In re Martin

• Decision Date: 17 September 2013
• Docket Number: Case No: 8:13–bk–00624–MGW
• Citation: 497 B.R. 349
• Parties: In re: Valerie Ann Martin, Debtor.
• Court: U.S. Bankruptcy Court — Middle District of Florida

497 B.R. 349

In re: Valerie Ann Martin, Debtor.

Case No: 8:13–bk–00624–MGW

United States Bankruptcy Court, M.D. Florida.

Tampa Division

September 17, 2013

Michael C. Caborn, Esq., Winderweedle, Haines, Ward & Woodman, P.A., Orlando, FL, Counsel for Cadles of Grassy Meadows II, LLC.

Buddy D. Ford, Esq., Buddy D. Ford, P.A., Tampa, FL, Counsel for Debtor.

Chapter 11

MEMORANDUM OPINION ON ABSOLUTE PRIORITY RULE

Michael G. Williamson, United States Bankruptcy Judge

In this Memorandum Opinion, the Court adopts the “narrow view” of the applicability of the absolute priority rule in individual Chapter 11 cases following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act.¹ Under this view, a plan cannot be confirmed unless either a non-accepting class of unsecured creditors will be paid in full or the debtor will not receive or retain any non-exempt pre-petition property under the plan following confirmation. In this case, the Plan filed by the Debtor, Valerie Ann Martin (“Martin”), allows her to keep three investment properties following confirmation even though unsecured creditors are not paid in full. Because this violates the absolute priority rule, confirmation will be denied.

Background

Martin filed this individual chapter 11 case on January 18, 2013. As of confirmation, there was a total of $170,531.08 in unsecured claims in this case. Cadles of Grassy Meadows II, LLC (“Cadles”) holds $62,987.43—or nearly 40%—of those unsecured claims. Martin proposed a chapter 11 plan that would pay holders of general unsecured claims (Class XIV) a total of $8,500—approximately a 5% distribution.

Of the five ballots cast by holders of Class XIV claims, four voted to accept the Plan. So more than half the number of allowed claims in Class XIV have voted to accept the Plan. But Cadles, which holds nearly 40% of the amount of unsecured claims, did not vote in favor of the plan, and as a consequence, Martin failed to satisfy the requirement that at least two-thirds of the amount of each class accept the plan.² That means Martin must “cram down” the unsecured (Class XIV) creditors under § 1129(b) to confirm her plan.

Cadles, however, contends Martin cannot confirm her plan under § 1129(b) because the plan provides that she will retain three investment properties following confirmation. During the course of the case, Martin was able to either strip down or strip off mortgages on these investment properties. ³ Martin was also able to successfully negotiate repayment terms with the holders of the stripped-down mortgages that will allow her to continue to rent these properties, service the remaining secured debt, and benefit from any excess cash flow (as well as future appreciation). So the issue before the Court is whether the absolute priority rule codified in § 1129(b)(2)(B) precludes confirmation of a plan in which (i) a dissenting class of unsecured creditors is not being paid in full; and (ii) the debtor will continue to own non-exempt pre-petition property.

Conclusions of Law

A. Cramdown in Individual Chapter 11 Cases and the Absolute Priority Rule Pre–BAPCPA.

In order for a Chapter 11 plan to be confirmed, the proponent of the plan—typically the debtor—has the burden of establishing the requirements enumerated in § 1129(a)(1)–(16). One of those subsections—§ 1129(a)(8)—requires that each impaired class has accepted the plan.⁴ But § 1129(b) contains an alternative to 1129(a)(8).

Under § 1129(b), the Court can still confirm the plan over the objection of an impaired creditor (assuming all of the other requirements of confirmation of § 1129(a) are met) if it is “fair and equitable.” ⁵ This procedure is commonly referred to as “cramdown” because the Court is imposing a plan treatment on an impaired class of creditors—involuntarily—over their objection. Section 1129(b) goes on to provide when a plan is “fair and equitable” with respect to different classes of creditors. With respect to a class of unsecured claims, there are two ways a plan can satisfy the “fair and equitable” requirement.

First, if the plan provides that the holders of claims in the class will receive “property of a value, as of the effective date of the plan, equal to the allowed amount[s]” of their claims, then the vote of the class is not needed.⁶ This can be accomplished by either paying the claims in full in cash on the effective date of the plan or, more commonly, by paying the full amount of the claims over time with an interest rate sufficient to pay creditors the present value of the full amount of their claims.

