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Absolute priority ruling follows 4th Circuit’s lead

The 2005 amendments to the Bankruptcy Code did not exempt individual Chapter 11 debtors from the application of the absolute priority rule, the 10th U.S. Circuit Court of Appeals has ruled in reversing judgment.

The absolute priority rule bars junior claimants, including debtors, from retaining any interest in property when a dissenting class of senior creditors has not been paid in full.

In this case, the debtors owned a chain of convenience stores. Due to a downturn in business, the debtors became indebted to the oil company that supplied the debtors’ gasoline for $1.8 million. As security for the debt, the debtors executed mortgages in favor of the oil company on various tracts of real estate, including a home.

The debtors subsequently filed for Chapter 11 bankruptcy. Under their proposed plan of reorganization, the oil company would be paid $15,000 as a secured creditor, with the remainder of its claim being treated as unsecured debt. The debtors would retain possession and control of their property, whereas the oil company would receive a monthly payment for five years, totaling about 1 percent of its unsecured claim.

The oil company argued that the proposed plan violated the absolute priority rule.

The 10th Circuit agreed, noting that federal courts are divided on this issue.

The Bankruptcy Appellate Panel for the 9th Circuit and five bankruptcy courts have adopted a “broad view,” holding that the BAPCPA amendments eliminate the absolute priority rule as applied to an individual’s entire estate. However, the 4th U.S. Circuit Court of Appeals and 17 bankruptcy courts have reached the opposite conclusion.

“Here, the statutory language and legislative history lack any clear indication that Congress intended to erode a pillar of creditor bankruptcy protection. Especially in light of the fact that Congress has expressly repealed the [absolute priority rule] in the past, we decline to find an implied repeal here,” the court concluded.

Lawyers USA is a sister publication of The Daily Record.