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Ninth Circuit BAP Rules Absolute Priority Rule Does Not Apply to Individual Chapter 11 Debtors - In re Friedman

April 2, 2012

Vincent Howard and our Riverside consumer bankruptcy lawyers were extremely interested to see a ruling from the Ninth Circuit's Bankruptcy Appellate Panel on a somewhat controversial topic. In In re Friedman and Mercer-Friedman, the panel tackled the "absolute priority rule" as applied to Chapter 11 debtors who are individuals. Most Chapter 11 cases are filed by businesses, although individuals who run small businesses can also choose this chapter. However, since the passage of the 2005 changes to the bankruptcy laws, BAPCPA, the rule has become increasingly important to individual debtors, when Chapter 11 is a sensible alternative to Chapter 13 for them. For that reason, the National Association of Consumer Bankruptcy Attorneys filed a brief supporting the debtors in this case. The panel ultimately sided with the debtors and NACBA, over a lengthy dissent.

Gregory Friedman and Judith Mercer-Friedman of Arizona owned and operated several Internet companies. Through the bankruptcies of two of those, P+P, Inc. bought a loan they owed to a bank, secured by a home in Breckenrdge, Colo. P+P eventually obtained a default foreclosure judgment. The Friedmans filed for Chapter 11 bankruptcy. The bankruptcy court ultimately allowed the first lienholder, their mortgage company, to foreclose; due to the real estate downturn, P+P's claims became unsecured. The Friedmans' second bankruptcy plan proposed paying $634 per month to all unsecured creditors, including P+P, the largest unsecured creditor. The company filed an objection, saying the plan violated the absolute priority rule by ignoring the value of yet other businesses, which P+P put at more than $600,000 but the Friedmans had put as zero.

The bankruptcy court held a hearing and ultimately decided that the absolute priority rule does apply to individual Chapter 11 plans, and thus denied confirmation. It ordered them to file a third amended plan, but the Friedmans instead appealed. The bankruptcy court converted their case to Chapter 7, but permitted them a stay pending appeal, recognizing the split on the absolute priority rule.

The absolute priority rule says a bankruptcy plan may be confirmed over objections only if it is "fair and equitable." The definition of "fair and equitable" includes two conditions: When the objector is paid in full anyway, and then lienholders junior to the objector will not receive anything at all, "except that in a case in which the debtor is an individual, the debtor may retain property included in the estate" subject to some requirements. Thus, an individual debtor may retain certain property, mainly property or earnings acquired after the case is commenced but before plan confirmation or conversion. Thus, the BAP found that the absolute priority rule does not apply to individuals. In its analysis, it pointed out that this is consistent with newer requirements in the bankruptcy code as well as the plain language. A dissent called for the opposite conclusion, saying the meaning of the law is not plain and the majority failed to construe the statute as a whole or fairly weigh creditors' rights.

This may seem esoteric if you don't work in bankruptcy, but Vincent Howard and our Santa Ana personal bankruptcy attorneys help individuals though bankruptcy every day. As a result, we're very interested in the ongoing national debate over whether individuals are subject to this rule. We agree with the panel's majority that the language of the law strongly seems to provide an exception to individuals using Chapter 11. In addition, as the panel noted, courts finding otherwise have included some rather weak logic, including claming it's inconsistent to send a ballot to a creditor and then disregard its opinion. (Anyone who's voted for a losing presidential candidate might disagree.) At Howard Law, P.C., our Murrieta individual bankruptcy lawyers will look forward to hearing more if this case is appealed.

If you're deep in debt and you don't believe you can get out without a little help, you should talk to Vincent Howard and his team about the possibility of a bankruptcy. To tell us about your case and learn more, call today at 1-800-872-5925 or send us an email.

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