BRUCE FOX, Bankruptcy Judge.
Before me are motions filed by Mario Ferroni and Roberta A. Deangelis, Esq., the United States Trustee for Region 3, both seeking to dismiss this chapter 11 case pursuant to 11 U.S.C. § 1112(b)(1).
The debtors oppose dismissal and request the opportunity to submit another chapter 11 plan to creditors for creditor voting.
After reviewing the parties' thoughtful post-hearing submissions, for the following reasons I find that dismissal of this case is warranted. In so concluding, I shall address an issue of almost first impression within this circuit: whether the 2005 amendments to the Bankruptcy Code eliminated the requirement that individual chapter 11 debtors must meet the absolute priority rule when an impaired unsecured creditor class does not vote in favor of their plan.
After an evidentiary hearing, the following facts, as relevant to this dispute, were proven.
The debtors, Steven and Linda Brown, filed a joint voluntary bankruptcy petition under chapter 11 on April 25, 2012. Mr. Brown is an architect, licensed in Pennsylvania, and Mrs. Brown is a homemaker and volunteer special education teacher. Only Mr. Brown earns income, see ex. T-1 (Schedule I), and it is with his income that the debtors intend to reorganize.
In addition to providing architectural services, Mr. Brown also earns income as a construction manager and general contractor. He performs all of these services as an employee/member of one or more of the following three entities: Design Associates, Inc.; Design Build, LLC; and Build US, LLC. See ex. T-1; see generally 63 P.S. §§ 34.1, et seq. ("Architects Licensure Law"). Mr. Brown explained that he distributes all net income earned by Design Associates and Build U.S. into Design Build, and then takes distributions from Design Build.
Indeed, Mr. Brown now operates primarily through Design Build, averring that he ceased using Design Associates in 2011 and formed Build U.S. in 2011. See ex. F4 (2011 Federal Tax Form 1120 for Build US, LLC). He is the sole member of Design Build, the sole shareholder of Design Associates, and one of two members (along with his bookkeeper) of Build US.
Design Associates, a subchapter S corporation, although not currently operating, has not dissolved as a corporation and has asserted a mechanics lien claim against real property owned by Mr. and Mrs. Dolan
Design Build has current contracts for architectural work and has submitted proposals for construction management services. Mr. Brown testified that he takes distributions from this company as needed to pay his family expenses, and asserts that these distributions average about $11,000 per month. See also ex. F-7 (Amended Bankruptcy Schedule I). He further averred that his monthly expenses average approximately $9,710. Id. (Amended Bankruptcy Schedule J). The debtors' monthly operating reports, however, reflect a lower average net monthly income. See ex. T-5.
At the time of their bankruptcy filing, the debtors (and two of their children) resided in real property owned jointly, located at 922 Cedar Grove Road, Broomall, Pennsylvania. They also owned property located at 1334 Burke Road, West Whiteland, Pennsylvania, and Mr. Brown owned realty located at 224 Dutton Mill Road, Willstown, Pennsylvania. Ex. T-1.
The West Whiteland realty is secured by a mortgage held by TD Bank. The mortgagee has obtained relief from the bankruptcy stay to foreclose and the debtors anticipate that this property will be sold at an execution sale with TD Bank asserting a deficiency claim estimated at $50,000. See ex. Dolan-1, at 3, 10.
The Willstown property was secured by a lien held by Mr. Ferroni. Ex. Dolan-1, at 4. Mr. Ferroni confessed judgment against the debtors and began execution proceedings, which is the underlying reason the debtors filed their voluntary bankruptcy petition. Id., at 4; Debtors' Post-Hearing Memorandum, at 2, 6. Mr. Ferroni executed upon the Willstown property and filed a deficiency claim in this court in the amount of $489,000. See Claim Register, Proof of Claim # 13. The debtors were afforded an opportunity to object to this deficiency claim, see docket entry #119 (Order dated May 15, 2013), but opted not to do so. Thus, for purposes of this contested matter, Mr. Ferroni's claim will be deemed allowed. See 11 U.S.C. § 502(a); Debtors' Post-Hearing Memorandum, at 2.
On the debtors' Amended Bankruptcy Schedule C they elected the federal bankruptcy exemptions found in section 522(b)(2). Ex. T-1. Rather than take any homestead exemption under section 522(d)(1),
As noted above, after confirmation of their initial chapter 11 plan was denied, the debtors filed an amended chapter 11 plan, ex. T-3, which they assert can be confirmed and should be submitted to creditors for voting. This amended proposed plan may be summarized in relevant part as follows:
Ex. T-3, at 7. Although the proposed plan does not so state, the debtors orally argued through their counsel that they intended to distribute payments to class 6 in quarterly installments for five years, thus totaling $75,000. See also Debtors' Post-Hearing Memorandum, at 16 (referring to the "five year term of the plan").
