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The Essential Resource for Today’s Busy Insolvency Professional
Student Gallery
By Janine Lee
The Individual Chapter 11
“Double Whammy” Conundrum
I
n Ice House America LLC v. Cardin (In re
Cardin), the Sixth Circuit held that “the absolute
priority rule continues to apply to pre-petition
property of individual debtors in Chapter 11 cases.”1
Consequently, the debtor could only retain post-
petition property taken into the estate under § 1115
of the Bankruptcy Code.2
The Sixth Circuit joined
other circuit courts in taking the “narrow” view
as to whether the 2005 amendment to 11 U.S.C.
§ 1129(b)(2)(B)(ii) abrogated the absolute priority
rule with regard to individual debtors.3
Background
In 2008, Ice House America obtained judgments
against Charles Cardin totaling $1,301,900.4
In
2011, Cardin filed an individual voluntary petition
for reorganization under chapter 11.5
His pre-peti-
tion property included his home, eight ice-making
machines, a vehicle and other personal property,6
and his business consisted of selling bagged ice
from ice machines.7
Since two of his assets were
oversecured, Cardin had approximately $200,000 in
equity when he filed his petition.8
Ice House objected to Cardin’s plan, asserting
that it violated the absolute priority rule because
it would allow Cardin to retain his pre-petition
assets while failing to pay Ice House in full.9
The
U.S. Bankruptcy Court for the Eastern District of
Tennessee overruled the objection and ultimately
confirmed Cardin’s plan, allowing him to retain
most of his pre-petition assets and to pay Ice House
$124,000 toward its claim of $1.5 million.10
This
resulted in a payment of less than 10 cents on the
dollar to Ice House.11
Ice House appealed to the U.S.
District Court for the Eastern District of Tennessee,
which certified the question for appeal to the Sixth
Circuit.12
The main issue on appeal was whether
the Bankruptcy Abuse Prevention and Consumer
Protection Act of 2005 (BAPCPA) resulted in a
complete abrogation of the absolute priority rule as
it applies to individual debtors.13
Changes under BAPCPA
Ice House’s objection to Cardin’s plan rested
upon specific language in § 1129(b)(2)(B)(ii) per-
taining to individual debtors.14
Under chapter 13 or
11, individual debtors may reorganize their financial
affairs by preparing a written reorganization plan,
obtaining court approval of the plan and fulfilling
the plan’s requirements.15
Individuals normally
petition to reorganize as wage-earners under chap-
ter 13;16
however, individuals may also reorganize
under chapter 11.17
Individual debtors often reorga-
nize under chapter 11 due to the debt limits imposed
on chapter 13 debtors.18
Pre-BAPCPA, an individual chapter 11 debtor
was in a substantially better financial position than
an individual chapter 13 debtor.19
A chapter 13
debtor was required to fund his/her plan with post-
petition “disposable income” in order for a plan to
Janine Lee
UNLV William S. Boyd
School of Law
Las Vegas
1 Ice House Am. v. Cardin, 751 F.3d 734, 740 (6th Cir. 2014).
2 Id. at 739.
3 See, e.g., In re Stephens, 704 F.3d 1279 (10th Cir. 2013); In re Lively, 717 F.3d 406 (5th
Cir. 2013). But see, e.g., In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012); In re Shat,
424 B.R. 854, 856 (Bankr. D. Nev. 2010).
4 Ice House, 751 F.3d at 736.
5 Brief for Appellant at 10, Ice House Am. v. Cardin, 751 F.3d 734, 740 (6th Cir. 2014) (No. 24).
6 Ice House, 751 F.3d at 737.
7 Id. at 736.
8 Id. at 737.
9 Id.
Janine Lee is a 2016
J.D. candidate at the
University of Nevada
at Las Vegas William
S. Boyd School of
Law and a senior
paralegal at The
Schwartz Law Firm
Inc. in Las Vegas.
10 Id. at 736.
11 Id. at 737.
12 Id.
13 Id. at 736.
14 Id. at 737.
15 11 U.S.C. §§ 1121 and 1321, et seq.
16 11 U.S.C. § 109(e).
17 Toibb v. Radloff, 501 U.S. 157, 160-61 (1991).
18 See 11 U.S.C. § 109(e) (as of April 1, 2013, the unsecured debt limit is $383,175 and the
secured debt limit is $1,149,525).
