In re Karlovich

• Decision Date: 16 November 2010
• Docket Number: No. 10–10860–PB11.,10–10860–PB11.
• Citation: 456 B.R. 677
• Parties: In re Carol KARLOVICH, Debtors.
• Court: U.S. Bankruptcy Court — Southern District of California

456 B.R. 677

In re Carol KARLOVICH, Debtors.

No. 10–10860–PB11.

United States Bankruptcy Court, S.D. California.

Nov. 16, 2010.

Gustavo E. Bravo, John L. Smaha, John Paul Teague, Smaha Law Group, APLC, San Diego, CA, for Debtor.

ORDER ON MOTION FOR RELIEF FROM STAY

PETER W. BOWIE, Chief Judge.

This rather convoluted bankruptcy case has given rise to a very discreet legal issue—whether, in this post-BAPCPA era, the absolute priority rule applies in a chapter 11 case of an individual. For the reasons set forth below, the Court holds that it does.

This Court has subject matter jurisdiction pursuant to 28 U.S.C. § 1334 and General Order No. 312–D of the United States District Court for the Southern District of California. This is a core proceeding under 28 U.S.C. § 157(b)(2)(A) & (G).

BACKGROUND

Creditor San Diego County Credit Union (SDCCU) seeks relief from the automatic stay in this individual debtor's Chapter 11 case in order to conduct a nonjudicial foreclosure of the debtor's Knoll Road property. For purposes of this motion SDCCU stipulates to the debtor's value of $1.33 million. SDCCU is owed over $2.8 million. SDCCU's core argument is that the Knoll Road property is not necessary to an effective reorganization. To the contrary, it impairs a reorganization. The debtor proposes to strip down the undersecured portion of the debt—approximately $1,477 million—and add that amount to the unsecured debt to be addressed in the debtor's Chapter 11 plan. SDCCU argues even if that were accomplished, the Knoll Road property would generate little net cash flow to the estate (as acknowledged by debtor in her draft disclosure statement) for the next several years, while adding a large amount of debt to the class of unsecured creditors, thereby diluting the return to other unsecured creditors significantly.

Section 362(d)(2) of Title 11 provides that relief from the automatic stay should be granted if the debtor has no equity in the property and the property is not necessary for reorganization. It is stipulated, for purposes of the hearing, that debtor has no equity in the property. So, as SDCCU argues, necessity for reorganization is the remaining issue. While SDCCU argued its position from every conceivable facet, including the inability of the debtor to meet the absolute priority rule, the debtor argued that knowing whether the absolute priority rule applies in individual Chapter 11 cases is essential for the debtor to determine how to proceed. Debtor argues that SDCCU would have the opportunity to elect certain treatment of the debt owed to it under 11 U.S.C. § 1111(b) which, in turn, would affect how the debtor would be able to deal with the debt. Debtor says she wants to keep the Knoll Road property so she can recover the capital invested in it when the market improves. At the hearing on the motion for relief from stay, the parties and the Court concluded that before the parties can fully discuss and resolve whether the property is necessary to an effective reorganization the Court must decide whether the absolute priority rule applies in this case. The Court took the matter under submission to answer that question.

DISCUSSION

If a plan is not accepted by all classes of creditors it may still be confirmed so long as it is “fair and equitable.” 11 U.S.C. § 1129(b)(1). With respect to the members of a class of unsecured creditors, a plan is “fair and equitable” under section 1129(b)(2)(B) if they are paid in full or no junior class retains any interest in estate property. This is typically referred to as the “absolute priority rule.” Section 1129(b) is one of several sections which was amended by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”). The amendments have given rise to disagreement between the courts, as well as the parties to this case, on whether the absolute priority rule, as amended by BAPCPA, still applies to individual chapter 11 debtors. The prior and current forms of the absolute priority rule were well discussed in In re Gbadebo:

Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (“BAPCPA”), 11 U.S.C. § 1129(b)(2)(B) stated that, if an impaired class of unsecured claims voted against a plan, the plan could not be confirmed unless the court found that it was “fair and equitable.” “Fair and equitable” meant, at a minimum, that either the class would receive property with a present value equal to its claim or no one with a claim or interest junior to the class of unsecured claims would retain any property. This provision applied to both individual debtors and debtors that were entities. This provision is generally referred to as the “absolute priority” rule.