The interests of the debtors are placed in class 7 of the proposed plan, but the plan does not expressly provide for the treatment of this class, other than as follows:
Ex. T-3, at 10 (¶ 7.1).
Since "[t]he Reorganized Debtors shall fund the payments required under the Plan from husband's continued business operations," id., at 11 (¶ 7.3.1), I conclude that the proposed plan must provide for Mr. Brown to retain his prepetition interests in his three entities: Design Associates, Design Build, and Build US. Moreover, the income derived from these entities is the debtors' only possible source of plan funding.
At the hearing, it was agreed that Mr. Ferroni's allowed unsecured claim will not and cannot be paid in full. See also Debtors'
As mentioned above, Mr. Ferroni and the United States Trustee separately filed motions to dismiss this chapter 11 case, motions supported by the Dolans. Both movants contend that the debtors are unable to reorganize under chapter 11, warranting dismissal under 11 U.S.C. § 1112(b)(1).
In determining this issue, I shall focus only upon whether there is a realistic possibility that any feasible plan they might propose could be confirmed and not whether the precise amended plan the debtors have filed would be approved. See generally In re American Capital Equipment, LLC, 688 F.3d 145, 161-62 (3d Cir. 2012); In re Fossum, 764 F.2d 520, 521-22 (8th Cir.1985); see also In re Cedar Shore Resort, Inc., 235 F.3d 375, 381 (8th Cir. 2000) (section 1112(b) permits dismissal of a chapter 11 case when there is a lack of any realistic possibility of confirming a plan). The terms of the debtors' amended plan were outlined above because this plan contains many provisions that would be included in any chapter 11 plan these debtors could reasonably propose.
Mr. Ferroni, emphasizing information on certain federal tax returns filed by Design Build, Design Associates, and Build US, see ex. F-4, as well as upon certain expenses the debtors have incurred since the bankruptcy filing, contends that the debtors proposed amended plan materially understates their projected disposable income for purposes of section 1129(a)(15)(B), thereby precluding confirmation. See generally In re Gbadebo, 431 B.R. 222, 226-27 (Bankr.N.D.Cal.2010). In contrast, the Dolans, relying upon the debtors' monthly operating reports, see ex. T-5, maintain that the debtors are overstating their projected disposable income and thus their proposal to tender $15,000 per annum is not feasible under section 1129(a)(11). See generally In re Hockenberry, 457 B.R. 646, 659-60 (Bankr. S.D.Ohio 2011); In re Chadda, 2007 WL 3407375, at *6 (Bankr.E.D.Pa. Nov. 9, 2007). Since these chapter 11 debtors may be able to modify their plan proposal to address these two confirmation issues, see 11 U.S.C. § 1127(a), I view it as inappropriate to conclude, based upon this evidentiary record, that these debtors could never meet the two above-mentioned confirmation requirements, sections 1129(a)(11) and (a)(15), and so justify dismissal at present. (Indeed, the debtors argue strenuously in their post-hearing memorandum that they can afford to pay $15,000 annually to their creditors, for reasons I need not now evaluate.)
In addition, Mr. Ferroni, orally joined by the Dolans as well as the United States Trustee at the hearing, contends that these debtors cannot propose any chapter 11 plan that would meet the good faith requirement found in 11 U.S.C. § 1129(a)(3). See Ferroni, Motion to Dismiss ¶¶ 15-15; Dolans' Post-Hearing Memorandum, at 15-16. He argues that the debtors failed to disclose in their initial
Based upon these failures, which the movants contend were made by the debtors either knowingly or recklessly, the movants argue that the debtors cannot now propose any chapter 11 plan in good faith. See In re Georgetown Limited Partnership, 209 B.R. 763, 769-70 (Bankr. M.D.Ga.1997); see also Tenn-Fla Partners v. First Union Nat'l Bank of Florida, 229 B.R. 720, 734 (W.D.Tenn.1999) (plan was not proposed in good faith when plan proponent failed to disclose the actual value of property dealt with by the plan).
The debtors reply that any omissions in their Bankruptcy Schedules and Statement of Financial Affairs were either immaterial or inadvertent, and that these errors and omissions have been or will be corrected, thus rendering any plan proposed by them in good faith. See In re Marshall, 298 B.R. 670, 677-78 (Bankr.C.D.Cal.2003); see generally Federal Nat'l Mortg. Ass'n v. Village Green I, GP, 483 B.R. 807, 821-22 (W.D.Tenn.2012). They also explain as follows:
Debtors' Post-Hearing Memorandum, at 13; cf. In re Jones, 490 F.2d 452, 456-57 (5th Cir.1974) (mistakes of counsel did not preclude debtor from receiving a bankruptcy discharge); In re Topper, 229 F.2d 691, 693 (3d Cir.1956) (same).