19 See In re Lively, 717 F.3d 406, 409 (5th Cir. 2013).
2. 66 Canal Center Plaza, Suite 600 • Alexandria, VA 22314 • (703) 739-0800 • Fax (703) 739-1060 • www.abi.org
be confirmed, but a chapter 11 individual debtor only had
to use assets that were property of the bankruptcy estate as
of the petition date.20
The chapter 11 debtor’s post-petition
earnings were not part of the estate and therefore were not
used to fund a reorganization plan.21
By amending the defi-
nition of “property of the estate” under § 1115, Congress
alleviated this inconsistency by adding individual chapter
11 debtors’ post-petition earnings and property acquisi-
tions to the definition, in addition to the property specified
in § 541.22
This amendment, in light of the amendment to
§ 1129(b)(2)(B)(ii), left open the question regarding the
applicability of the absolute priority rule with regard to
individual debtors.
Absolute Priority Rule
Absent a “cramdown” plan under § 1129(b), a court gen-
erally cannot confirm a plan if an impaired creditor rejects
it.23
Under § 1129(b), in order for such a nonconsensual plan
to be “fair and equitable,” it must satisfy the absolute prior-
ity rule.24
The absolute priority rule allows a cramdown of a
nonconsensual plan without the payment of unsecured claims
in full, but only if “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 indi-
vidual, the debtor may retain property included in the estate
under section 1115, subject to the requirements of subsection
(a)(14) of this section.”25
The absolute priority rule debate revolves around what
Congress meant by the phrase “except that in a case in which
the debtor is an individual, the debtor may retain property
included in the estate under section 1115” (the “exception”).26
Since pre-BAPCPA “property of the estate” did not include
property or earnings that were acquired post-petition, both
an individual and a corporate debtor could retain these assets
without an “absolute priority” issue.27
The 2005 amendments
to § 1115 changed the status quo by adding an individual’s
post-petition earnings and acquired property as “property of
the estate.”28
After the amendment, § 1115 now reads:
(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 com-
mencement 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 con-
verted to a case under chapter 7, 12, or 13,
whichever occurs first.29
Thus, in evaluating Ice House’s claim, the Sixth Circuit ana-
lyzed whether, given the Code amendments, Cardin could
retain both pre-petition and post-petition property and still
confirm a nonconsensual plan.30
The Sixth Circuit’s Decision: “Double
Whammy” Defined
The Sixth Circuit began its analysis with an overview
of the requirements of plan confirmation under chapter
11, including a discussion of the absolute priority rule.31
The court asserted that the rule has been “a cornerstone of
equitable distribution for Chapter 11 creditors for over a
century.”32
Since the debtor’s plan allowed him to retain
pre-petition property and did not pay Ice House in full, the
parties agreed that Cardin’s plan did not satisfy the absolute
priority rule.33
The Sixth Circuit then compared definitions of the word
“included” from The American Heritage Dictionary with
the usage in the statute.34
The court determined that the
usage in the statute “refers to property that § 1115 includes
in the estate, which naturally reads as ‘property that § 1115
takes into the estate,’ rather than as property that § 1115
contains in the estate.”35
Since § 1115 cannot take property
into the estate that was already there, the court concluded
that § 1115 takes into the estate only property “that the
debtor acquires after [the] commencement of the case.”36
Thus, when unsecured creditors are not paid in full, an indi-
vidual chapter 11 debtor may only retain property that was
acquired post-petition.37
The Sixth Circuit stated that if Congress wanted to
exclude individual debtors from the absolute priority rule,
it would have done so in a clear way.38
It then agreed with
the bankruptcy court’s observation that “an individual debtor
in Chapter 11 is hit by a double whammy.”39
This “double
whammy” refers to the following:
20 Id.
21 Id.
22 Id.; 11 U.S.C. §§ 1115 and 541.
23 Ice House, 751 F.3d 734, 737 (6th Cir. 2014).
24 Id. (quoting Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 202 (1988)); 11 U.S.C. § 1129(b).
25 11 U.S.C. § 1129(b)(2)(B)(ii).
26 Id.
27 In re Karlovich, 456 B.R. 677, 681 (Bankr. S.D. Cal. 2010).
28 Id.
29 11 U.S.C. § 1115 (emphasis added).
30 Ice House, 751 F.3d 734, 738 (6th Cir. 2014).
31 Id. at 736-37.
32 Id. at 737 (quoting In re Lively, 717 F.3d. 406, 410 (5th Cir. 2013)).
33 Id.
34 Id. at 738-39.
35 Id. at 739 (emphasis added).
36 Id.
37 Id.
38 Id.
39 Id. at 740 (emphasis added).
The “double whammy” ...
presents quite a conundrum
for the individual chapter 11
debtor. A strict application of
the absolute priority rule to
individual chapter 11 debtors ...
could result in a debtor’s
surrender of both pre-petition
property and future earnings
to creditors in order to confirm
a nonconsensual plan.