Second, absent full payment, the other alternative for cramdown of a class of unsecured creditors is that the plan does not allow the holder of any claim or interest that is junior to the dissenting class to receive or retain any property on account of the junior claim or interest.⁷ This long-standing concept is called the “absolute priority rule” because it recognizes that an owner's interest in property is subordinate to the interests of the owner's creditors.⁸ So in a typical Chapter 11 reorganization of a corporation, the corporation's shareholders cannot—absent consent of the unsecured creditors—receive any payment or retain any stock on account of their pre-petition shareholder interests if the plan does not provide for full payment of the unsecured creditors.

Of course, individuals do not have shareholders. So the absolute priority rule with respect to individuals was historically interpreted to preclude individuals from retaining any property if their creditors were not being paid in full under the plan.⁹ The one possible exception to this is a debtor's ability to retain exempt property. Although some courts have held that even the retention of exempt property violates the absolute priority rule, ¹⁰ the majority (and better reasoned) decisions disagree, concluding that the total liquidation of an individual Chapter 11 debtor's assets is not required in order to satisfy the absolute priority rule.¹¹

As Judge Paskay reasoned when considering this issue in Henderson, a debtor's interest in exempt property can never be “junior” to the interests of creditors (including claims of dissenting unsecured creditors) because unsecured creditors cannot reach exempt property outside of bankruptcy, and exempt property is immune and not subject to liquidation under any of the chapters of the Bankruptcy Code.¹² This conclusion is consistent with the underlying rationale for the absolute priority rule—namely, that an owner's interest in property is subordinate to the interests of the owner's creditors—subject to the long-recognized exception to this subordination with respect to exempt property as reflected in various provisions of state and federal law.¹³ But other than that issue, application of the absolute priority rule in individual Chapter 11 cases was fairly straightforward before BAPCPA was enacted in 2005. BAPCPA, however, made two amendments to the provisions affecting individual Chapter 11 debtors that have complicated application of the absolute priority rule in individual cases. ¹⁴

B. The BAPCPA Amendments Affecting the Absolute Priority Rule for Individual Chapter 11 Debtors.

The first relevant BAPCPA Amendment affecting individual Chapter 11 debtors is that the definition of property of the estate for an individual debtor in Chapter 11 was expanded. Pre–BAPCPA, “property of the estate” was defined under § 541 as including all legal or equitable interests of the debtor in property as of the commencement of the case, as well as the proceeds, rents, or profits from such property, “except such as are earnings from services performed by an individual debtor after the commencement of the case.” ¹⁵ So simply stated, pre-BAPCPA, property of the estate in the Chapter 11 case of an individual included everything the debtor owned on the date of the petition but did not include anything earned by the debtor post-petition.

Under the BAPCPA Amendments, property of the estate now includes, “in addition to the property specified in section 541... earnings from services performed by the debtor after the commencement of the case” in a Chapter 11 case in which the debtor is an individual.¹⁶ Again, simply stated, post-BAPCPA, property of the estate in the Chapter 11 case of an individual includes everything the debtor owned on the date of the petition plus anything earned by the debtor post-petition.

The effect of this amendment is to add back “earnings from services” that are otherwise generally excluded from property of the estate under § 541(a)(6). This is consistent with the provisions of Chapter 13, which includes earnings from the debtor's post-petition services within the property of the estate (“in addition to the property specified in section 541”) and allows a debtor to remain in possession of such property before confirmation and vests all such property in the debtor upon confirmation of the plan.¹⁷

The second relevant change resulting from BAPCPA relates to the application of the absolute priority rule codified in § 1129(b)(2)(B)(ii). Recall that under this provision, the holder of any claim or interest that is junior to the claims of an impaired dissenting class cannot retain property on account of that junior interest unless the class is being paid in full under subparagraph (i) of § 1129(b)(2)(B). So the absolute priority rule applied as it has been historically would prohibit an individual Chapter 11 debtor from retaining any property under a plan—even including the post-petition earnings from services. Subparagraph (ii), as amended, now provides an exception to that requirement for individual Chapter 11 debtors, stating that “the debtor may retain property included in the estate under § 1115.” ¹⁸ The question is: What is the property included in the estate under § 1115? Unfortunately, as with many BAPCPA amendments, the courts are split on how to interpret this new provision.

One line of cases embracing...