Recognizing that "good faith" under section 1129(a)(3) is not defined, the Third Circuit has adopted the Seventh Circuit's definition of this confirmation requirement. In re Abbotts Dairies of Pennsylvania, Inc., 788 F.2d 143, 150 n. 5 (3d Cir.1986):
(quoting In re Madison Hotel Assocs., 749 F.2d 410, 425 (7th Cir.1984)); see In re Federal-Mogul Global Inc., 684 F.3d 355, 381 (3d Cir.2012); In re Combustion Engineering, Inc., 391 F.3d 190, 247 (3d Cir. 2004); In re PWS Holding Corp., 228 F.3d 224, 242 (3d Cir.2000).
The Court of Appeals has further explained the objectives and purposes that the good faith requirement of section 1129(a)(3) is intended to protect:
In re American Capital Equipment, LLC, 688 F.3d 145, 157 (3d Cir.2012) (parallel citations omitted); see, e.g., In re WR Grace & Co., 729 F.3d 332, 346-47 (3d Cir.2013).
In applying section 1129(a)(3), "[t]he requisite good faith determination is based on the totality of the circumstances." In re Sylmar Plaza, L.P., 314 F.3d 1070, 1074 (9th Cir.2002); see, e.g., In re Village at Camp Bowie I, L.P., 710 F.3d 239, 247 (5th Cir.2013); In re Piper Aircraft Corp., 244 F.3d 1289, 1300 (11th Cir.2001).
In considering the evidence presented, I find that the strongest argument posed by the movants involves the debtors' failure to disclose Mr. Brown's interest in Design Associates and that entity's mechanics lien claim against the property of Mr. and Mrs. Dolan. As Mr. Brown acknowledged, if the mechanics lien claim is successful, he may receive a significant distribution after payment of outstanding corporate liabilities. See generally 15 Pa.C.S.A. § 1551. The other errors and omissions were either not significant (e.g., the debtor's modest retirement account may be exempt property under section 522(d)(12)), or not clearly material on this record (e.g., the attorney's fees paid in the Dolan litigation may have been non-estate property paid for the benefit of a non-debtor entity; the distributions made by debtor-owned entities may have been used, in part, to pay business operating expenses, including payments to subcontractors).
As for the material omissions concerning Design Associates, for purposes of this motion I will accept as credible Mr. Brown's testimony that he failed initially to disclose his interest because Design Associates had ceased doing business at the time of his bankruptcy filing, and that he did not separately disclose information about Design Associates and Build U.S. because all of their net income is paid to Design Build. Furthermore, he did not mention the Dolan litigation to his bankruptcy counsel since that counsel had been referred to him by his attorney in the state court Dolan litigation; in other words, he assumed that bankruptcy counsel knew of the litigation and had concluded that it need not be disclosed. Thus, for purposes
Accordingly, for these reasons I find that these debtors may propose a chapter 11 plan that would meet the good faith requirement of section 1129(a)(3). See generally In re WR Grace & Co., 729 F.3d at 346-47 (3d Cir.2013).
In addition, Mr. Ferroni and the Dolans, but not the United States Trustee, also contend that the debtors cannot confirm a chapter 11 plan because they cannot meet the requirements of 11 U.S.C. § 1129(b)(2)(B)(ii), known as the "absolute priority rule."
As the parties agree that this legal issue is dispositive, in that there is no possible plan these debtors could propose that would not involve consideration of this issue, and as it has been well-addressed in their post-hearing memoranda, it is ripe for consideration.
In general, confirmation of a chapter 11 plan requires that the plan proponent meet all the requirements of section 1129(a). See, e.g., In re Dupell, 2000 WL 192972, at *3 (Bankr.E.D.Pa. Feb. 15, 2000); In re Future Energy Corp., 83 B.R. 470, 481 (Bankr.S.D.Ohio 1988). The sole exception involves subsection 1129(a)(8), requiring every impaired class of claims or interests to accept the plan. If all the provisions of
As mentioned earlier, the debtors' proposed plan contends that class 3, the claim of TD Bank, class 4, the claim of the Pennsylvania Department of Revenue, and class 5, the claim of Mr. Ferroni, are all impaired classes.
As summarized by the Third Circuit Court of Appeals:
In re Armstrong World Industries, Inc., 432 F.3d 507, 511-12 (3d Cir.2005); see, e.g., LaSala v. Bordier et Cie, 519 F.3d 121, 133 n. 16 (3d Cir.2008) ("For a plan to be approved, either (1) each impaired class must accept the plan, or (2) the bankruptcy court must approve the plan as `fair and equitable' despite a class's disapproval. 11 U.S.C. § 1129(b).")
Since the parties in this contested matter agree that there is no possibility that all impaired classes will accept a plan proposed
As explained by the Supreme Court, one important component of the "fair and equitable" standard in section 1129(b)(2)(B) is the "absolute priority rule" found in clause (ii). This rule "provides that a dissenting class of unsecured creditors must be provided for in full before any junior class can receive or retain any property [under a reorganization] plan." Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 202, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988) (quoting In re Ahlers, 794 F.2d 388, 401 (8th Cir.1986)). The Court further explained:
Bank of America National Trust and Sav. Ass'n v. 203 North LaSalle Street P'ship, 526 U.S. 434, 441-42, 119 S.Ct. 1411, 143 L.Ed.2d 607 (1999).
