In Re Arnold
MEMORANDUM DECISION RE DENIAL OF APPROVAL OF THE DEBTORS’ AMENDED DISCLOSURE STATEMENT
On August 24, 2011, Debtors David L. Arnold and Grace E. Arnold filed a Disclosure Statement and a proposed Chapter 11 Plan of Reorganization. A hearing was held on approval of the Disclosure Statement on September 28, 2011. Issues regarding the confirmability of the Plan were raised by creditor U.S. Bank, arguing that the court should not approve the Disclosure Statement because the Plan violated the absolute priority rule. The hearing was continued, and the Debtors filed an Amended Disclosure Statement and proposed Chapter 11 Plan of Reorganization dated and filed on October 14, 2011. On November 16, 2011, the court held a hearing on the Amended Disclosure Statement, where U.S. Bank objected on the same grounds. That hearing was continued to January 18, 2012. Supplemental briefing was filed, and before that hearing, the court vacated the January 18 hearing and took the matter under submission.
While the matter was under submission, the Bankruptcy Appellate Panel (“BAP”) of the Ninth Circuit, in a divided 2-1 decision, issued an opinion on March 19, 2012 in
Friedman v. P+P, LLC (In re Friedman),
The court finds that the Amended Disclosure Statement does not contain adequate information. The court also concludes that the absolute priority rule applies in this individual Chapter 11 bankruptcy case, and the court finds that the proposed Plan would violate the absolute priority rule. Therefore, the court denies approval of the Amended Disclosure Statement.
BACKGROUND
The Debtors commenced their bankruptcy case by filing a voluntary Chapter 11 petition on March 3, 2011. The Debtors are the co-trustors and co-trustees of the David L. and Grace E. Arnold Trust Dated July 21, 2004 (the “Trust”).
1
The Trust is a revocable trust that held title to several investment properties and the Debtors’ current residence. Soon after the Debtors’ filing, a limited partnership named Full House Enterprises, L.P. (“Full House”) also filed a voluntary Chapter 11 petition. Full House has a sophisticated business structure in which B & D Real Estate, LLC (“B & D”) is the general partner, the Trust is the limited partner,
Through the Trust, the Debtors had acquired a number of investment properties. The properties were highly leveraged as of the Petition Date:
1.El Camino Business Center is multi-tenant office complex with 36,366 square feet of rentable space. The Debtors in their Schedules and Amended Disclosure Statement state that this property is valued at $5,434,000. The Debtors also state in these documents that the outstanding amount owing to U.S. Bank on the El Camino Business Center is $4,500,000 (including both the mortgage and the equity line of credit). Based on these figures of the Debtors, the loan-to-value ratio for the El Camino Business Center is approximately 82%. U.S. Bank on its proof of claim filed in this case asserts that as of the Petition Date, the outstanding amount owing to U.S. Bank on a loan secured by the El Camino property is $4,616,074.08. Proof of Claim No. 22-1, filed by U.S. Bank National Association on July 12, 2011. This amount includes the outstanding balance on the mortgage in the amount of $4,422,791.53 (including principal of $3,977,639.43, interest of $395,017.37, and late charges of $50,134.73) as well as the outstanding balance on the equity line of credit in the amount of $193,282.55 (including principal in the amount of $170,550.11, interest in the amount of $20,769.22, and late fees in the amount of $1,963.22). Id. Based on the Debtors’ valuation in their Schedules and the outstanding balance figures of U.S. Bank, the loan-to-value ratio for the El Camino Business Center is approximately 85%.
2. Treehaven Plaza is a multi-tenant office complex with 19,274 square feet of rentable space. The Debtors in their Schedules state that this property is valued at $2,795,000. The Debtors also state in these documents that the outstanding amount owing to U.S. Bank on this property is $2,770,000. Based on these figures provided by the Debtors, the loan-to-value ratio for the Treehaven property is approximately 99%. 2
3. Yorba Professional and Business Centers are two multi-tenant office buildings with a total of 17,453 square feet of rentable space. The Debtors allege in their Schedules that the value of the Yorba Professional and Business Centers is $2,950,000 and the outstanding amount owing to U.S. Bank is $2,407,975. U.S. Bank contends that as of the Petition Date, the outstanding amount owing to U.S. Bank on Yorba Professional and Business Centers is $2,667,708.76 (including principal of $2,387,661.49, interest of $248,543.10 and late charges of $34,504.17). Motion for Order Approving Stipulation for Relief from Stay (Docket No. 26) at 3. Using the Debtors’ outstanding ' balance amounts, the loan-to-value ratio on the Yorba Professional Business Centers is approximately 82%. Using U.S. Bank’s outstanding balance amounts, the loan-to-value ratio on the Yorba Professional and Business Centers is approximately 90%.
4. Lido Sands Property is the Debtors’ principal residence. The Debtors allege in their Schedules and their Amended Disclosure Statement that the value of the Lido Sands Property is $1,300,000. The Debtors allege in these documents that the outstanding amount owing to U.S. Bank on the Lido Sands Property is $1,200,000. U.S. Bank contends that as of October 24, 2011, the outstanding amount owing to U.S. Bank on the Lido Sands Property is $1,256,313.16 (including principal of $1,190,607.77, interest of $22,170.93, and late charges of $43,534.46). Motion for Relief from the Automatic Stay filed by U.S. Bank (Docket No. 122) at 7. Using the Debtors’ outstanding balance amounts, the loan-to-value ratio on the Lido Sands Property is approximately 92%. Using U.S. Bank’s outstanding balance amounts, the loan-to-value ratio on the Lido Sands property is approximately 97%.
