9th CIRCUIT HOLDS ABSOLUTE PRIORITY RULE APPLIES IN INDIVIDUAL DEBTOR CHAPTER 11 CASES

In a major development affecting individual chapter 11 bankruptcy debtors, the 9th Circuit Court of Appeals has overruled earlier case law and ruled that the “absolute priority rule” under 11 U.S.C. § 1129(b)(2)(B)(ii) continues to apply to individual debtors following the 2005 BAPCPA amendments to the Bankruptcy Code.  See David K. Zachary v. California Bank & Trust (In re Zachary), No. 13-16402 (January 28, 2016) (“Zachary“).

After BAPCPA, it became questionable whether the absolute priority rule continued to apply in individual debtor cases.  The amendments to the Bankruptcy Code included a provision (§ 1115) that added as “property of the estate,” all property of the kind specified in section 541 acquired by an individual debtor after commencement of the case in addition to property owned by the debtor as of the petition date.  In conjunction therewith, BAPCPA created an exception to the absolute priority rule that allowed individual debtors to retain property “included in the estate under section 1115.”  These amendments created an ambiguity that was not easily resolved, forcing the courts to consider:  Could an individual debtor retain all property of the estate, including property owned at the time the Chapter 11 was filed and also property added post petition, or was the debtor limited to only property acquired post filing?

A split of authority quickly developed in the circuits over this issue.  A split panel of the Bankruptcy Appellate Panel for the 9th Circuit in In re Friedman, 466 B.R. 471 (9th Cir. BAP 2012), and a majority of the district, bankruptcy appellate, and bankruptcy courts, adopted a broad view that permitted the debtor to retain all property, whenever acquired, while the Courts of Appeal for the 3rd, 4th, 5th, and 10th Circuits favored a narrower view that the debtor could only retain property acquired after the case was filed.  In Zachary, the 9th Circuit has overruled In re Friedman, falling in line with its sister circuits in holding that the absolute priority rule continues to apply in individual debtor Chapter 11 cases.

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