It is undisputed that no plan could be proposed by these debtors in good faith that could provide for the payment in full of the unsecured deficiency claim of Mr. Ferroni. Therefore, the debtors cannot comply with section 1129(b)(2)(B)(i). It is also agreed by the debtors that no plan could be proposed by them in good faith that could not provide for Mr. Brown to retain his interests in his business entities, even though the unsecured creditor class containing Mr. Ferroni's claim will not be paid in full. Therefore, if the absolute priority rule found in section 1129(b)(2)(B)(ii) applies in individual chapter 11 cases, such as this one, the debtors concede that there is no plan they may propose in good faith that would not run afoul of this confirmation requirement.
Before 2005, the Supreme Court, in Norwest Bank Worthington v. Ahlers, concluded that the absolute priority rule applied in a chapter 11 case filed by individual debtors, and that this provision would be violated by the Ahlers's retaining their interest in their family farm. Id., 485 U.S. at 202, 108 S.Ct. 963 ("There is little doubt that a reorganization plan in which respondents retain an equity interest in the farm is contrary to the absolute priority rule.").
In addition, the Ahlers Court held that if an exception or corollary to the absolute priority rule, referred to as the "new value exception," exists, that exception — which has generally been stated to require the junior interest holder that was retaining property to provide "1) new, 2) substantial, 3) money or money's worth, 4) necessary for a successful reorganization and 5) reasonably equivalent to the value or interest received," In re Bonner Mall Partnership, 2 F.3d 899, 908 (9th Cir.1993) — would not be met by the Ahlers's proposal to fund their plan through future income earned from their farming efforts. Ahlers, 485 U.S. at 204, 108 S.Ct. 963:
See also id., at 206, 108 S.Ct. 963 ("We conclude that the [absolute priority] rule applies here, and respondents' promise of future labor warrants no exception to its operation.").
Finally, the Ahlers Court also concluded that the retention of a property interest, even one whose value is primarily dependent upon future services provided by the chapter 11 debtor, violates the absolute priority rule found in section 1129(b)(2)(B)(ii). Id., 485 U.S. at 208-09, 108 S.Ct. 963. Therefore, as of 2005, it is clear that individual debtors, such as the Browns, could not obtain approval of a chapter 11 plan with a dissenting class of unsecured claims, when that plan calls for them to retain their non-exempt interest in business entities, with the source of plan funding their future earnings from those entities.
Before discussing the 2005 statutory amendments as they apply to the question of the continued existence of the absolute priority rule in individual chapter 11 cases, I note that the debtors in this contested matter propose to retain their interest in the personal property they have claimed as exempt, as well as Mr. Brown's interest in his three business entities. Mr. Ferroni makes no mention about the debtors' retention of exempt property as violative of the absolute priority rule. See Ferroni's Post-Hearing Memorandum, at 23. The Dolans, however, do not identify in their post-hearing memorandum the particular property interests that the debtors cannot retain. Therefore, they may take the position that the debtors' retention of exempt property would violate section 1129(b)(2)(B)(ii).
Although the question of the application of the absolute priority rule to exempt property was not altered by the Bankruptcy Abuse and Prevention and Consumer Protection Act of 2005 ("BAPCPA"), as the Dolans may be raising this issue, and because its resolution is consistent with my interpretation of amended section 1129(b)(2)(B)(ii), I shall address it.
While the Ahlers decision made clear by 1988 that the absolute priority rule found in section 1129(b)(2)(B)(ii) applied in individual debtor chapter 11 cases, before the 2005 amendments to the Bankruptcy Code the few courts that considered the question whether the individual chapter 11 debtor's retention of exempt property violated this provision were divided. Compare, e.g., In re Fross, 233 B.R. 176 (table), 1999 WL 26886 (10th Cir. BAP Jan. 15, 1999) (exempt property cannot be retained), with, e.g., In re Henderson, 321 B.R. 550 (Bankr.M.D.Fla.2005) (exempt property can be retained), aff'd, 341 B.R. 783, 789-90 (M.D.Fla.2006).
Although the BAPCPA amendments to the Bankruptcy Code did not alter the relevant Code provisions that gave rise to
Section 1129(b)(2) provides in relevant part:
The underlined portion of clause (ii) to subparagraph (B) was added in 2005 by BAPCPA.
Because clause (ii), before and after its amendment in 2005, prohibits retention by junior interest holders of "any property," rather than "any property of the bankruptcy estate," decisions such as In re Fross concluded that Congress intended that property claimed by the debtor as exempt falls within the scope of section 1129(b)(2)(B)(ii). Id., 1999 WL 26886, at *8.