BAPCPA modified the “absolute priority” rule as applied to individual debtors. Section 1129(b)(2)(B)(ii) now states that a plan may be “fair and equitable” even though the debtor retains “property included in the estate under section 1115....” 11 U.S.C. § 1129(b)(2)(B)(ii) (emphasis added). Section 1115 is a new provision, also added by BAPCPA. It states as follows:

(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 the estate.

11 U.S.C. § 1115 (emphasis added).

431 B.R. 222, 227 (Bankr.N.D.Cal.2010).

Since these amendments to the Code several courts have addressed this issue and have reached divergent results. One camp has held that Congress abolished the absolute priority rule with respect to individual debtors, the other that it did not. For the reasons set for below, this Court believes the latter side more correctly explains Congress' action.

Section 1129(b)(2)(B)(ii) does not expressly exclude individuals. It does, however, provide that, unlike other chapter 11 debtors, individuals may retain some property—“property included in the estate under section 1115 ...” As set forth above, § 1115 provides that in the case of an individual chapter 11 debtor “property of the estate includes, in addition to the property specified in section 541 ... all property of the kind specified in section 541 that the debtor acquires after the commencement of the case....” So for an individual chapter 11 debtor property of the estate includes all non-exempt property which would be property of the estate for any chapter 11 debtor plus, as added by § 1115, property acquired post-petition.¹

The courts that held that the absolute priority rule is abolished with respect to individual debtors begin by finding ambiguity in § 1129(b)(2)(b)(ii) and its reference to § 1115. They conclude that the sections are susceptible to the interpretation that all property of an individual may be retained under § 1129(b)(2)(B)(ii):

This new provision both refers to the property already brought into the bankruptcy estate by § 541 and brings more property into the estate. Unfortunately, the exception and § 1115(a) are worded in such a way that the exception could be construed narrowly to cover only the additional, postpetition property brought into the Chapter 11 bankruptcy estate by § 1115(a), or broadly to cover not only that property but also all the property brought into the estate by § 541, most of which is property the debtor had before filing for bankruptcy. The first construction would greatly limit the impact of the new exception under § 1129(b)(2)(B)(ii), but the second would exempt an individual Chapter 11 debtor from the main facet of the absolute priority rule, allowing him or her to retain both pre-and postpetition property under a plan even though a class of unsecured creditors would not be paid in full. The Court must determine which interpretation matches Congress's intent in making these changes.

In re Roedemeier, 374 B.R. 264, 274 (Bankr.D.Kan.2007). See also In re Shat, 424 B.R. 854, 862 (Bankr.D.Nev.2010).

This Court disagrees with the foregoing and holds that the most reasonable interpretation is the one referred to as “narrow.” The Court in Gbadebo explained:

If the Court were writing on a clean slate, it would view the language of § 1129(b)(2)(B)(ii) as unambiguous. The Court would read the phrase “included in the estate under section 1115” to be reasonably susceptible to only one meaning: i.e., added to the bankruptcy estate by § 1115.

431 B.R. at 229. The Court parts company with Gbadebo in that this Court finds it is writing on a clean slate. The Court appreciates the analysis of the prior courts. However, none of them are binding on this Court. Without binding precedent, the Court's first step in statutory analysis is to review the statutory scheme and determine if there is a clear unambiguous answer. “[A]s long as the statutory scheme is coherent and consistent, there generally is no need for a court to inquire beyond the plain language of the statute.” United States v. Ron Pair Enterprises, Inc., 489 U.S. 235, 241, 109 S.Ct. 1026, 1030, 103 L.Ed.2d 290 (1989). When statutory language is plain, “the sole function of the courts is to enforce it according to its terms.” Id.

The Court finds that there is a plain, unambiguous reading of the statutes. Section 1129(b)(2)(B)(ii) limits the application of the absolute priority rule by allowing an individual to retain only the “property included in the estate under § 1115.” The property included under § 1115 is property “the debtor acquires after the commencement of ...