In re Davis, 00-00250.

• Decision Date: 14 March 2001
• Docket Number: No. 00-00250.,00-00250.
• Citation: 262 BR 791
• Parties: In re William S. DAVIS and Linda L. Davis, Debtors.
• Court: U.S. Bankruptcy Court — District of Arizona

262 B.R. 791 (2001)

In re William S. DAVIS and Linda L. Davis, Debtors.

No. 00-00250.

United States Bankruptcy Court, D. Arizona.

March 14, 2001.

Brian Sirower, Quarles & Brady Streich Lang, LLP, Phoenix, Arizona, for debtors.

Robert L. Conn, Newport Beach, California, Steven Keist, Glendale, Arizona, for Bill J. Davis.

UNDER ADVISEMENT DECISION RE: (1) APPLICATION OF ABSOLUTE PRIORITY RULE; AND (2) DEBTOR'S MOTION TO EXTEND EXCLUSIVITY

CHARLES G. CASE, II, Bankruptcy Judge.

I. INTRODUCTION

This case presents three distinct questions. First, is the absolute priority rule applicable to the plan proposed by these individual Chapter 11 Debtors? Second, if it is, how, if at all, does the Supreme Court's decision in 203 North LaSalle¹ affect the Debtors' plan? And, third, should Debtors' exclusivity period be further extended?

II. BACKGROUND

Debtors William and Linda Davis ("Debtors") collect rents from various interests held by them, including their interests in real property and partnership interests (the "Properties").² The estate's largest creditor is Bill J. Davis, Debtor William S. Davis' father, who holds a judgment against the estate that exceeds $1.4 million. That judgment is currently under appeal in the California state courts. Debtors' plan provides that they will issue a note for $400,000 or "such greater amount as found by the Court to pay General Unsecured Claims as much as they would receive in a Chapter 7 liquidation." Under the plan, Debtors will retain the Properties; the semi-annual note payments will be funded by the distributions received by the Debtors from the Properties until either all unsecured creditors are paid in full or $400,000 (or any greater amount determined by the Court) has been paid. Thereafter, the Debtors will received all distributions from the Properties.

The plan further provides that the Bill J. Davis claim will share pro rata with other unsecured creditors once it is an "Allowed Claim", presumably after all appeals are exhausted and the judgment is upheld. It is clear that if the full amount of the judgment is upheld on appeal, the Bill J. Davis claim will not be paid in full.³

The Plan provides that, if the Court determines that "a contribution of new value is necessary for confirmation," then the Debtors will "agree to contribute $100,000 of non-estate funds as their new value contribution," provided, however, that they reserve the right to liquidate the Properties. The Plan states that the purpose of the new value would be to ensure timely performance of their obligations under the Plan and "to avoid adverse tax consequences which might arise from the sale or disposition of the Properties." The Plan does not address the source or means of funding the new value; that is left to a separate hearing 60 days after confirmation.⁴

The Plan went to vote and the Bill J. Davis class rejected; other impaired classes voted to accept, satisfying 11 U.S.C. § 1129(a)(10). During the same time period, the Debtors moved to extend the 180-day exclusivity period under 11 U.S.C. § 1121(c)(3), in effect urging that they should be entitled to complete the confirmation process for their plan in the absence of a competing plan from Bill J. Davis. Bill J. Davis objected, urging that the Debtors' plan could not be confirmed because it violates LaSalle and therefore further exclusivity is unwarranted.⁵

In this context, the Court requested the parties to brief the issue of whether the absolute priority rule applies to Debtors as individual, nonbusiness Chapter 11 debtors and, if so, how the LaSalle would apply.

II. ANALYSIS

A. Does the Absolute Priority Rule Apply in Individual Cases?

In essence, the absolute priority rule provides that a junior class of creditors or interest holders may not receive or retain any property on account of their claims or interests unless the claims or interests of an objecting senior class are satisfied in full.⁶ The Debtors' argument is that it makes no sense to apply the rule in individual cases for two fundamental reasons: first, that the rule was developed in the context of corporate or partnership cases where equity "interests" are held by third parties, not by the debtors themselves; and second, that it is impossible to apply without, in effect, denying meaningful Chapter 11 relief to individual debtors.