I find more persuasive, however, the reasoning of those courts and commentators who have observed that property allowed as exempt is removed from the bankruptcy estate, see generally In re Orton, 687 F.3d 612, 615 (3d Cir.2012); In re Mollo, 196 Fed.Appx. 102, 104 (3d Cir. 2006) (non-precedential) ("[O]nce property is exempted, it is `no longer considered property of the bankruptcy estate.'") (quoting Taylor v. Freeland & Kronz, 938 F.2d 420, 423 (3d Cir.1991), aff'd, 503 U.S. 638, 112 S.Ct. 1644, 118 L.Ed.2d 280 (1992)), and may be retained by the debtor as provided by section 522.
As the Third Circuit Court of Appeals observed, relying upon Bank of America National Trust and Savings Association v. 203 North LaSalle Street Partnership, the absolute priority rule in section 1129(b)(2)(B)(ii) only addresses property retained under a chapter 11 plan "on account of," meaning "because of," the debtor's interest in the property at the time of confirmation. See In re PWS Holding Corp., 228 F.3d 224, 229 (3d Cir.2000). Property allowed as exempt, however, is retained because of section 522, independently of any plan provision or the confirmation process itself. See In re Bullard, 358 B.R. 541, 544-45 (Bankr.D.Conn.2007). Therefore, retention of exempt property is outside the scope of section 1129(b)(2)(B)(ii). See, e.g. In re Gerard, 495 B.R. 850, 854 (Bankr.E.D.Wis.2013); In re Henderson, 321 B.R. 550, 559-60 (Bankr.M.D.Fla.2005), aff'd, 341 B.R. 783, 790 (M.D.Fla.2006); 7 Collier on Bankruptcy, ¶ 1129.04[3][d] (16th ed. 2012).
Moreover, since 1978, section 1123(c) has provided:
While the literal language of section 1123(c) applies only to chapter 11 plans proposed by parties other than the individual debtor, the sparse legislative history states that this provision was enacted to "protect[] an individual debtor's exempt property [by its terms]." H.R. Rep. No. 95-595, 95th Cong., 1st Sess. at 407, 1978 U.S.C.C.A.N. 5963, 6363 (1977). I find it counterintuitive that Congress intended to insure that an individual chapter 11 debtor is permitted to retain his or her exempt property as part of the confirmation process in all instances other than when the debtor's own plan is at issue.
Indeed, the logic of those decisions that hold that the absolute priority rule applies to any and all property interests retained by the debtor after confirmation, including exempt property, seemingly would encompass even property interests that Congress, for policy reasons, expressly excluded from the scope of the bankruptcy estate in section 541(b) and the reach of creditors, such as retirement funds described in section 541(b)(5), educational trust funds in section 541(b)(6), and funds held by employers or received from them under section 541(b)(7). Such property interests need not be claimed as exempt to be unavailable to a bankruptcy trustee or creditors, and are thus retained by the debtor. It is not persuasive to conclude that Congress required that a chapter 11 debtor relinquish such non-estate property as part of the confirmation process whenever an impaired class of unsecured creditors does not support the proposed plan.
Accordingly, in considering whether Congress intended its 2005 amendments to the Bankruptcy Code to eliminate the absolute priority rule for individual chapter
The parties in this dispute all recognize that whether the absolute priority rule still applies in individual chapter 11 cases after the 2005 BAPCPA amendments is an issue that has divided courts. In 2005, Congress added or modified numerous sections of chapter 11 regarding individual debtors. Three such sections are clearly relevant to the analysis.
First, 11 U.S.C. § 1115 was added and states:
Section 1115 was patterned after section 1306, applicable to chapter 13 cases. The House Report explains the addition of section 1115(a):
H.R.Rep. No. 109-31, Pt. 1, 109th Cong., 1st Sess. at 80, 2005 U.S.C.C.A.N. 88, 147 (2005).
Second, section 1129(a) was modified to add a new paragraph (15):
Thus, in an individual chapter 11 case, if the debtor's proposed plan does not provide for payment in full of an allowed unsecured claim then, upon the objection of that creditor to confirmation, the debtor's
Third, as was mentioned earlier, section 1129(b)(2)(B)(ii) was modified so that it now reads:
(emphasis added).
The same House Report explains the addition of section 1129(a)(15) and the modification to section 1129(b)(2)(B)(ii) in the following paragraph:
H.R.Rep. No. 109-31, Pt. 1, 109th Cong., 1st Sess. at 80, 2005 U.S.C.C.A.N. at 147 (2005).
To a large extent, the debate over the meaning of section 1129(b)(2)(B)(ii) has involved interpreting its phrase: "the [individual] debtor may retain property included in the estate under section 1115." See, e.g., In re Lively, 717 F.3d 406, 408 (5th Cir.2013); In re O'Neal, 490 B.R. 837, 847 (Bankr.W.D.Ark.2013); see also 7 Collier on Bankruptcy, ¶ 1129.04[3][d] (16th ed. 2012).
