CHAPTER 8, D. Chapter 11's Double Whammy on Individual Debtors

• Jurisdiction: United States

D. Chapter 11's Double Whammy on Individual Debtors

ABI Journal

October 2019

Brian Gifford

U.S. Bankruptcy Court (S.D. Ohio)

Columbus, Ohio

Laura Atack¹

U.S. Bankruptcy Court (S.D. Ohio)

Columbus, Ohio

We have come a long way since the U.S. Supreme Court decided that individuals not engaged in business are eligible to file under chapter 11.² Today, it is commonplace for individuals who exceed chapter 13's debt limits to consider chapter 11 as a path forward when they need to restructure their debts. In fact, a national study funded by ABI noted that the share of chapter 11 cases filed by individuals has increased over time and that individuals now file more than 25 percent of chapter 11 cases.³

Individuals filing under chapter 11 face unique challenges due to the combined effect of two Bankruptcy Code provisions: Section 1129(a)(15)(B)'s "projected disposable income" standard, and § 1129(b)(2)'s "absolute priority" rule. In the words of the Sixth Circuit, these requirements can hit individuals with a "double whammy."⁴ This article examines the relief that the Small Business Reorganization Act of 2019 (SBRA) could potentially have to small business bankruptcies to avoid the impact of these Code sections.⁵

The Projected-Disposable-Income Requirement

Section 1129(a)(15)(B)'s disposable-income requirement is triggered when the holder of an allowed unsecured claim that will not be paid in full objects to confirmation of the individual debtor's chapter 11 plan. Under these circumstances, the plan must provide that "the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in section 1325(b)(2))" during the longer of five years or the period for which the plan provides payments.⁶

Courts have held that the amount of projected disposable income serves as the benchmark for determining the value of property to be distributed under the plan, but that debtors might distribute less than their entire projected disposable income if they use other property to make up for any shortfall.⁷ The "value of the property to be distributed under the plan" includes all distributions (including those made to priority creditors and administrative claimants), not just distributions to general unsecured creditors.⁸

Creditors whose claims are not being paid in full under a proposed plan have sometimes argued that § 1129(a)(15)(B), which references § 1325(b)(2), prohibits an individual debtor's post-confirmation personal expenses from being any higher than the expenses that an above-median-income chapter 13 debtor would be permitted to incur. At least one court has agreed and held that the expense limitations of chapter 13 apply to chapter 11 debtors who have above-median income.⁹ However, most courts, including a bankruptcy court that decided the issue earlier this year, have held that these limitations do not apply when the amounts reasonably necessary to be expended by debtors are being determined under § 1129(a)(15)(B).¹⁰

The Absolute-Priority Rule

To confirm a proposed chapter 11 plan, a plan proponent must meet the standards set forth in § 1129(a), including the requirement that each impaired class has accepted the plan.¹¹ However, even when an impaired class of creditors votes to reject the plan, the Bankruptcy Code offers plan proponents another path to confirmation: a process commonly known as a "cramdown." In a cramdown scenario, all classes need not accept the plan so long as there is at least one accepting impaired class¹² and the plan "does not discriminate unfairly, and is fair and equitable" with respect to the dissenting creditors.¹³

Section 1129(b)(2) specifies certain requirements that a plan must meet in order to be found "fair and equitable." Among those is the absolute-priority rule, which dictates that either dissenting creditors be paid in full or else no person with a junior claim or interest in property may "receive or retain under the plan on account of such junior claim or interest any property."¹⁴ In plain terms, when strictly applied, the absolute-priority rule prevents individual debtors from keeping their property¹⁵ unless unsecured creditors are paid in full. Before the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), that is exactly how the absolute-priority rule operated with respect to...