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a) Like Chapter 13 debtors, the 2005 Amendment
in § 1129(a)(15)(B) requires individual debtors in
Chapter 11 to dedicate all of their projected dispos-
able income for five years to the payment of unse-
cured creditors.40
b) Unlike Chapter 13 debtors, individual Chapter 11
debtors are subject to the absolute priority rule, pre-
venting them from retaining any pre-petition property
without paying unsecured creditors in full.41
The Sixth Circuit recognized the resulting hardship that
the “double whammy” places on the individual chapter 11
debtor.42
In the court’s words, “he must dedicate at least five
years’ disposable income to the payment of unsecured credi-
tors, and — unlike a debtor in Chapter 13 — is also subject
to the absolute priority rule (and thus cannot retain any pre-
petition property) if he does not pay those creditors in full.”43
This “double whammy” highlights particular obstacles
that are presented to individual chapter 11 debtors as a
result of the BAPCPA amendments. Which begs the fol-
lowing question: What was the congressional intent behind
BAPCPA pertaining to individual chapter 11 debtors?
Congressional Intent: The Shat View
Did Congress make specific changes under BAPCPA
with the intent of treating individual chapter 11 debt-
ors like chapter 13 debtors? In In re Shat from the U.S.
Bankruptcy Court for the District of Nevada, the debt-
ors owned a profitable dry cleaning business and several
unprofitable residential investment properties.44
Their plan
proposed that they retain all of the property while paying
an unsecured creditor class 10 percent of their allowed
claims over five years.45
Concluding that the exception in
§ 1129(b)(2)(B)(ii) modified the absolute priority rule to
allow the debtors to retain their business, the Shat court
confirmed the debtors’ plan over the objection of one dis-
senting creditor.46
The Shat court then discussed the historic treatment of
individual chapter 11 debtors under the Bankruptcy Code,
as well as BAPCPA’s history and effect with regard to indi-
vidual debtors.47
Hon. Bruce A. Markell concluded that
Congress intended to “adopt and adapt as much of Chapter
13 as possible with respect to individual debtors in Chapter
11” by making the following amendments:48
• redefining “property of the estate” under § 1115 to
resemble the definition in § 1306;
• changing the mandatory contents of a plan under
§ 1123(a)(8) to resemble § 1322(a)(1);
• adding the disposable-income test in § 1325(b) to
§ 1129(a)(15);
• delaying discharge until the completion of all plan pay-
ments as in § 1328(a);
• permitting a discharge for cause prior to the completion
of all payments under § 1141(d)(5), which resembles the
hardship discharge in § 1328(b); and
• the addition of § 1127(e) to permit plan modification,
even after substantial consummation, for purposes that
are similar to § 1329(a).49
If Congress intended to treat individual chapter 11 debtors
like chapter 13 debtors under BAPCPA, then the absolute
priority rule presents a clear roadblock to this goal, as well
as to the goal of granting a fresh start to debtors.50
Conclusion
The “double whammy” discussed by the Sixth Circuit
presents quite a conundrum for the individual chapter 11
debtor. A strict application of the absolute priority rule to
individual chapter 11 debtors (the “narrow” view) could
result in a debtor’s surrender of both pre-petition property
and future earnings to creditors in order to confirm a non-
consensual plan. Under those circumstances, confirmation
of such a plan seems almost — if not entirely — impossible.
Alternatively, the conclusion that BAPCPA abrogated the
absolute priority rule as to individual debtors may result in
providing such debtors with a realistic opportunity to reor-
ganize and successfully exit bankruptcy, just as a chapter 13
debtor can do. abi
Reprinted with permission from the ABI Journal, Vol. XXXIV,
No. 1, January 2015.
The American Bankruptcy Institute is a multi-disciplinary, non-
partisan organization devoted to bankruptcy issues. ABI has
more than 12,000 members, representing all facets of the insol-
vency field. For more information, visit abi.org.
40 Id.; 11 U.S.C. § 1325(b)(1)(B).
41 Ice House, 751 F.3d at 740.
42 Id. at 739-40.
43 Id. at 740.
44 In re Shat, 424 B.R. 854, 856 (Bankr. D. Nev. 2010).
45 Id. at 857.
46 Id. at 865, 868.
47 Id. at 868.
48 Id. at 858-62.
49 Id. at 862.
50 Rousey v. Jacoway, 544 U.S. 320, 325 (2005).