Some time ago I wrote in great detail about personal Chapter 11 bankruptcy. In that post I discussed the application of one of the complexities of Chapter 11 bankruptcy to individual (as opposed to business) cases. That complexity is the absolute priority rule. At the time of the post, we had a patchwork of inconsistent case law on the topic, making the success of a personal Chapter 11 case dependent, in part, on the identity of the judge assigned to the case.
Things have been resolved ― at least in the Ninth Circuit ― and not in favor of individuals. Let’s recall the setting:
I. The Absolute Priority Rule
The absolute priority rule is an important idiosyncrasy of Chapter 11 that has no analogue in either Chapter 7 or Chapter 13 bankruptcy. We’ll begin by describing the absolute priority rule in the business Chapter 11 context.
A. The Business Chapter 11 Absolute Priority Rule
In bankruptcy not all debts are treated equally. For example, the law distinguishes between secured debts ― debts that are secured by collateral that can be repossessed in the event of a default ― and unsecured debts. Secured debts are not treated the same as unsecured debts because the secured creditor has special rights attached to the collateral securing the debt.
Even among unsecured debts there are distinctions. Some are given priority over others. The various priority classes are listed in 11 U.S.C. § 507(a). This distinction sets the stage for the so-called absolute priority rule for Chapter 11.