5. Beacon Bay Property is a land lease from the City of Newport Beach and the Debtor’s former residence. The Debtоrs allege in their Schedules and their Amended Disclosure Statement that the Beacon Bay Property’s value is $3,495,000. The Debtors allege in these documents that the outstanding amount owing to Chase Home Finance, LLC (“Chase”) on the Beacon Bay Property is $2,150,000 and the amount owing to U.S. Bank is $1,000,000. Therefore, using the Debtors’ outstanding balance amounts, the loan-to-value ratio on the Beacon Bay Property is approximately 90%. 3
U.S. Bank asserts liens on each of the Debtors’ above-listed properties. Relief from the automatic stay has been granted as to Treehaven Plaza and the Yorba Professional and Business Centers, and a state court receiver is administering each of these properties.
On the Petition Date in this case, Full House held title to three other properties:
1. Costa Mesa Property, a commercial office building totaling 26,841 square feet. Full House listed in its Schedules that the value of the Costa Mesa Property is $5,000,000 and the outstanding amount owing on the property was $2,640,000. However, as of January 17, 2011, Full House valued the Costa Mesa Property at $3,261,000. Debtor’s Opposition to Motion for Relief from the Automatic Stay (Docket No. 131) at 4.
2. Escondido Property consists of two office buildings totaling 28,770 square feet. Full House alleged in its Schedules that the value of the Escondido Property was $5,000,000 and the outstanding amount owing on the property was $3,423,000. Full House subsequently valued the Escondido Property at $2,225,000 based upon an offer allegedly received from an unrelated third partyto purchase the Escondido Property. Debtor’s Opposition to Motion for Relief from the Automatic Stay (Docket No. 131) at 5.
3. Indian Trail Property, a property that includes a 32-room hotel and restaurant, a single family residence and vacant land. Full House alleged in its Schedules that the value of the Indian Trail Property was $5,000,000 and the outstanding amount owing was $2,937,000. This property was sold for $3,150,000 pursuant to § 363(b).
Prior to the Petition Date, U.S. Bank made three loans to Full House: a loan on the Costa Mesa Property, a First Loan on the Escondido Property and a Second Loan on the Escondido Property, in the aggregate principal amount of $6,392,500. As stipulated in the Amendment to Stipulation for Order (1) Authorizing Debtor’s Use of Cash Collateral; and (2) Adequate Protection to U.S. Bank National Association, filed on January 26, 2010 (Docket No. 79), and approved by this court on June 19, 2010 (Docket No. 96), the parties agreed that all pre-petition collateral would secure all of Full House’s obligations to U.S. Bank. As of the Petition Date, Full House’s obligations to U.S. Bank totaled $6,665,178.67. As such, by January 2011, the outstanding loan balance on the Costa Mesa and Escondido properties was at least $1,179,178 more than their value. Relief from stay was granted on February 16, 2011, to allow U.S. Bank to foreclose (Docket No. 135).
The Debtors had personally guaranteed Full House’s debt obligations to U.S. Bank, which resulted in the bank asserting deficiency claims in the Debtors’ bankruptcy case. The Amended Disclosure Statement lists this deficiency claim as the “Disputed U.S. Bank Claim,” which is defined as “the general unsecured claim in the amount of $3,023,783.38 asserted by U.S. Bank against the Debtors as alleged guarantors of certain debts of Full House.” Amended Disclosure Statement at 13. The Debtors objected to the Disputed U.S. Bank Claim, and by order entered on March 14, 2012, the court overruled the Debtors’ objection to this claim. The court’s order overruling the objection is now final.
The Debtors are in the process of marketing their former residence, and as discussed in their Amended Disclosure Statement, they propose in their Plan to retain their current residence, the Lido Sands Property, and an investment property, the El Camino Business Center. Id. at 29. U.S. Bank objects to the Amended Disclosure Statement on grounds that it lacks adequate information and that it describes a Plan that is patently unconfirmable.
DISCUSSION
I. Lack of Adequate Information
To approve a disclosure statement, the court must determine that it contains “adequate information” as defined by Section 1125 of the Bankruptcy Code:
“adequate information” means information of a kind, and in sufficient detail, as far as is reasonably practicable in light of the nature and history of the debtor and the condition of the debtor’s books and records, including a discussion of the potential material Federal tax consequences of the plan to the debtor, any successor to the debtor, and a hypothetical investor typical of the holders of claims or interests in the case, that would enable such a hypothetical investor of the relevant class to make an informed judgment about the plan, but adequate information need not include such information about any other possible or proposed plan and in determiningwhether a disclosure statement provides adequate information, the court shall consider the complexity of the case, the benefit of additional information to creditors and other parties in interest, and the cost of providing additional information ....
The Amended Disclosure Statement and Plan identifies several Options that Class 5, which is composed of General Unsecured Creditors, may receive under the Plan. Amended Disclosure Statement at 31-33. The Options are mutually exclusive, and each has a set of conditions under which it applies:
• Option A: If the Debtors’ objection to the Disputed U.S. Bank Claim is sustained in full and if the absolute priority rule does not apply.
• Option B : If the Debtors’ objection to the Disputed U.S. Bank Claim is overruled and if the absolute priority rule does not apply.
• Option C: If the Debtors’ objection to the Disputed U.S. Bank Claim is sustained in full and if the absolute priority rule applies.
• Option D : If the Debtors’ objection to the Disputed U.S. Bank Claim is overruled, if the absolute priority rule applies, and if the New Value Contribution is made.
• Option E: If the Debtors’ objection to the Disputed U.S. Bank Claim is overruled, if the absolute priority rule applies and if the New Value Contribution is not made.
Id.
Because the court has overruled the Debtors’ objection to the Disputed U.S. Bank Claim, Option A and Option C are no longer relevant. Option B is also not relevant because, as discussed below, the absolute priority rule applies in this case. Therefore, in light of the court’s rulings on the objection to the Disputed U.S. Bank’s Claim and on the applicability of the absolute priority rule, the only relevant two Options are Option D and Option E.
