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4th Circuit: ‘Absolute priority’ survived bankruptcy reform

The latest reform of the Bankruptcy Code did not eliminate a longstanding protection for dissenting creditors when there’s a “cram down” under the Chapter 11 plan of an individual debtor in possession, the 4th U.S. Circuit Court of Appeals has affirmed.

While bankruptcy courts are sharply divided on the issue, the 4th Circuit said, Congress would not have made such a “dramatic” change as abolishing the absolute priority rule in such a vague fashion.

The absolute priority rule predates the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005. Generally, it provides that if a proposed Chapter 11 plan allows the debtor to retain property, any dissenting creditors must be paid in full in order for the plan to be “crammed down.”

In this case, the debtors continued to own and operate their auto body shop as debtors in possession. The plan proposed refinancing $3.5 million in business debt secured by the debtors’ home, keeping their automobile under current terms of payment and paying unsecured debt at an estimated 1.7 cents on the dollar.

Discover Bank, which held a relatively small unsecured claim, was the only creditor that voted to reject the plan.

The debtors sought to confirm the plan over Discover Bank’s dissent, contending the absolute priority rule no longer applied to individual debtors in possession in the wake of BAPCPA.

The court rejected the contention of an implied repeal in a June 14 opinion.

“The dramatic nature of such a departure from longstanding pre-BAPCPA law, the ambiguous language of the statutes, and the total lack of any indication in the legislative history of such an intent, lead us to conclude that Congress intended to and did preserve the absolute priority rule,” the opinion said. “Congress knows how to eliminate or partially abrogate the absolute priority rule; it has done so before, but did not do so again in BAPCPA.”

The case is In re Maharaj, No. 11-1747.