Zachary v. Cal. Bank & Trust

Decision Date28 January 2016
Docket NumberNo. 13–16402.,13–16402.
Parties David K. ZACHARY; Annmarie S. Snorsky, Debtors–Appellants, v. CALIFORNIA BANK & TRUST, Respondent–Appellee.
CourtU.S. Court of Appeals — Ninth Circuit

Gregg W. Koechlein (argued), Reno, NV, for DebtorsAppellants.

Matthew D. Murphey (argued), Penelope Parmes, Martin W. Taylor, Meghan Canty Sherrill, Troutman Sanders LLP, Irvine, CA, for RespondentAppellee.

Before: RICHARD A. PAEZ, MARY H. MURGUIA, and ANDREW D. HURWITZ, Circuit Judges.

OPINION

HURWITZ, Circuit Judge:

This case presents an arcane but important question of first impression in this Circuit: Does the absolute priority rule continue to apply in individual chapter 11 reorganizations after the amendments to the Bankruptcy Code enacted as part of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ("BAPCPA")? We hold that it does.

I. Factual and Procedural Background

In September 2011, David K. Zachary and Annmarie S. Snorsky ("Debtors") filed a joint voluntary individual chapter 11 petition. The Debtors' operative plan of reorganization placed their largest unsecured creditor, California Bank & Trust ("California Bank"), into its own class of unsecured creditors and proposed to pay it $5,000 on its claim of nearly $2,000,000. California Bank's claim was thus "impaired under the plan." 11 U.S.C. § 1129(a)(8)(B).

California Bank objected, arguing that the plan violated the so-called absolute priority rule of 11 U.S.C. § 1129(b)(2)(B)(ii). The bankruptcy judge, disagreeing with the Ninth Circuit Bankruptcy Appellate Panel ("BAP") opinion in In re Friedman, 466 B.R. 471 (9th Cir. BAP 2012), sustained the objection, holding that "the absolute priority rule still prevails" in individual chapter 11 bankruptcies after the enactment of BAPCPA.1

Debtors filed a timely notice of appeal of the bankruptcy court's order sustaining California Bank's objection to their plan. The bankruptcy court certified the appeal, and this Court authorized a direct appeal. 28 U.S.C. § 158(a), (d)(2)(A).

II. Discussion

We review "de novo the bankruptcy court's and the BAP's interpretations of the bankruptcy statute." In re Boyajian, 564 F.3d 1088, 1090 (9th Cir.2009). "A party contending that legislative action changed settled law has the burden of showing that the legislature intended such a change." Green v. Bock Laundry Mach. Co., 490 U.S. 504, 521, 109 S.Ct. 1981, 104 L.Ed.2d 557 (1989).

A. Individual chapter 11 bankruptcies and the absolute priority rule.

"Individual debtors have two basic options under the Code." Ice House Am., LLC v. Cardin, 751 F.3d 734, 736 (6th Cir.2014). They can either liquidate their non-exempt assets under chapter 7, or file for reorganization under chapters 11 or 13. See 11 U.S.C. §§ 701 –84, 1101 –46, 1301 –30. A chapter 13 reorganization, however, is only available to individual debtors whose debts fall below certain limits. See 11 U.S.C. § 109(e). Individual debtors with more debt can only file for reorganization under chapter 11, which is "used primarily by debtors with ongoing businesses." Toibb v. Radloff, 501 U.S. 157, 163, 111 S.Ct. 2197, 115 L.Ed.2d 145 (1991) (emphasis omitted).

An individual filing under chapter 11 may confirm a plan of reorganization in one of two ways. The first is by satisfying the bankruptcy court that a plan complies with each of the sixteen paragraphs in 11 U.S.C. § 1129(a). Under this path, "[o]f particular note is the requirement of obtaining the consent of each class of creditor as required by paragraph (8) of § 1129(a)." In re Friedman, 466 B.R. at 480. Absent unanimous approval of the plan by each class of creditors, a debtor must pursue the second path to confirmation.

Under the second path, a debtor can obtain confirmation by satisfying the bankruptcy court that, notwithstanding any creditor's objections, the plan is "fair and equitable" to each creditor class. 11 U.S.C. § 1129(b)(1), (2). Because this "nonconsensual method of confirmation" is obtained over creditor objection, it is known as a "cramdown." In re Friedman, 466 B.R. at 480. A debtor may cram down a plan only if it complies with the absolute priority rule in § 1129(b)(2)(B)(ii). Put another way, a bankruptcy judge may find that a debtor's plan is "fair and equitable" to an objecting creditor only if the plan complies with the absolute priority rule.