Both Options mention the “New Value Contribution,” which is stated to apply in some of the Options and not apply in others. The Amended Disclosure Statement defines the “New Value Contribution” as follows:
“New Value Contribution” means the sum of money that the Debtors may, at their election, deposit with the Estate on the Effective Date. The New Value Contribution will only be made if (a) the Court determines that the absolute priority rule applies to the Debtors’ bankruptcy case, and (b) if the Debtors elect to make the contribution. The amount of the New Value Contribution is $250,000.
Amended Disclosure Statement at 15.
It is unclear whether the Debtors are proposing to contribute new value and reorganize, under Option D, or whether they are proposing to sell the El Camino Property within 12 months of the Effective Date of the Plan, under Option E. From a disclosure statement, creditors should be able to ascertain whether the Debtors intend to reorganize or liquidate, and it is impossible to discern their intentions based on the Amended Disclosure Statement. Moreover, the Amended Disclosure Statement lacks adequate information for creditors to make an informed judgment about the plan under
The court also determines that the Amended Disclosure Statement lacks adequate information with respect to the Debtor’s discretionary New Value Contribution of $250,000. By its definition in the Amended Disclosure Statement and Plan, the Debtors state that the New Value Contribution will be made “at their election.”
Amended Disclosure Statement
at 15. The Amended Disclosure Statement and Plan do not provide information to substantiate the Debtors’ ability to make the New Value Contribution. The Amended" Disclosure Statement lists bank accounts holding only $38,000, and miscellaneous personal property worth approximately $45,000, as well as real property assets of unknown value with no information about whether the Debtors have any equity in these real property assets.
Id.
at 21. There is no information in the Plan or Amended Disclosure Statement to support the possibility of a New Value Contribution and the feasibility of the Plan, and therefore, the Amended Disclosure Statement does not contain adequate information for creditors to make an informed judgment about the plan under
Finally, the Amended Disclosure Statement does not contain adequate information with respect to the total amount owed to General Unsecured Creditors. The Amended Disclosure Statement lists total General Unsecured Claims as $1,128,383.86. Id. at 32, 49. The Debtors’ objection to the Disputed U.S. Bank Claim, listed in the Amended Disclosure Statement in the amount of $3,023,783.38, was overruled by a now final order of the court. Id. at 13. The Amended Disclosure Statement must be amended to include U.S. Bank’s allowed unsecured claim and to reflect an accurate amount owing to General Unsecured Creditors.
Thus, for the reasons stated above, the court holds that the Amended Disclosure Statement does not contain adequate information for creditors to make an informed judgment about the plan as defined by
II. The Plan is Patently Unconfirmable
“[Wjhere a plan is on its face nonconfirmable, as a matter of law, it is appropriate for the court to deny approval of the disclosure statement describing the nonconfirmable plan.”
In re Silberkraus,
Based on the moving and opposing papers, it is evident that Class 5 will reject the Plan, and the Debtors will attempt to cram down pursuant to Section 1129(b) of the Bankruptcy Code, 11 U.S.C. As discussed below, because the court concludes that that absolute priority rule applies in this ease and that the Plan violates the absolute priority rule, it is therefore appropriate to deny approval of the Amended Disclosure Statement on this basis as well.
The Amended Disclosure Statement lists total General Unsecured Claims as $1,128,388.86. U.S. Bank’s $3,023,783.38 claim, to which the Debtors objected, was not included in this figure as shown by the Amended Disclosure Statement and Plan. As explained above, the court entered an order overruling the Debtors’ objection. U.S. Bank, therefore, holds an allowed unsecured deficiency claim, and that amount must be added to the General Unsecured Clams listed by the Debtors. Thus, based on the figures included in the Amended Disclosure Statement, it is clear that U.S. Bank holds more than one-third of the outstanding General Unsecured Claims.
As discussed above, Class 5 is scheduled to receive distributions based on certain Options described in the Plan, and the only relevant Options are Option D and Option E. Under Option D creditors will receive a pro rata share of a promissory note created under the Plan (“Unsecured Creditor Note”) with a stated principal amount of $600,000 plus interest at the federal judgment rate, providing for less than 15% of outstanding General Unsecured Claims. Under Option E, the Debtors will “within 12 months of the Effective Date, close escrow on the sale of the [remaining property] and pay 100% of the Net Sale Proceeds to unsecured creditors who hold Allowed Claims.”
A claim is impaired unless a plan “leaves unaltered the legal, equitable, and contractual rights to which such claim or interest entitles the holder of such claim or interest.”
Class 5 can only consent if creditors “that hold at least two-thirds in amount and more than one-half in number of the allowed claims” vote to accept the Plan.
B. The Absolute Priority Rule Applies
In addressing whether the absolute priority rule applies in Chapter 11 bankruptcy cases of individual debtors after BAPCPA, the courts are sharply divided. The courts that hold that the rule does not apply based on the so-called “broad” view of property of the estate that an individual debtor may retain under a confirmed plan pursuant to
i. Friedman is Not Binding
In this circuit, orders of the bankruptcy courts may be appealed to either the federal district court or the BAP.
As recently observed by the court in
In re Grant,
Some bankruptcy courts, including the BAP itself, conclude that BAP decisions are binding on the bankruptcy courts of the circuit.
See, e.g., In re Windmill Farms, Inc.,
Citing
Bank of Maui,
other bankruptcy courts conclude that BAP decisions do not carry the weight of
stare decisis
and thus, are not binding on them.
