Absolute Priority Rule (1)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.
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Christmas presents under the treeIn this Christmas season children are eagerly awaiting prepackaged presents.  That’s an odd locution, isn’t it?  We usually refer to the gifts as wrapped rather than prepackaged.  I chose the word “prepackaged” because when something is prepackaged it’s all wrapped up.  What does this have to do with Chapter 11 bankruptcy?  A little background will help to put the answer in perspective.

I.  Chapter 11 Bankruptcy

The Bankruptcy Code (title 11 of the United States Code) is divided up into chapters.  The first three chapters (1, 3, and 5) are foundational chapters.  Their content comes along for the ride no matter which chapter under which the case is ultimately filed.  The remaining chapters (7, 9, 11, 12, 13, and 15) are the chapters under which bankruptcy cases are actually filed.

Side Note:  Why The Shortage Of Even-Numbered Chapters?

You may wonder why almost all of the chapters have odd numbers.  The answer lies with Congress.  Congress has been wrestling with budgetary problems for some time, and has been unable to afford even numbers, which are more expensive than odd numbers.  As a special treat it got one even number, 12, but for now that’ll have to do.  And if you believe that, I have some real estate on the moon I would like to sell you.

The real reason has to do with the passage of the Bankruptcy Reform Act of 1978.  Prior to that, the bankruptcy statute had even-numbered chapters.  However, Congress felt that some of them had been abused (i.e., sections of the Uniform Bankruptcy Act of 1898, not members of Congress), in some cases by creditors, in others by debtors.  Therefore, it jettisoned the offending sections, which turned out to comprise all of the even-numbered chapters.  In the 1980s the need of family farmers for bankruptcy relief was not being satisfactorily addressed with the remaining chapters, so Chapter 12 was temporarily added.  But it had to be reauthorized every two years.  Then in 2005 the entire Code underwent revision.  As part of that revision, Chapter 12 was made permanent, and its ambit was expanded to include, not only family farmers, but also family fishing operations.

Back To Chapter 11:

Chapter 11 was originally envisioned as a corporate restructuring provision, though it is now available, not only to businesses, but also to individuals and married couples.

The big picture goal in a Chapter 11 is to deal with debt in a way that allows the debtor to reorganize so that is can continue to participate in the economy.  Some debt may be wiped out, some may be reduced to pennies on the dollar, some assets may be liquidated, and the debtor reorganizes its financial affairs.  The main vehicle for Chapter 11 restructuring is the Chapter 11 plan.  (I am ignoring the idea of a total liquidation Chapter 11 plan.)
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The popular wisdom says that an individual or a married couple can file for bankruptcy under either chapter 7 to discharge debts without paying them, or chapter 13 to pay back some of the debts through a court-administered, multi-year, partial debt repayment plan, while a business files under chapter 7 if it is going out of business, or chapter 11 if it needs to reorganize.  There is some truth to this wisdom, but it fails to take into consideration the personal chapter 11 bankruptcy.  This post looks briefly at just a few characteristics of personal chapter 11 bankruptcy.
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