the objections of impaired creditors if it is non-discriminatory and “fair and equitable” to the dissenting unsecured creditors. Id. § 1129(b)(1). A plan is fair and equitable when it provides either that each unsecured creditor's allowed claim will be satisfied in full, or each dissenting unsecured creditor will be paid in full before the debtor receives or retains property. Bank of America, 526 U.S. at 441–42, 119 S.Ct. 1411 (citing § 1129(b)(2)(B)(i) and (ii)).

The end result of the application of the rule is that if all dissenting creditors are paid in full, the debtor can retain or receive property. If they are not paid in full, the debtor cannot retain or receive property that is part of the estate over the objections of dissenting creditors.

The Browns realize that their plan cannot satisfy § 1129(a)(8) because Ferroni will not accept it. Consequently, it can be confirmed only if it is “crammed down” under § 1129(b)(1). Because the Browns' plan does not contemplate payment of unsecured creditors in full, § 1129(b)(2)(B)(ii), the section codifying the absolute priority rule, comes into play.

Prior to 2005, there was no question that the absolute priority rule applied to an individual debtor in a Chapter 11 case. As a result of BAPCPA, there is a disagreement whether it still applies.

In 2005, when Congress enacted BAPCPA, it amended § 1129(b)(2)(B)(ii) by adding language that has engendered the split among courts regarding the continuing viability of the absolute priority rule in individual Chapter 11 debtor cases. That section now provides as follows:

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.

11 U.S.C. § 1129(b)(2)(B)(ii) (2005 amendment language italicized).

Section 1115, a new section added by BAPCPA and referenced in the added language of § 1129(b)(2)(B)(ii), has contributed to the disagreement among the courts as to what property Congress contemplated as comprising the estate for purposes of applying § 1129(b)(2)(B)(ii). Section 1115 provides:

(a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—

(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and

(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.

(b) Except as provided in section 1104 or a confirmed plan or order confirming a plan, the debtor shall remain in possession of all property of...