See, e.g., In re Rinard,
If an appeal is taken of this court’s decision, which does not follow the BAP’s holding in
Friedman,
to the BAP, most likely the BAP would reverse this court’s decision in accordance with its policy stated in
Windmill Farms
that its decisions are binding on the bankruptcy courts of the circuit. However, if an appeal is taken and a party alternatively elects to have the district court hear the appeal, the BAP’s decision in
Friedman
would not be binding on the district court under
Bank of Maui.
This situation presents a quandary for the
As discussed below, the court concludes that the “broad” interpretation of § 1115 espoused by the majority BAP opinion in
Friedman
is not persuasive. One reason is the significant statement at the beginning of the opinion that “[n]o party has participated as an appellee in this appeal,” or in other words, the BAP reached its decision in
Friedman
without the benefit of briefing from both sides.
In re Friedman,
Chapter 11 of the Bankruptcy Code, 11 U.S.C., is the reorganization
In proceedings under the reorganization provisions of the Bankruptcy Code, a troubled enterprise may be restructured to enable it to operate successfully in the future.... By permitting reorganization, Congress anticipated that the business would continue to provide jobs, to satisfy creditors’ claims, and to produce a return for its owners.... Congress presumed that the assets of the debtor would be more valuable if used in a rehabilitated business than if “sold for scrap.”
United States v. Whiting Pools, Inc.,
Most Chapter 11 cases are filed by entities, not individuals, but individual persons may file a Chapter 11 case. Warren,
Chapter 11: Reorganizing American Businesses
at 4. (“About 90 percent of the Chapter 11 filers are legal fictions, mostly corporations, with a few LLCs and partnerships thrown in.”) (footnote omitted);
see also Toibb v. Radloff,
There has never been any great rush on the part of individuals to get into chapter 11. For the most part, the individual cases in chapter 11 are limited to those with complex personal investments. In the late 1980s and early 1990s, there were a fair number of real estate developer cases. We may see that again during the next real estate cycle.
Ayer & Bernstein, Bankruptcy in Practice at 96.
“The front door to Chapter 11 is wide — there are few restrictions to filing. But the back door is narrow — only about a third of all businesses that file for Chapter 11 manage to emerge with a confirmed
In order for a plan to be confirmed consensually under
The Bankruptcy Code, however, “provides that where all requirements for confirmation but
In describing the Chapter 11 cramdown plan, Professor Warren commented:
The cramdown plan ... incorporates all of the requirements of the consensual plan — and all its normative values — except that the plan can be confirmed even if some classes vote against it. By permitting confirmation without the consent of all classes, the Code necessarily realigns the power of participants in the bankruptcy process. Cramdowns diminish the power of creditors, particularly their power to hold out for bettertreatment than the minimum amounts guaranteed elsewhere in the Code. The availability of the cramdown option also increases the number of bankrupt businesses that are reorganized rather than liquidated, demonstrating once again a preference in the Code for reorganization.
Warren, Chapter 11: Reorganizing American Businesses at 168. As further observed by Professor Warren, the absolute priority rule is an important limitation on cramdown plans:
The absolute priority rule restricts the DIP’s [debtor-in-possession’s] use of the cramdown by requiring that equity holders retain no ownership in the reorganizing business unless superior classes either have accepted the plan or received payment in full. This fine-tunes the balance of power among the parties. If the DIP wants to confirm a plan that includes retaining equity ownership, it will either have to pay the creditors in full or negotiate for their cooperation. If, however, the DIP wants to sell the business and distribute the assets to creditors, a dissenting class cannot block that action unless some other Code requirement has been violated. Thus, the power of creditors if they choose to dissent is restricted; they can block some actions but not others. The balance achieved is one that is designed to enhance reorganization, but to provide some creditor protection as well.
Id.', see also Elizabeth Warren, A Theory of Absolute Priority, 1991 Annual Survey of American Law 9 (1991).
In discussing cramdown and the absolute priority rule, Professors Warren and Westbrook emphasize the importance of creditor consent:
There is a tendency ... to focus on cramdown in Chapter 11 because it is a legal rule, and to ignore the negotiation that leads to creditor acceptance of a plan because it is a messy, idiosyncratic process. Yet negotiated consent is the essence of the Chapter 11 scheme.... The exclusive right to propose a plan and the possibility of cramdown represent the leverage that the debtor brings to the negotiating table, but agreement is the larger theme. Chapter 11 is descended from both of the reorganization chapters, Chapters X and XI, under the old Act, but more from the latter than the former. Consent was the essence of Chapter XI ... while absolute priority was the central focus of Chapter X.... When they were combined into Chapter 11, the absolute priority rule was modified to permit equity participation if creditor consent was obtained. Thus consent remains the heart of Chapter 11.
Warren & Westbrook, The Law of Debtors and Creditors at 669.
The absolute priority 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,
The rule had its genesis in judicial construction of the undefined requirement of the early bankruptcy statute that reorganization plans be “fair and equitable.” See Northern Pacific R. Co. v. Boyd,228 U.S. 482 , 504-505,38 S.Ct. 554 , 560,57 L.Ed. 931 (1913); Louisville Trust Co. v. Louisville, N.A. & C.R. Co.,174 U.S. 674 , 684,19 S.Ct. 827 , 830,43 L.Ed. 1130 (1899). The rule has since gained express statutory force, and was incorporated into Chapter 11 of theBankruptcy Code adopted in 1978. See 11 U.S.C. § 1129(b)(2)(B)(ii) (1982 ed., Supp. TV). Under current law, no Chapter 11 reorganization plan can be confirmed over the creditors’ legitimate objections (absent certain conditions not relevant here) if it fails to comply with the absolute priority rule.
The absolute priority rule is codified at
(b)(1) Notwithstanding section 510(a) of this title, if all of the applicable requirements of subsection (a) of this section other than paragraph (8) are met with respect to a plan, the court, on request of the proponent of the plan, shall confirm the plan notwithstanding the requirements of such paragraph if the plan does not discriminate unfairly, and is fair and equitable, with respect to each class of claims that is impaired under, and has not accepted, the plan.
