Mcle Article: Test Your Knowledge: Recent Developments in Insolvency Law
| Publication year | 2016 |
| Citation | Vol. 2016 No. 2 |
| Author | Tom Phinney and Paul J. Pascuzzi |
Tom Phinney and Paul J. Pascuzzi
Tom Phinney is a partner with Parkinson Phinney in Sacramento, practicing bankruptcy law and commercial litigation. He is a Business Bankruptcy Specialist certified by the American Board of Certification. He is currently President of the California Bankruptcy Forum.
Paul J. Pascuzzi is a partner at Felderstein Fitzgerald Willoughby & Pascuzzi LLP in Sacramento. Mr. Pascuzzi is a former chair of the Executive Committee and the Insolvency Law Committee of the Business Law Section of the California State Bar. Mr. Pascuzzi's practice focuses on all aspects of business bankruptcy and insolvency law.
Welcome to the fourth annual edition of our article covering developments in bankruptcy law. This article comes from a program we presented for the Bankruptcy and Commercial Law Section of the Sacramento County Bar Association. Once again, we invite you to test your knowledge of recent developments in the area of insolvency law. Unless otherwise noted, all references are to the Bankruptcy Code. We provide a summary of the facts, issues and holdings from a mix of important and interesting bankruptcy decisions over the past year. For MCLE credit, please see instructions for accessing the 20 true/false questions at the end of the article. Good luck!
This case involves whether the absolute priority rule codified in Bankruptcy Code section 1129(b) survived the 2005 amendments to the Bankruptcy Code commonly known as BAPCPA. Many courts are divided on whether it did, but the Ninth Circuit Court of Appeals finally decided the issue in early 2016.
In Zachary v. California Bank & Trust, the Debtors proposed a plan of reorganization that put their largest unsecured creditor, California Bank & Trust ("Bank"), into a separate class and proposed to pay it $5,000 on a claim of nearly $2,000,000. The Bank objected on the ground that the plan violated the absolute priority rule of § 1129(b)(2)(B)(ii). The bankruptcy court sustained the objection, disagreeing with the Ninth Circuit Bankruptcy Appellate Panel ("BAP") opinion in In re Friedman, 466 B.R. 471 (B.A.P. 9th Cir. 2012) holding that the absolute priority rule was abrogated by Congress in BAPCPA. The bankruptcy court certified the appeal, and the Ninth Circuit authorized a direct appeal pursuant to 28 U.S.C. §§ 158(a) & (d)(2)(A).
The absolute priority rule, as it applies to a class of unsecured creditors, 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. Before the adoption of BAPCPA, it was clear that a chapter 11 plan could not be confirmed over the creditors' legitimate objections if it failed to comply with the absolute priority rule.
However, BAPCPA added § 1115 to the Bankruptcy Code, essentially modifying § 541 to provide that property an individual chapter 11 debtor acquires after the commencement of the case also becomes property of the estate. BAPCPA also amended § 1129(b)(2)(B)(ii) by adding a new clause allowing an individual debtor to retain certain property acquired after the commencement of the case. Basically, that amendment says that in a case in which the debtor is an individual, the debtor may retain property included in the estate under § 1115.
The court noted that these amendments plainly create an exception to the absolute priority rule that applies only to individual chapter 11 cases. According to the court, the question to answer was the scope of that exception. Stated another way, what property may an individual chapter 11 debtor retain under a plan without violating the absolute priority rule?
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On direct appeal, the Ninth Circuit affirmed the bankruptcy court's ruling that the absolute priority rule survived the BAPCPA amendments and the plan could not be confirmed. The court adopted the "narrow" view that an individual debtor may not cram down a plan that would permit the debtor to retain pre-petition property that is not excluded from the estate by § 541, but may cram down a plan that permits the debtor to retain only post-petition property brought into the estate by § 1115.
While many insolvency law practitioners thought this case was an opportunity for the Ninth Circuit to decide whether BAP decisions are binding on the bankruptcy courts in the circuit where the BAP sits, the court declined to so rule.
On the merits, the court examined the so-called "broad" view adopted by the BAP in In re Friedman. That view holds that the new clause in § 1129(b)(2)(B) (ii) means Congress intended to include the entirety of the bankruptcy estate as property that the individual debtor may retain, because § 1115 references § 541. Because § 1115 references § 541, the argument goes, Congress intended that an individual debtor could retain all property under a plan, not just property acquired post-petition. That reading of § 1115 effectively abrogates the absolute priority rule in chapter 11 for individual debtors.
The "narrow" view is the view the Ninth Circuit adopted here. It also is the majority view among the circuit courts, district courts, and bankruptcy courts that have addressed the issue. Under the "narrow" view, an individual debtor may not cram down a plan that would permit the debtor to retain pre-petition property that is not excluded from the estate by § 541, but may cram down a plan that permits the debtor to retain only post-petition property brought into the estate by §1115.
The court said the key is determining what the word "included" means in the clause in § 1129(b)(2)(B)(ii) stating that "the debtor may retain property included in the estate under section 1115." The court agreed with the Sixth Circuit's analysis of the word in Ice House Am., LLC v. Cardin, 751 F.3d 734, 736 (6th Cir. 2014), that "included" should be interpreted as "to take in." Viewing "included" as "to take in," the court found that § 1129(b) (2)(B)(ii) provides that "the debtor may retain property that § 1115 takes into the estate." Thus, what § 1115 takes into the estate is property that the debtor acquires after the commencement of the case, and it is only that property that the debtor may retain when her unsecured creditors are not fully paid.
To further support its interpretation, the court also noted that the U.S. Supreme Court has expressly warned against finding implied repeal of provisions of the Bankruptcy Code, citing United Sav. Ass'n of Tex. v. Timbers of Inwood Forest Assocs., Ltd., 484 U.S. 365, 380 (1988). Thus, the Ninth Circuit affirmed the bankruptcy court's ruling denying confirmation of the plan because it violated the absolute priority rule.
The rule in the Ninth Circuit relating to claims for contract-based attorneys' fees incurred in bankruptcy disputes used to be governed by the relatively simple "Fobian Rule."1 Under this rule, claims for attorneys' fees arising from litigating issues that are "peculiar to federal bankruptcy law," rather than contract enforcement issues, generally were not recoverable. However, in Travelers,2 the U.S. Supreme Court rejected the Ninth Circuit's long-standing Fobian Rule. Instead, the Court stated the general rule that "claims enforceable under applicable state law will be allowed in bankruptcy unless they are expressly disallowed." The Ninth Circuit recently explored the contours of recovering contract-based attorneys' fees in bankruptcy litigation in In re Penrod,3 and awarded the debtor its very substantial attorneys' fees for prevailing in litigation against a creditor relating to the debtor's chapter 13 plan.
The facts in Penrod were that the debtor ("Debtor") had a car worth $6,000, on which she owed $13,000, leaving $7,000 in "negative equity." A car dealer ("Creditor") sold the Debtor a new car, and included in the car loan the full purchase price of the new car, plus the $7,000 in negative equity. When the Debtor filed a chapter 13 bankruptcy petition two years later, the value of her car was $16,000, and the car loan totaled $26,000. She sought confirmation of a chapter 13 plan that initially bifurcated Creditor's claim into a $16,000 secured claim (i.e., the value of the car) and a $10,000 unsecured claim. She later amended her plan to bifurcate Creditor's claim into a purchase-money secured claim for $19,000, and an unsecured claim for the "negative equity" portion of $7,000, which the Debtor contended was the non-purchase money portion of the loan.
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Creditor objected to the Debtor's plan on...
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