Those courts adopting the so-called "broad view" have held that section 1115(a) was intended by Congress to supplant section 541(a), and thus this new provision is the sole source for defining the scope of property of the bankruptcy estate in an individual chapter 11 case, which property includes the debtor's prepetition as well as postpetition property. Accordingly, the broad view holds that in 2005 Congress eliminated the absolute priority rule in individual chapter 11 cases since amended section 1129(b)(2)(B)(ii) permits individual debtors to retain section 1115(a)'s broad definition of property of the estate. See, e.g., In re Friedman, 466 B.R. 471, 482 (9th Cir. BAP 2012):
(footnote omitted).
Courts favoring this interpretation also emphasize that Congress, when amending chapter 11 in 2005, added a number of provisions similar or identical to chapter 13; and chapter 13, which permits individual debtors with regular income and liabilities below certain amounts (set forth in section 109(e)) to reorganize, has no absolute priority rule. See, e.g., In re O'Neal, 490 B.R. at 850-51; In re Shat, 424 B.R. 854, 862 (Bankr.D.Nev.2010). They also note that:
In re Shat, 424 B.R. at 868. In other words, if the addendum to section 1129(b)(2)(B)(ii) simply allows individual debtors to retain postpetition assets and earnings under the absolute priority rule, then the provisions of section 1129(a)(15), which can obligate the individual debtor to tender post-confirmation earnings for five years, greatly reduces the import of this exception.
Courts adopting the "narrow view" of section 1129(b)(2)(B)(ii) hold that its reference to section 1115 was intended by Congress to encompass only the property added by section 1115(a) to the prior section 541(a) definition of property of the estate. See, e.g., In re Lindsey, 453 B.R. 886, 905 (Bankr.E.D.Tenn.2011); In re Gbadebo, 431 B.R. 222, 229 (Bankr.N.D.Cal.2010); 5 Norton Bankr.L. & Prac. 3d, § 106:8 (2013). In other words, section 541(a) continues to define property of the estate in all cases, including individual chapter 11 cases, as generally limited to the debtor's prepetition assets. The enactment of section 1115(a) simply adds an individual debtor's postpetition property and earnings to this estate. Therefore, the narrow view holds that the absolute priority rule, after the enactment of BAPCPA, only allows individual debtors to retain the postpetition property and earnings added by section 1115(a) to the section 541(a) definition of the bankruptcy estate, but not prepetition non-exempt property. This interpretation of section 1129(b)(2)(B)(ii) is now the majority position, 7 Collier on Bankruptcy, ¶ 1129.04[3] (16th ed. 2013), and is the one endorsed by the three Courts of
Support for the narrow view is derived from the absence of any legislative history suggesting that Congress intended to change the long-standing application of the absolute priority rule to all chapter 11 cases, including individual cases, see, e.g., In re Stephens, 704 F.3d at 1286-87; In re Maharaj, 681 F.3d at 570-71; see generally, e.g., Hamilton v. Lanning, 560 U.S. 505, 130 S.Ct. 2464, 2473, 177 L.Ed.2d 23 (2010) ("Pre-BAPCPA bankruptcy practice is telling because we `will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.'") (quoting Travelers Casualty & Surety Co. of America v. Pacific Gas & Elec. Co., 549 U.S. 443, 454, 127 S.Ct. 1199, 167 L.Ed.2d 178 (2007)); Cohen v. de la Cruz, 523 U.S. 213, 221, 118 S.Ct. 1212, 140 L.Ed.2d 341 (1998), and from the "convoluted statutory language that now exists after the 2005 Amendments." 5 Norton Bankr.L. & Prac. 3d, § 106:8 (2013); see In re Lively, 717 F.3d at 410. As observed by one court:
In re Maharaj, 681 F.3d at 565-66; see also In re Mullins, 435 B.R. 352, 360-61 (Bankr.W.D.Va.2010).
Courts have also observed that if Congress intended in 2005 to eliminate the absolute priority rule in all individual bankruptcy reorganizations, it would have altered the eligibility requirements for filing chapter 13 cases, since chapter 13 contains no absolute priority rule:
In re Karlovich, 456 B.R. 677, 682 (Bankr. S.D.Cal.2010); see, e.g., In re Kamell, 451 B.R. 505, 510 (Bankr.C.D.Cal.2011).
In considering the various arguments set forth above, I am persuaded that the narrow view more accurately reflects congressional intent. Indeed, section 321 of BAPCPA, P.L. No. 109-8, which both added section 1115 and amended section 1129(b)(2)(B)(ii), as well as its legislative history, by addressing the new provisions in sections 1115 and 1129 in tandem, implies that Congress amended section 1129(b)(2)(B)(ii) in order to preserve the absolute priority rule as it applied to individual debtors prior to the 2005 Bankruptcy Code amendments. That is, the addition of postpetition assets and earnings to the definition of estate property in individual cases by section 1115(a) triggered the amendment to section 1129(b)(2)(B)(ii), so as not to further expand the scope of the
In re Karlovich, 456 B.R. at 681; see also In re Lively, 717 F.3d at 409 ("When the debtor's post-petition property and earnings were added to Chapter 11, however, Congress also had to modify the absolute priority rule so that a debtor would not be saddled with committing all post-petition property to satisfy creditors' claims."); In re Kamell, 451 B.R. 505, 511 (Bankr. C.D.Cal.2011).