(2) For the purpose of this subsection, the condition that a plan be fair and equitable with respect to a class includes the following requirements:
(B) With respect to a class of unsecured claims—
(i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or
(ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property, except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section.
In Bank of America National Trust & Savings Assn. v. 203 North LaSalle Street Partnership, the Supreme Court described the rationale for the absolute priority rule:
The Bankruptcy Act preceding the Code contained no such provision as subsection (b)(2)(B)(ii), its subject having been addressed by two interpretive rules. The first was a specific gloss on therequirement of § 77B (and its successor, Chapter X) of the old Act, that any reorganization plan be “fair and equitable.” 11 U.S.C. § 205(e) (1934 ed., Supp. I) (repealed 1938) (§ 77B);11 U.S.C. § 621(2) (1934 ed., Supp. IV) (repealed 1979) (Chapter X). The reason for such a limitation was the danger inherent in any reorganization plan proposed by a debtor, then and now, that the plan will simply turn out to be too good a deal for the debtor’s owners. See H.R. Doc. No. 93-137, pt. I, p. 255 (1973) (discussing concern with “the ability of a few insiders, whether representatives of management or major creditors, to use the reorganization process to gain an unfair advantage”); ibid. (“[I]t was believed that creditors, because of management’s position of dominance, were not able to bargain effectively without a clear standard of fairness and judicial control”); Ayer, Rethinking Absolute Priority After Ahlers, 87 Mich. L.Rev. 963, 969-973 (1989). Hence the pre-Code judicial response known as the absolute priority rule, that fairness and equity required that “the creditors ... be paid before the stockholders could retain [equity interests] for any purpose whatever.” Northern Pacific R. Co. v. Boyd,228 U.S. 482 , 508,33 S.Ct. 554 ,57 L.Ed. 931 (1913). See also Louisville Trust Co. v. Louisville, N.A. & C.R. Co.,174 U.S. 674 , 684,19 S.Ct. 827 ,43 L.Ed. 1130 (1899) (reciting “the familiar rule that the stockholder’s interest in the property is subordinate to the rights of creditors; first of secured and then of unsecured creditors,” and concluding that “any arrangement of the parties by which the subordinate rights and interests of the stockholders are attempted to be secured at the expense of the prior rights of either class of creditors comes within judicial denunciation”).
The legal rule of absolute priority had its genesis in the long-standing common law maxim that creditors would be paid ahead of equity. This rule assured those who did business with the corporation that if the business were dissolved the creditors would be paid before the insiders would recover their investments. In case of collapse, the creditors could count on payment in full before equity collected anything from the business assets.
The provision is a form of creditor protection, one of many that attempt to restrict the ability of corporate owners and insiders from depleting a failing business for their own benefit, leaving the creditors with only the empty shell of a business. In part, the rule is designed to offset some of the consequences of superior information and control necessarily available to equity owners when they manage the business or exercise close supervision over the nominal managers. The rules of absolute priority satisfy concerns similar to those of state law rules of dividend distribution, for example, which require that the corporation only distribute stock dividends from earned surplus rather than from the general assets of the business. As any good law-and-economics devotee could point out, creditors could have insisted on such provisions in advance, but the law provides an off-the-rack ordering among the parties that is nearest to what the parties would likely have negotiated for themselves, requiring that the owners/insiders restrict their abilities to take assets from the business to the injury of the creditors.
Warren, A Theory of Absolute Priority at 37-38.
As described by Professor Baird, the centrality of the absolute priority rule drives the Chapter 11 process:
The ambition of every lawyer whose client files a Chapter 11 petition is to persuade each group of creditors to consent to a plan of reorganization. Whether a group consents depends on its rights under the plan versus the rights it would have if it refused to go along with the plan. The absolute priority rule is central to the law of corporate reorganizations because it is the source of substantive rights as well as the procedural protections that each participant in a reorganization enjoys. Parties can insist that the priority rights they enjoyed outside of bankruptcy be respected inside. Nevertheless, every junior party, including the shareholders, can invoke elaborate procedures before their rights are compromised. The absolute priority rule allows the senior parties to insist on full payment, but it also grants all junior parties those procedural protections necessary for a “just reorganization.” Resolving this tension between substantive and procedural rights that began with [Northern Pacific R. Co. v. ] Boyd [174 U.S. 482 ,33 S.Ct. 554 ,57 L.Ed. 931 (1913) ] remains central to answering the hard questions that arise under Chapter 11.
Baird, The Elements of Bankruptcy at 86.
Thus, the court considers the hard question of whether Congress in enacting BAPCPA abrogated the absolute priority for Chapter 11 bankruptcy cases of individual debtors in adding new § 1115 to, and amending
iii. Reconciliation of
The absolute priority rule was amended by BAPCPA to provide for an exception in the Chapter 11 case of an individual debt- or.
(a) In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—
(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.
How the court interprets amended
This new provision [i.e.,Section 1115 ] both refers to the property already brought into the bankruptcy estate by § 541 and brings more property into the estate. Unfortunately, the exception and§ 1115(a) are worded in such a way that the exception could be construed narrowly to cover only the additional, post-petition property brought into the Chapter 11 bankruptcy case by§ 1115(a) , or broadly to cover not only that property but also all of the property brought into the estate by § 541, most of which is property the debtor had before filing for bankruptcy. The first construction would greatly limit the impact of the new exception under§ 1129(b)(2)(B)(ii) , but the second would exemрt an individual Chapter 11 debtor from the main facet of the absolute priority rule, allowing him or her to retain both pre- and postpetition property under a plan even though a class of unsecured creditors would not be paid in full. The Court must determine which interpretation matches Congress’s intent in making these changes.
