Does the Absolute Priority Rule Still Apply to Individual Chapter 11 Debtors Post-BAPCPA

Abstract

Section 1129(b)(1) of the Bankruptcy Code codifies a principle known as the 'absolute priority rule.' The absolute priority rule requires that creditors be provided for in full before holders of equity can receive or retain any property under a plan of reorganization. The absolute priority rule ensures that a plan of reorganization will not be used to allow equity to benefit at the cost of higher-priority unsecured debt. A small number of insiders, whether representatives of management or major creditors, can often use the reorganization process to gain an unfair advantage if left unchecked. This problem is magnified in chapter 11 cases with individual debtors. Chapter 11, as it was originally conceived, was never intended to be used by individual debtors. Courts have struggled to find the proper balance in applying many of chapter 11’s corporate oriented provisions – including the absolute priority rule – to living, breathing human beings, i.e., individual debtors. In 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ('BAPCPA'). BAPCPA amended chapter 11 by expanding the bankruptcy estate in individual chapter 11 cases to include post-commencement property and earnings. Due to the poor drafting of certain BAPCPA amendments, the exception language in § 1129(b)(2)(B)(ii) is susceptible to two different interpretations. The first, popularly termed the 'broad view,' would abrogate the absolute priority rule in individual chapter 11 cases. The second, termed the 'narrow view,' would have the absolute priority rule apply only to an individual debtor’s pre-petition property. This article argues that the principles of statutory construction favor the narrow view. First, this interpretation is supported by a plain reading of the text of the statute. Second, the narrow view is supported by the overall context of the Bankruptcy Code. The legislative history involved is sparse at best and is generally not helpful in determining Congress’s intent on the issue. As a result, the preexisting bankruptcy practice – the narrow view – should prevail.