The Absolute Priority Rule Torpedoes Mediation in Individual Chapter 11 Cases (Part Two)

The Absolute Priority Rule: 11 U.S.C. § 1129(b)(2)(B)

By: Donald L. Swanson

A tragedy of recent Chapter 11 times is this:

–it looks like Congress tried to remove the absolute priority rule from individual Chapter 11 cases (see the “individual” exception in § 1129(b)(2)(B)(ii) photo above); but Congress didn’t quite get the removal words right, according to subsequent court rulings.

We now have an excellent example in the Nebraska Bankruptcy Court of benefits arising from a removal of the absolute priority rule in individual cases.

–Judge Thomas L. Saladino, Chief Bankruptcy Judge in Nebraska’s Bankruptcy Court, issues the first-ever ruling on effects of the newly-amended § 1129(b)(2)(B)(ii), which adds an “individual” exception to the absolute priority rule. In the case of In re Tegeder, 369 B.R. 477 (Bankr. Neb. 2007)Judge Saladino rules that the absolute priority rule no longer applies in individual Chapter 11 cases because of the newly-amended § 1129(b)(2)(B)(ii).

–As a result, individual Chapter 11 plans are thereafter confirmed in Nebraska, and mediation plays a role in resolving plan confirmation disputes in some of such cases.

–Another result is that standards become relatively low for involuntary conversion of high-earner debtors from Chapter 7 to Chapter 11 under § 706(b), based on an ability to pay creditors.

–When the weight of precedent in other jurisdictions goes a different direction, Judge Saladino has an opportunity to reverse course but declines to do so.  He reasons that his ruling in Tegeder “has worked well in this jurisdiction the last seven years,” in that “many individual Chapter 11 plans have been confirmed” (In re Woodward, Case No. 11-40936, Doc. 287 (Bankr. Neb. April 4, 2014)).

–Thereafter, the Eighth Circuit BAP reverses Judge Saladino and says the absolute priority rule still applies in individual Chapter 11 cases, despite the statutory exception (In re Woodward, Case No. 15-6001 (8th Cir. BAP 2015)).

So now, here in Nebraska, we are back to the old absolute priority rule being operative in individual Chapter 11 cases. As a result, the old pathologies of the absolute priority rule return in individual cases, including the following:

–many individuals with large debts and significant assets (e.g., failed entrepreneurs) don’t qualify for Chapter 13 and have no viable reorganization option in Chapter 11;

–creditors who might have benefited from an involuntary conversion of a case from Chapter 7 to Chapter 11 under § 706(b), based on an ability to pay, probably no longer have that option, since a confirmable Chapter 11 plan is no longer viable in many cases; and

–mediation can no longer play a significant role in Chapter 11 plan confirmation disputes for individual debtors, when the debtor can’t pay all debts in full and creditors won’t agree to something less, because we are back to a 0% chance of confirming a plan over creditor objection.

Action Item

Congress needs to amend § 1129(b)(2)(B)(ii) to get it right this time: namely, to remove the absolute priority rule from individual Chapter 11 cases.

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