The absolute priority rule is a "judicially created concept," with its genesis in "early twentieth-century railroad cases." In re Friedman, 466 B.R. at 478. It arose from the Bankruptcy Code's statutory requirement, now codified in 11 U.S.C. § 1129(b)(2), that a reorganization plan be "fair and equitable" to each class of creditors. The rule "provides that a dissenting class of unsecured creditors must be provided for in full before any junior class can receive or retain any property under a reorganization plan." Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 202, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988) (alteration omitted) (quoting In re Ahlers, 794 F.2d 388, 401 (8th Cir.1986) ). "The U.S. Supreme Court adopted the absolute priority rule to prevent deals between senior creditors and equity holders that would impose unfair terms on unsecured creditors." In re Friedman, 466 B.R. at 478 ; see also N. Pac. Ry. Co. v. Boyd, 228 U.S. 482, 503–04, 33 S.Ct. 554, 57 L.Ed. 931 (1913). The rule later "gained express statutory force, and was incorporated into Chapter 11 of the Bankruptcy Code adopted in 1978" as 11 U.S.C. § 1129(b)(2)(B)(ii). Norwest, 485 U.S. at 202, 108 S.Ct. 963.

Before the adoption of BAPCPA in 2005, it was clear that "no Chapter 11 reorganization plan can be confirmed over the creditors' legitimate objections (absent certain conditions not relevant here) if it fails to comply with the absolute priority rule." Id. At that time, the absolute priority rule provided:

[T]he condition that a plan be fair and equitable with respect to a class [of creditors] includes the following requirements:
....
(B) With respect to a class of unsecured claims—
(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)(ii) (1994) (emphasis added). Thus, under the pre-BAPCPA Bankruptcy Code, it was clear that "every unsecured creditor must be paid in full before the debtor can retain ‘any property’ under a plan." Ice House, 751 F.3d at 737 (quoting 11 U.S.C. § 1129(b)(2)(B)(ii) ).

B. Amendment of the absolute priority rule by BAPCPA.

Three provisions of the post-BAPCPA Bankruptcy Code intertwine to implement the absolute priority rule. First, § 541, which was not altered by BAPCPA, defines an estate in bankruptcy as "comprised of all" the property enumerated in that section, "wherever located and by whomever held," including "all legal or equitable interests of the debtor in property as of the commencement of the case. " 11 U.S.C. § 541(a), (a)(1) (emphasis added). Under this section, the "property of the estate," and, therefore, the property subject to the absolute priority rule in chapter 11 cases, is "the property the debtor owned ‘as of the commencement of the case.’ " Ice House, 751 F.3d at 737–38 (quoting 11 U.S.C. § 541(a)(1) ).

The second relevant provision is § 1115, which was added in 2005 by BAPCPA. Pub.L. No. 109–8, § 321, 119 Stat. 23, 94–95 (2005). Section 1115, which only applies to individual chapter 11 proceedings, adds to the § 541"property of the estate" certain property obtained by the debtor "after the commencement of the case":

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.

11 U.S.C. § 1115(a) (emphasis added).

Finally, BAPCPA amended the absolutely priority rule itself, adding the underscored language to § 1129(b)(2)(B)(ii) :

[T]he condition that a plan be fair and equitable with respect to a class [of creditors] includes the following requirements:
....
(B) With respect to a class of unsecured claims—
(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, 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.

Pub.L. No. 109–8, § 321, 119 Stat. 23, 95 (emphasis added).

The new clauses in subsection (B)(ii) plainly create an exception to the absolute priority rule that applies only to a chapter 11 "case in which the debtor is an individual." 11 U.S.C. § 1129(b)(2)(B)(ii). But the question is, what is the exception's scope? Or, put another way, what property may an individual chapter 11 debtor retain "without running afoul of the absolute priority rule"? In re Friedman, 466 B.R. at 487 (Jury, Bankr. J., dissenting).

C. Post–BAPCPA case law.

"A significant split of authorities has developed nationally among the bankruptcy courts" regarding the answer to this question. In...

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