In re Shat

• Citation: 424 B.R. 854
• Decision Date: 22 February 2010
• Docket Number: No. BK-S-08-23136-BAM.,BK-S-08-23136-BAM.
• Parties: In re Martin SHAT and Anjanette Shat, Debtors.
• Court: United States Bankruptcy Courts. Ninth Circuit. U.S. Bankruptcy Court — District of Nevada

424 B.R. 854

In re Martin SHAT and Anjanette Shat, Debtors.

No. BK-S-08-23136-BAM.

United States Bankruptcy Court, D. Nevada.

February 22, 2010.

COPYRIGHT MATERIAL OMITTED

Christopher G. Gellner, Jeffrey A. Cogan, Jeffrey A. Cogan, Esq., Ltd., Las Vegas, NV, for Debtors.

OPINION ON ABSOLUTE PRIORITY RULE

BRUCE A. MARKELL, Bankruptcy Judge.

Martin and Anjanette Shat ("Debtors") filed for bankruptcy protection under chapter 11 on November 5, 2008. On August 20, 2009, they filed their Third Amended Plan of Reorganization ("Plan"),¹ which the court orally confirmed on October 13, 2009.

The only contested issue at the confirmation hearing was whether the "absolute priority" rule of 11 U.S.C. § 1129(b)(2)(B)(ii) applies to individual chapter 11 debtors after passage of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, Pub.L. No. 109-8 (2005) ("BAPCPA"). This court holds that it does not.

I. FACTS

The Debtors run a dry cleaning business, known as Flair Cleaners, which they own as a sole proprietorship. It is profitable. They also invested in several residential rental properties. Those are not so profitable.

The Debtors' Plan classifies their creditors into eight classes. Three of these classes are for creditors holding unsecured claims: one for a prior domestic support obligation; one for mortgage lenders' deficiencies; and one for creditors holding credit card claims.

Seven of the eight classes either accepted the plan or did not vote.² The eighth class was Class V, which the Plan labeled as "Miscellaneous General Unsecured Creditors (Credit Card Creditors), With Claims Totaling to Approximately $85,000." Under the Plan, creditors in this class were to be paid "10% of their allowed claims without interest over 5 years." Only one member of this class voted, and it rejected the plan.³ This dissenting unsecured creditor did not make any objection under 11 U.S.C. § 1129(a)(15) or file any other objection to the Plan.⁴

The Plan provided that, upon confirmation, "the Debtors shall be revested with their assets, subject only to outstanding liens which are not modified or avoided by the Debtors...."

II. "FAIR AND EQUITABLE" AND THE ABSOLUTE PRIORITY RULE

A. Confirmation Generally

As a general matter, a plan of reorganization can be confirmed in one of two ways. If all sixteen paragraphs of Section 1129(a) are satisfied, a plan can be confirmed consensually under Section 1129(a).⁵ If, however, a plan proponent satisfies all paragraphs of Section 1129(a) other than the voting requirement of paragraph (8), then the court may still confirm the plan as long as the plan is, among other things, "fair and equitable."⁶ This second, nonconsensual, method of confirmation is colloquially referred to as "cramdown."⁷

B. Historic Treatment of Individual Chapter 11 Debtors and Confirmation

Given Class V's rejection, the Debtors bore the burden of proving that the Plan was "fair and equitable" in order to confirm their Plan. Acequia, Inc. v. Clinton (In re Acequia, Inc.), 787 F.2d 1352, 1358 (9th Cir.1986). Before 2005, the Bankruptcy Code provided that a plan was "fair and equitable" as to unsecured creditors if it met the following test:

(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or

(ii) 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.

11 U.S.C. § 1129(b)(2)(B) (before taking into account changes made by BAPCPA).

Before BAPCPA, most courts applied this provision equally to individual and nonindividual debtors;⁸ that is, courts held that these provisions applied to humans and corporations alike. See, e.g., Unruh v. Rushville State Bank, 987 F.2d 1506, 1508 (10th Cir.1993); Computer Task Group, Inc. v. Brotby (In re Brotby), 303 B.R. 177, 195 (9th Cir. BAP 2003) (assuming applicability for purposes of analysis); In re Gosman, 282 B.R. 45, 48 (Bankr. S.D.Fla.2002); Davis v. Davis (In re Davis), 262 B.R. 791, 797 (Bankr.D.Ariz. 2001).