In re Roedemeier,
The courts have disagreed on whether the meaning of the operative language of
Furthermore, the Supreme Court has stated that “[i]t is ‘a cardinal principle of statutory construction’ that ‘a statute ought, upon the whole, to be so construed that, if it can be prevented, no clause, sentence, or word shall be superfluous, void, or insignificant.’ ”
TRW Inc. v. Andrews,
The court in
Roedemeier
precisely identified the interpretative problem raised by the statutes here: “Unfortunately, the exception and
The exception to the absolute priority rule added by Section 321(c) of BAPCPA excepts from the rule in the case of an individual Chapter 11 debtor, “property included in the estate under
(a) In a case in which the debtor is an individual, property of the estate includes, in additiоn to the property specified in section 541—
(1) all property of the kind specified in section 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7,12, or 13, whichever occurs first.
Prior cases have focused on analyzing the word “includes” in
Definitions of the words, “includes” and “included,” are set forth in the American Heritage Dictionary of the English Language, as follows:
Include tr. v. -eluded, -eluding, -eludes 1. To take in as a part, element, or member. 2. To contain as a secondary or subordinate element. 3. To consider with or place into a group, class or total....
American Heritage Dictionary of the English Language at 887 (4th ed. 2000).
For the reasons set forth in this memorandum decision, the structure of the sentence in
In order to understand a subject and a predicate, parts of speech, i.e., noun or pronoun, and verb, must be defined:
“A
In interpreting
In a case in which the debtor is an individual, property of the estate includes, in addition to the property specified in section 541—
(1) all property of the kind specified in section 541 that thе debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first; and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.
The subject of the sentence, or the noun or pronoun that tells what the subject is about, is “property of the estate.” Rozak-is,
English Grammar for the Utterly Confused
at 116. “Property of the estate” is not a single-word noun; it is a collective noun, which is a noun that “name[s] groups of people or things,” and which in this case is a group of assets constituting assets of the bankruptcy estate.
As stated previously, transitive verbs require a direct object or direct objects, and a direct object is a noun or pronoun that receives the action. The direct objects of the sentence, or the nouns that receive the action of the transitive verb, “includes,” are:
(1) all property of the kind specified insection 541 that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first (i.e., all post petition property acquired by the debtor); and
(2) earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first (i.e., all earnings from the debtor’s postpetition services).
Because the original meaning of “includes” is “[t]o take in as a part, element or member,” separate enumeration of the items “included” helps to identify what parts, elements or members are included. That appears to be the reason why Congress separately enumerated: (1) all post-petition property of the debtor; and (2) all earnings from the debtor’s postpetition services in
The third category of assets, “the property specified in
The phrase, “in addition to,” is part of a prepositional phrase because it begins with a preposition, “in.” Rozakis,
English Grammar for the Utterly Confused
at 9, 102-103. “Prepositions link a noun or a pronoun following it to another word in the sentence.”
Id.
at 9. The object of the prepositional phrase is “the property specified in
In technical grammatical terms, the specific question is whether “in addition to property specified in
When a prepositional phrase serves as an adjective, it’s called an adjectival phrase. An adjectival phrase, as with an adjective, describes a noun or pronoun. To find out if a prepositional phrase is functioning as an adjectival phrase, see if it answers these questions: “Which one?” or “What kind?”
Id. at 102 (italics in original). An “adverbial phrase” is defined as follows:
When a prepositional phrase serves as an adverb, it’s called an adverbial phrase. In these cases, it describes a verb, an adjective, or adverb. To find out if a prepositional phrase is functioning as an adverbial phrase, see if it answers one of these questions: “Where?” “When?” “In what manner?” “To what extent?”
Id. at 103 (italics in original).
Applying this analysis, the prepositional phrase, “in addition to the property specified in
Another point of grammar is that “[p]hrases or clauses introduced by such expressions as
together with, as well as, in addition to
are not part of the subject and, therefore, do not affect the number of the verb.” Margaret Shertzer,
The Elements of Grammar
at 23 (1986) (italics in original);
see also
William Strunk
&
E.B. White,
Elements of Style
at 10 (3d ed. 1979). This grammatical point reinforces the idea that “in addition to” means that the matter is “besides” or “separate from” the subject of the sentence, which in
The courts favoring the broad view of
We believe that
(1) Property specified in§ 541 (i.e., “property of the estate includes, in addition to the property specified in section 511 ”) (emphasis added);
(2) All property of the kind specified in§ 541 that the (individual) debtor acquires after the commencement (but before the closure, dismissal or conversion) of the case; and
(3) [Ejarnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 12, or 13, whichever occurs first.
In re Friedman,
(a) The commencement of a case under section 301, 302, or 303 of this title creates an estate. Such estate is comprised of all the following property, wherever located and by whomever held:
(1) Except as provided in subsections (b) and (c)(2) of this section, all legal or equitable interests of the debtor in property as of the commencement of the case....
Section 541 embodies the essence of the Bankruptcy Code. It creates the bankruptcy estate, which consists of all of the property that will be subject to the jurisdiction of the bankruptcy court. Property belonging to the estate is рrotected from piecemeal dismantling by creditors by the automatic stay of section 362. It is this central aggregation of property that promotes the fundamental purposes of the Bankruptcy Code: the breathing room given to a debtor that attempts to make a fresh start, and the equality of distribution of assets among similarly situated creditors, according to the priorities set forth within the Code. It is from this central core of estate property that the debtor’s creditors will be paid.