When a Chapter 11 debtor seeks to cramdown a plan over the objection of an impaired creditor, two conditions must be met:

First, all requirements of § 1129(a) must be met (save for the plan\'s acceptance by each impaired class of claims or interests, see § 1129(a)(8)). Critical among them are the conditions that the plan be accepted by at least one class of impaired creditors, see § 1229(a)(10), and satisfy the "best-interests-of-creditors" test, see § 1129(a)(7). . . . Second, the objection of an impaired creditor class may be overridden only if "the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims or interests that is impaired under, and has not accepted, the plan." § 1129(b)(1). As to a dissenting class of impaired unsecured creditors, such a plan may be found to be "fair and equitable" only if the allowed value of the claim is to be paid in full, § 1129(b)(2)(B)(i), or, in the alternative, if "the holder of any claim or interest that is junior to the claims of such impaired unsecured class will not receive or retain under the plan on account of such junior claim or interest any property," § 1129(b)(2)(B)(ii). The latter condition is the core of what is known as the "absolute priority rule."

LaSalle, 526 U.S. at 441-42, 119 S.Ct. at 1415-16 (citations omitted).

There is no dispute that an individual with no ongoing business may be a debtor under Chapter 11. Toibb v. Radloff, 501 U.S. 157, 111 S.Ct. 2197, 115 L.Ed.2d 145 (1991). There is also no dispute that some Chapter 11 provisions do not apply to individual, nonbusiness Chapter 11 debtors because Chapter 11's provisions are structured more for corporate debtors. Id. Debtors argue that Toibb's rationale strongly supports its conclusion that the rule should not apply to individual, nonbusiness debtors such as themselves. This Court disagrees, finding that Toibb stands primarily for the proposition that certain provisions in Chapter 11 have little application to nonbusiness debtors. Whether the absolute priority rule is one of those provisions was not addressed.

However, this Court finds it hard to ignore the United States Supreme Court's language in Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988):

Under current law, no Chapter 11 reorganization plan can be confirmed over the creditors\' legitimate objections . . . if it fails to comply with the absolute priority rule.

485 U.S. at 202, 108 S.Ct. at 966 (emphasis added). Ahlers, significantly, was the first Supreme Court case in decades to address the issue of whether there was a new value exception to the absolute priority rule and it involved individual debtors. In Ahlers, debtors operated a family farm and had borrowed money from Norwest Bank over a twenty year period. The loans were secured with farmland, machinery, crops, livestock and farm proceeds. Debtors subsequently defaulted, owing over a million dollars. Debtors filed Chapter 11 to stay the replevin proceedings brought by the Bank. The Bank then sought stay relief, which was ultimately denied upon the court of appeals' conclusion that a plan could be confirmed and that stay relief was therefore not justified. The court of appeals rejected the notion that the absolute priority rule prohibited debtors from retaining an equity interest in their farm where they contributed money, or money's worth, to the reorganized entity. In this case, debtors contributed labor, experience and expertise as new value.

The Supreme Court reversed, stating that, as the law currently stood, a Chapter 11 plan could not be confirmed over creditors' legitimate objections if it failed to comply with the absolute priority rule: "There is little doubt that a reorganization plan in which respondents debtors retain an equity interest in the farm is contrary to the absolute priority rule." 485 U.S. at 202, 108 S.Ct. at 966. The Court then refused to find that the contribution of labor, experience and expertise was sufficient to gain the benefit of the "new value" exception to the absolute priority rule.⁷ Id. at 203-04 & n. 3, 108 S.Ct. at 967 & n. 3. "Unlike `money or money's worth, a promise of future services cannot be exchanged in any market for something of value to the creditors today." Id. at 204, 108 S.Ct. at 967.

Admittedly, the parties in Ahlers did not contest the application of the absolute priority rule to the pending Chapter 11 involving individual, nonbusiness debtors. It is disingenuous, however, to conclude that the application of the absolute priority rule to individuals was not at issue. Before the Court could discuss whether the exception applied in the case, it had to conclude that the absolute priority rule itself applied in the first instance.⁸ Simply because there was no dispute between the parties regarding that conclusion does not mean the Court did not consider the matter on its own.

Debtor has cited no decision that squarely holds that individual debtors are exempt from the application of the absolute priority rule. Indeed, every case of which the court is aware comes to the opposite conclusion. The most significant is Tenth Circuit's decision in Unruh v. Rushville State Bank of Rushville, Missouri, 987 F.2d 1506 (10th Cir.1993), which relied on the Supreme Court's analysis in Ahlers. Unruh also involved debtors who owned and operated a family farm as a sole proprietorship. The court rejected debtors' argument that the absolute priority rule applied only to corporate reorganizations and that "`interest holders' were people considered to have separate legal identities from the...