For some, this uniform application effectively meant that no individual debtor could ever confirm a chapter 11 plan. See, e.g., In re Gosman, 282 B.R. 45 (Bankr. S.D.Fla.2002) (may not use homestead as "new value" contribution; exempt property must be devoted to creditors' claims in chapter 11 plan). See also Ralph A. Peeples, Staying In: Chapter 11, Close Corporations and the Absolute Priority Rule, 63 AM. BANKR.L.J. 65 (1989); Raymond T. Nimmer, Negotiated Bankruptcy Reorganization Plans: Absolute Priority and New Value Contributions, 36 EMORY L.J. 1009, 1068-82 (1987). This reasoning had the effect of preventing individual debtors from keeping a business under a chapter 11 plan if they did not pay their unsecured creditors in full. Accordingly, had the Debtors filed their case before 2005, their Plan likely could not have been confirmed.

C. BAPCPA Amendments to 11 U.S.C. § 1129(b)(2)(B)(ii)

As part of BAPCPA, however, Congress amended Section 1129(b)(2)(B)(ii) with respect to individual chapter 11 debtors. The statute now reads as follows, with the provisions added by BAPCPA in italics:

(ii) 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.

This clause obviously modifies the absolute priority rule stated in subparagraph (ii). The question is, how extensive is this modification? Specifically, may the Debtors in this case retain their dry cleaning business without paying their unsecured creditors in full? To answer these questions requires an examination of the history of the BAPCPA amendment, and an examination of the role of the absolute priority rule in individual chapter 11 reorganizations.

1. History of the 2005 Amendments Relating to Individual Chapter 11 Debtors⁹

BAPCPA origins are in the National Bankruptcy Review Commission created by the 1994 Bankruptcy Reform Act.¹⁰ That Commission delivered its report in 1997,¹¹ although Congress had begun the process of reform even before the report had been finally issued.¹² The principal purpose of the legislation was to change the rules related to an individual's eligibility for bankruptcy, particularly in chapter 7, by linking the availability of bankruptcy relief to a debtor's income and other means.¹³ The initial "means-testing" provisions did not purport to make any changes to chapter 11.

This changed in 1999, when the Senate was considering the then-current bankruptcy reform bill, S. 625. At that time, the Senate Judiciary Committee added Section 321 to the bill. That amendment provided as follows:

SEC. 321. TREATMENT OF CERTAIN EARNINGS OF AN INDIVIDUAL DEBTOR WHO FILES A VOLUNTARY CASE UNDER CHAPTER 11.

Section 541(a)(6) of title 11, United States Code, is amended by inserting "(other than an individual debtor who, in accordance with section 301, files a petition to commence a voluntary case under chapter 11)" after "individual debtor".¹⁴

The section-by-section portion of the Senate Report accompanying the bill as ultimately passed by the Senate simply stated that "[t]his section provides that post-petition income will become property of the bankruptcy estate in individual consumer cases under chapter 11."¹⁵

The amendment did not go without comment. Senators Leahy, Kennedy, Feingold, and Schumer added the following in their Minority Views section of the Senate Report:

At the Judiciary Committee markup, Senator Grassley successfully introduced an amendment to include post-petition earnings for individual chapter 11 debtors as `property of the estate.' This so-called `super-rich' amendment, which would have been considered rather controversial had it been vetted among the bankruptcy community, is undoubtedly a significant change to bankruptcy law but is not the direct or most effective method of controlling higher income debtors and in any event is not responsive to our concerns regarding the disparate effects of the bill.¹⁶

At the same time the Senate debated S. 625, the House was considering a companion bill, H.R. 833.¹⁷ H.R. 833 passed the House on May 5, 1999.¹⁸ The bill as received in the Senate did not have any provisions for individual chapter 11 debtors.¹⁹ During its consideration in the Senate, however, the Grassley amendment from S. 625 was inserted into H.R. 333.

More importantly, it was also expanded. As a result, when the Senate ultimately passed H.R. 333,²⁰ Section 321 contained not only the original provision regarding personal service income (which had been changed from an amendment to Section 541 to the inclusion of a new Section 1115), but it also contained additional amendments which applied only to individuals in chapter 11. The list is short, but significant:

• Section 1123 was amended to require an individual's devotion of his or her postpetition service and other income as necessary to implement the plan;

• A "projected disposable income" test was added to Section 1129(a) as new paragraph (14);²¹ • An individual's discharge was delayed until the completion of plan payments; and

• A new section on plan modification was inserted.²²

There was one final change. The bill included a proposed change to Section 1129(b)(2)(B)(ii) consisting of the language italicized above.²³

Congress passed the substance of H.R. 833 after the 2000 elections, but President Clinton refused to sign the bill, and it was thus "pocket-vetoed."²⁴ Bankruptcy reform thus had to be reintroduced in the 107th Congress.

Reintroduction came soon. On January 31, 2001, H.R. 333 was introduced in the...