In order to achieve these goals, it is necessary and desirable that the property included in the bankruptcy estate be as inclusive as possible. Congress’s intent to define property of the estate in the broadest possible sense is evident from the language of the statute, which initially defines the scope of estate property to be all legal or equitable interests of the debtor in property as of the commencement of the ease, wherever located and by whomever held. It would be hard to imagine language that would be more encompassing. Yet the remainder ofsection 541(a) attempts to do just that_Thus,section 541(a) defines everything that is included in property of the estate.
5 Resnick
&
Sommer,
Collier on Bankruptcy
¶ 541.01 at 541-10;
see also
Baird,
The Elements of Bankruptcy
at 16 (“
By its very language,
The court agrees with
Stephens,
which recognized the phrase “all property of the kind specified in
The statutory language and numbering of
Use of the phrase “in addition to the property specified in
As stated previously, “It is ‘a cardinal principle of statutory construction’ that ‘a statute ought, upon the whole, to be so construed that, if it can be prevented, no clause, sentence, or word shall be superfluous, void, or insignificant.’ ”
TRW Inc. v. Andrews,
Thus, reading
iv. Legislative History
As discussed below in this and subsequent sections of this memorandum decision, the court’s analysis of the impact of the BAPCPA amendments in
The Supreme Court has given guidance in reconciling various sections within the Bankruptcy Code in light of the BAPCPA amendments. For example, with respect to BAPCPA Chapter 13 amendments, the Supreme Court has stated that it “will not read the Bankruptcy Code to erode past bankruptcy practice absent a clear indication that Congress intended such a departure.”
Hamilton v. Lanning,
— U.S. -,
With respect to the relevant legislative history of
Section 321(a) of the Act creates a new provision under chapter 11 of the Bankruptcy Code specifying that property of the estate of an individual debtor includes, in addition to that identified insection 541 of the Bankruptcy Code, all property of the kind described insection 541 that the debtor acquires after commencement of the case, but before the case is closed, dismissed or converted to a case under chapter 7, 12, or 13 (whichever occurs first). In addition, it includes earnings from services performed by the debtor after commencement of the case, but before the case is closed, dismissed or converted to a case under chapter 7,12, or 13. Except as provided in section 1104 of the Bankruptcy Code or the order confirming a chapter 11 plan, section 321(a) provides that the debtor remains in possession of all property of the estate.
Section 321(c) also amendssection 1129(b)(2)(B)(ii) of the Bankruptcy Code to provide that an individual debtor may retain property included in the estate undersection 1115 (as added by the Act), subject tosection 1129(a)(14) .
H.R.Rep. No. 109-31, pt. 1 at 80 (2005), 2005 U.S.C.C.A.N. 88, 147. Thus, the legislative history specifically referencing the addition of
What legislative history does exist, however, actually reinforces the idea that “the purpose behind BAPCPA was to have debtors pay more, not less.”
In re Friedman,
Moreover, as the House Report stated, Congress cited four general factors for enacting BAPCPA. H.R.Rep. No. 109-3(1), part 1 at 3-5 (2005),
At least one court favoring the broad view of
The court also notes that Section 321 of BAPCPA, which added
Given that there is no indication in the legislative history that Congress intended to abrogate the absolute priority rule as to individual Chapter 11 debtors as to all of their prepetition property, and given that the general purposes of BAPCPA cited by Congress were to curb perceived abuses by debtors, it is incorrect to read
v. Policy Considerations
Finally, strong policy considerations require the appliсation of the absolute priority rule to individual Chapter 11 cases. As explained in Kamell,
After BAPCPA, the debtor facing opposition of any one unsecured creditor must devote 5 years worth of “projected disposable income,” at a minimum (or longer if the plan is longer). But debtor is not compelled to give also his additional earnings or after-acquired property net of living expenses beyond five years unless the plan is proposed for a period longer than five years. But there is no compelling reason to also conclude that pre petition property need not be pledged under the plan as the price for cram down, just as it has always been. This does unnecessary violence to well-established jurisprudence.
In re Kamell,
If Congress had not amended
The narrow reading of
As the court in
Kamell
points out regarding the argument that the narrow view prohibits individual debtors from confirming a Chapter 11 plan, it does no such thing.
In re Kamell,
The argument for the broad view of
The broad view removes the creditor protection of the absolute priority rule in Chapter 11 cases as to individual debtors because there are no debt limits in Chapter 11. Thus, the broad view would allow highly leveraged individuals who are not eligible for Chapter 13 to qualify for Chapter 11 reorganization by allowing them to retain their prepetition propеrty without having to satisfy the absolute priority rule, no matter how much debt they had incurred. In this court’s view, this interpretation does violence to the delicate balance between creditors and debtors in Chapter
Individual chapter 11 debtors are not simply chapter 13 debtors with larger debts. Rather, chapter 11 debtors, individuals or not, stay in possession of their property and enjoy all the rights and powers of a trustee. They are authorized to operate their business and can choose to extend their plan beyond five years. In exchange, the chapter 11 process does not leave unsecured creditors by the wayside by affording individual chapter 11 debtors the luxury to retain all pre and postpetition property at their expense.
Individuals who own a business have the same opportunities as corporate shareholders to take advantage of unsecured creditors.
In re Friedman,
Thus, the court agrees with other courts adopting the narrow view that if Congress intended to make a “momentous change” in the law by eliminating the absolute priority rule, a central principle of Chapter 11 reorganization theory and practice, for individual Chapter 11 debtors, it would have merited at least a mention in the legislative history, which is silent on the issue.
See, e.g., In re Gbadebo,
In this case, based on the Debtors’ Schedules and the Amended Disclosure Statement, the Debtors have over $4 million in unsecured debts and over $13 million in secured debts, well in excess of the debt limits of Chapter 13 set forth in
Excepting financially sophisticated individual Chapter 11 debtors with complex personal investments, as here, from the absolute priority rule and allowing them to retain such investments despite their over-leveraging does not seem justified in light of the legislative history of BAPCPA and what Congress sought to accomplish in that act. This situation in this case appears to be what Congress stated it intended to prevent with the passage of BAPCPA. 10 Unlike Chapter 13, which has debt limits on the amount of secured and unsecured debt and attendant potential losses that are passed on to creditors, the broad view results in potentially unlimited losses that are passed on to unsecured creditors from the writing down of debt in cramdown plans of individual Chapter 11 debtors.