Indeed, this analysis — which recognizes that it was only section 1115(a)'s addition of postpetition assets and earnings to the definition of property of the estate that triggered the need for Congress to amend section 1129(b)(2)(B)(ii) and exclude such property from the scope of the absolute priority rule — is inferentially supported by the conclusion made earlier: that property allowed as exempt may be retained without violating the absolute priority rule, since exempt property is non-estate property and thus is retained by an individual debtor independently of the confirmation process.
Therefore, individual chapter 11 debtors who fail to obtain the consent of an impaired class of unsecured creditors cannot retain prepetition non-exempt property unless that dissenting creditor class will receive distributions under the proposed plan equal in value, as of the plan effective date, to the amount of its claims. 11 U.S.C. § 1129(b)(2)(B)(i); see, e.g., In re Lively. To the extent this interpretation renders confirmation difficult for individual chapter 11 debtors who operate businesses (and whose interest in those businesses cannot be claimed as exempt), as the debtors in this case suggest, see Debtors' Post-Hearing Memorandum, at 15, that difficulty
One additional issue, the application of the new value exception in individual chapter 11 cases, must be considered in determining that these debtors cannot possibly reorganize under chapter 11.
Section 1129(a)(7) imposes a confirmation requirement known as the "best interest of creditors test." "This test requires that each holder of an impaired claim or interest either accept the plan or receive under the plan not less than it would receive in a Chapter 7 liquidation." See, e.g., In re Wireless Data, Inc., 547 F.3d 484, 495 (2d Cir.2008); In re W.R. Grace & Co., 475 B.R. 34, 141 (D.Del.2012). Because exempt property is not liquidated in a chapter 7 case, see generally In re McCollum, 363 B.R. 789, 795 (E.D.La. 2007), to comply with this provision individual chapter 11 debtors must propose a plan that provides to dissenting creditors at least the present value, as of the plan effective date, of their non-exempt assets. See, e.g., In re Hockenberry, 457 B.R. 646, 652-54 (Bankr.S.D.Ohio 2011).
As mentioned earlier, pursuant to section 1129(a)(15), if an unsecured creditor objects to confirmation, and such creditor will not receive distributions under the proposed plan equal in value, as of the plan effective date, to the full amount of its claim, then the individual debtor's chapter 11 plan must provide for plan funding that includes disposable income for at least a five year period. See generally In re Stigliano, 483 B.R. 303 (Bankr.W.D.Pa.2012).
Section 1123(a)(8), added in 2005, provides that a chapter 11 plan shall:
Plan payments made by an individual chapter 11 debtor that are derived from post-confirmation earnings, even those required by section 1129(a)(15), can be used to meet the best interest of creditors test found in section 1129(a)(7). See In re Bennington, 2013 WL 1686305 (Bankr.D.Utah Apr. 18, 2013); see also In re Hockenberry, 457 B.R. at 653-54 (proposed annual payments were insufficient to meet the requirements of section 1129(a)(7)). Would payments made under section 1129(a)(15) also constitute "new value" when applying section 1129(b)(2)(B)(ii)?
As discussed earlier, the Supreme Court in Norwest Bank Worthington v. Ahlers instructed that plan funding consisting of payments derived from future earnings do not constitute "new value" for purposes of any exception to absolute priority rule. One commentator has opined, however, that in enacting section 1123(a)(8) Congress implicitly overruled this holding in Ahlers. See 2007 No. 1,
Section 1123(a)(8) does not mandate that individual debtors can only fund their plans from the earnings of postpetition services. Rather, it directs that such earnings be so applied "as is necessary for the execution of the plan." Thus, if a plan can be fully funded from the sale of the debtor's assets it can be confirmed without the inclusion of any post-confirmation earnings. See In re Lippmann, 2013 WL 45628, at *1 (Bankr.D.Utah Jan. 2, 2013). Therefore, the addition of section 1123(a)(8) does not create any tension with the Ahlers definition of a new value exception to the absolute priority rule.
Accordingly, consistent with the Supreme Court's directive in Ahlers, to the extent that section 1129(b)(2)(B)(ii) implicitly contains a new value exception to the absolute priority rule, an individual debtor's use of post-confirmation earnings as a component of plan funding does not constitute new value. However, plan payments derived from post-confirmation services, as permitted by section 1123(a)(8), are considered in determining whether an individual debtor has met the fair and equitable requirements of section 1129(b)(2)(B)(i) (payment in full) and thereby avoids the application of the absolute priority rule found in clause (ii). See generally In re Lichtin/Wade, L.L.C., 478 B.R. 204, 212 (Bankr.E.D.N.C.2012).
