In January, 2016  the Ninth Circuit Court of Appeals in Zachary v. California Bank and Trust ruled that the Absolute Priority Rule still applies to individual Chapter 11 reorganizations after the Bankruptcy Code was amended in 2005. This ruling means that the several court opinions that concluded that the 2005 amendment made it easier for individuals to confirm Chapter 11 plans will no longer be the law in the Ninth Circuit which includes the State of California as the absolute priority rule still must be complied with by individuals filing Chapter 11.

The Absolute Priority Rule provides that a dissenting class of unsecured creditors must be provided for in full before the debtor can receive or retain property under a plan of reorganization. In Zachery, the husband and wife debtors sought confirmation of a Chapter 11 plan that provided that the debtors retain ownership of their business, their home and their rental property.  The plan provided that the dissenting class of unsecured creditors would receive $5,000 on account of their $2 million claim.  The Bankruptcy Court denied confirmation because the court held that the plan violated the Absolute Priority Rule.

After the amendment in 2005, several courts concluded that individual Chapter 11 debtors were able to retain their property even over the objection of dissenting creditors if the Bankruptcy Court found that the plan was otherwise fair and equitable. This was a substantial deviation from the law that existed prior to the 2005 amendment.  A slight majority of trial courts addressing this issue, however, came to a different conclusion and found that nothing in the amendment changed with respect to the finding necessary to confirm the Chapter 11 plan of reorganization. Those courts concluded that the Absolute Priority Rule still must be complied with and dissenting classes of unsecured creditors must be paid in full before a junior class, such as the debtor, can retain property.

The Ninth Circuit in Zachary concluded that the debtors’ reading of the 2005 Amendments would required the court to find an implied repeal of a 100 plus year old rule.  The court declined to find an implied repeal stating that Congress would not repeal a statute “in the most oblique way possible, and yet omit any mention of this remedy from the legislative history.”

Marshack Hays has substantial experience in representing debtors and creditors in individual Chapter 11 cases.  We welcome any questions you may have.

Richard Marshack
Marshack Hays LLP