A majority of the courts that have ruled on the issue of whether
Thus, the structure and statutory language of the Bankruptcy Code, the legislative history of BAPCPA, strong policy considerations, and the weight of the case law, in support of the narrow interpretation of
C. The Debtors’ Plan Violates the Absolute Priority Rule
Under the narrow view of
CONCLUSION
The court finds that the Amended Disclosure Statement cannot be approved because it contains inadequate information and because it describes a plan that may not confirmed. Accordingly, approval of the Amended Disclosure Statement must be DENIED. A separate order is being filed concurrently herewith.
Notes
. Except as otherwise noted, the stаtement of facts in this background section is primarily based on the (Stipulated Facts and Joint Exhibit List in Connection with Evidentiary Hearing on (1) Objection to Claim of U.S. Bank and (2) Application of Absolute Priority Rule "Stipulated Facts”), filed on Nov. 4, 2011, and exhibits attached thereto, the Debtor’s Schedules filed in this case and the bankruptcy schedules filed by Full House Enterprises in its bankruptcy case, No. 2:12-bk-16197 RK Chapter 11.
. U.S. Bank has alleged that the outstanding balance is $2,758,924.44 (including principal of $2,457,589.47, interest of $268,602.58 and late charges of $32,732.39). Proof of Claim No. 22-1. Using U.S. Bank’s outstanding balance amounts, the loan-to-value ratio on Tree-haven Plaza is approximately 98%.
. Chase contends that the amount owing on the Beacon Bay Property is $2,195,573.00 as of the Petition Date, including $164,778.99 in arrearages. Claim 13-1, filed by Chase Home Finance, LLC on April 12, 2011. U.S. Bank contends that, as of the Petition Date, the outstanding amount owing to U.S. Bank on the Beacon Bay Property is $978,763.10, including $5,989.86 in arrearages. Proof of Claim No. 22-1. Using the banks’ outstanding balance amounts, the loan-to-value ratio on the Beacon Bay Property is also approximately 90%.
. In a law review article on the writing of judicial opinions, specifically on writing separately, Judge (now Justice) Ruth Bader Ginsburg wrote: "Disclosure of votes and opinion writers may nourish a judge's ego, his or her sense of individuality; but if our system affords the judge personal satisfaction, it also serves to hold the individual judge accountable. The process of writing signed opinions is a testing venture. California’s once Chief Justice Roger Traynor wrote of the process: T have not found a better test for the solution of a case than its articulation in writing, which is thinking at its hardest. A judge ... often discovers that his tentative views will not jell in the writing. He wrestles with the devil more than once to set forth a sound opinion that will be sufficient unto more than the day.’ The prospect of a dissent or separate concurring statement pointing out an opinion’s inaccuracies and inadequacies strengthens thе best; it heightens the opinion writer’s incentive to 'get it right.’ ” Ruth Bader Ginsburg. Remarks on Writing Separately, 65 Wash. L.Rev. 133, 139 (1990), quoting Roger J. Traynor, Some Open Questions on the Work of State Appellate Courts, 24 U. Chi. L.Rev. 211, 218 (1957). This opinion is this court's effort to "get it right." While this court may be critical of the opinions of other courts, hopefully in an appropriate tone and manner, in pointing out what it perceives to be inaccuracies and inadequacies, this court respects and admires the sincere efforts of those other courts to “get it right” and to be as transparent and accountable as possible in articulating in writing the reasons for their decisions.
.
. The author of this reference work, Laurie Rozakis, Ph.D, is professor of English at Farmington State College, State University of New York, who has taught grammar and usage for more than 25 years. Rozakis, English Grammar for the Utterly Confused at back cover; http://www.farmingdale.edu/ academics/arts-sciences/english/faculty.shtml.
. Sections 301, 302 and 303 of the Bankruptcy Code provide respectively that a voluntary case under a chapter of the Code, a joint bankruptcy case under a chapter of the Code, and an involuntary bankruptcy case under Chapter 7 or 11 of the Code are commenced with the filing of a bankruptcy petition.
. The court takes no position as to whether the absolute priority rule applies to property claimed as exempt since this issue was not raised, nor briefed, by the parties. Given the court's ruling on the absolute priority rule as to property of the estate in general, the court need not address the issue.
See In re Bullard,
. The court agrees with the court in
Gbadebo
and disagrees with the BAP in
Friedman
on this point because under the broad view, individual debtors can and will approach creditor negotiations with the premise that they can keep their prepetition property without having to comply with the absolute priority rule as long as they meet the “best interests” test of
. The House Report made the following statement in this vein: "Second, there are significant losses associated with bankruptcy rulings. As one witness explained during the Senate Judiciary Committee’s hearing on S. 256 earlier this year: 'Like all other business expenses, when creditors are unable to collect debts because of bankruptcy, some of those losses are inevitably passed on to responsible Americans who live up to their financial obligations. Every phone bill, electric bill, mortgage, furniture purchase, medical bill, and car loan contains an implicit bankruptcy "tax” that the rest of us pay to subsidize those who do not pay their bills. Exactly how much of these bankruptcy losses is passed on from lenders to consumer borrowers is unclear, but economics tells us that at least some of it is. We all pay for bankruptcy abuse in higher down payments, higher interest rates, and higher costs for goods and services'." H.R.Rep. No. 109-31, part 1, at 3-5,