As noted at the outset, the movants seek dismissal of this chapter 11 case pursuant to 11 U.S.C. § 1112(b)(1). Section 1112(b) provides that, on request of a party in interest, a court may dismiss a chapter 11 case or convert it to chapter 7, "whichever is in the best interest of creditors and the estate, if the movant establishes cause." 11 U.S.C. § 1112(b)(1).
In re DCNC North Carolina I, LLC, 407 B.R. 651, 665 (Bankr.E.D.Pa.2009); see also In re SHAP, LLC, 457 B.R. 625, 629 (Bankr.E.D.Mich.2011).
As earlier mentioned, the debtors in this contested matter concede that they cannot reorganize unless Mr. Brown can retain his non-exempt interests in his business entities: Design Associates, Design Build, and Build US. They also concede that they cannot afford to pay Mr. Ferroni's allowed unsecured claim in full, even over time, and that there will be an impaired class of creditors — the one containing Mr. Ferroni — that will not approve any feasible plan they can propose. Thus, as the debtors acknowledge, the imposition of the absolute priority rule in section 1129(b)(2)(B)(ii) precludes their ability to reorganize under chapter 11. See Debtor's Post-Hearing Memorandum, at 2.
Therefore, the movants have established grounds for relief under section 1112(b)(1), and the exception to relief of section 1112(b)(2) is inapplicable because the debtors
I also note that, given the debtors' assets and liabilities, no party in interest suggests that conversion to chapter 7 would be in the best interests of creditors and the bankruptcy estate.
Accordingly, an order will be entered dismissing this chapter 11 case. Moreover, as the movants requested at the hearing, this dismissal order will limit the debtors' ability to file future chapter 11 bankruptcy cases. See generally 11 U.S.C. § 349(a); In re Casse, 198 F.3d 327 (2d Cir.1999).
Accordingly, I need not consider whether the debtors' proposed plan seeks impermissibly to classify unsecured deficiency claims separately. See In re Swedeland Development Group, Inc., 16 F.3d 552, 568 (3d Cir.1994) ("We recently held that the deficiency claim of an undersecured mortgagee could not be classified separately from the claims of other unsecured creditors of the debtor...." (citing John Hancock Mutual Life Ins. Co. v. Route 37 Business Park Assocs., 987 F.2d 154, 161 (3d Cir.1993)).
The Third Circuit has recently observed that: "The question of whether a Chapter 11 bankruptcy petition is filed in good faith is a judicial doctrine, distinct from the statutory good faith requirement for confirmation pursuant to § 1129(a)(3)." In re American Capital Equipment, LLC, 688 F.3d 145, 157 (3d Cir.2012). Whether any bankruptcy case is filed in bad faith depends upon the totality of the circumstances. See, e.g., In re 15375 Memorial Corp. v. Bepco, L.P., 589 F.3d 605, 618 (3d Cir.2009). While the totality of the circumstances approach is not constrained to any particular fact pattern, the Third Circuit has generally instructed: "Our cases have accordingly focused on two inquiries that are particularly relevant to the question of good faith: (1) whether the petition serves a valid bankruptcy purpose, e.g., by preserving a going concern or maximizing the value of the debtor's estate, and (2) whether the petition is filed merely to obtain a tactical litigation advantage." In re Integrated Telecom Express, Inc., 384 F.3d 108, 119-20 (3d Cir.2004), cert. denied, 545 U.S. 1110, 125 S.Ct. 2542, 162 L.Ed.2d 286 (2005) 384 F.3d at 119-20; see In re 15375 Memorial Corp. v. Bepco. L.P., 589 F.3d at 618.
In this contested matter, Mr. Ferroni and the United States Trustee both alleged that dismissal was warranted because the debtors cannot reorganize, and the debtors have focused upon that issue in their opposition. To the extent that Mr. Ferroni now contends that the debtors acted in bad faith in filing their April 2012 chapter 11 petition, and that bad faith is distinct from the question of their ability to confirm a chapter 11 plan, I decline to address it as I conclude that reorganization is not possible.
Id., at 408; see also In re Grasso, 497 B.R. at 461 n. 13 ("Because the Chapter 11 Trustee and Debtor do not propose to pay his estate's unsecured creditors the value of their claims as of the effective date of any plan, the Debtor may not retain pursuant to any nonconsensual plan his interest in any non-exempt, prepetition assets.").
Moreover, the requirement of section 1129(a)(15)(B) is only triggered by an objection to confirmation by an unsecured creditor, and not simply by the failure of a class of unsecured creditors to affirmatively support the plan. See, e.g., In re Washington, 2010 WL 1417708 (Bankr.N.D.Tex. Apr. 2, 2010).