Sunday, June 10, 2018

The Absolute Priority Rule (Probably) Still Applies in Individual Bankruptcy Cases

Stephen W. Sather
Barron & Newburger, P.C.
Austin, TX

The absolute priority rule under 11 U.S.C. §1129(b) is one of the fundamental principles of chapter 11.   Under the absolute priority rule, a debtor has three options:  (i)  obtain a favorable vote from all classes of unsecured creditors; (ii) pay unsecured creditors in full; or (iii) provide that interests junior to unsecured creditors will not receive or retain any property on account of their interest.
            In 2005, Congress amended the Bankruptcy Code to make Chapter 11 more like Chapter 13 for individual debtors.   Because of some inexact drafting a question arose as to whether the absolute priority rule continued to apply in individual cases.    While the majority view is that Congress did not abrogate the absolute priority rule in individual cases, there are still some circuits where the question remains open.
There are three relevant statutory sections.    First, section 1115 provides that property of the estate in an individual case included property acquired post-petition, including earnings from personal services.  Second, section 1129(a)(15) provides that in an individual case in which an unsecured creditor objected, the Debtor must submit his projected disposable income under the plan for a period of five years.
Finally, section 1129(b)(2)(B) provides that a plan would be fair and equitable with regard to a rejecting class of claims if:
(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. (emphasis added).

*--The reference to subsection (a)(14) should probably refer to subsection (a)(15) instead.

            The statutory provisions add certain post-petition property to the estate, require the Debtor to make payments of projected disposable income if a creditor objects and allow the Debtor to retain "property included in the estate under section 1115." This required an examination of just what property was included by section 1115. According to section 1115(a)
(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 . . . ; and
(2) earnings from services performed by the debtor after the commencement of the case. . . . .

Courts which have examined this language have divided between a "narrow" interpretation holds that "property included in the estate under section 1115" refers only to the post-petition property added to the estate, while the "broad" interpretation holds that section 1115's reference to "property specified in section 541" refers to all section 541 property. Under the broad interpretation, because section 1115 encompassed all section 541 property, the Debtor could retain all of his property without violating the absolute priority rule.   For a brief period of time, the broad approach seemed to be gaining favor.   However, today all circuit courts which have addressed the issue and most lower courts have followed the narrow approach in which the absolute priority rule continues to apply.
The trend in the cases is definitely in favor of the narrow approach.   The Fourth, Fifth, Sixth, Ninth and Tenth Circuits have all adopted this approach, while no circuit court has followed the broad approach.   While there is still a split of authority in the First, Seventh, Eighth and Eleventh Circuits, they are likely to come around to the narrow approach.

Narrow Approach
Broad Approach
In re Walsh, 447 B.R. 45 (Bankr. D. Mass. 2011); In re Lee Min Ho Chen, 482 B.R. 473 (Bankr. D. P.R. 2012)
In re Perez, 2015 Bankr. LEXIS 1488 (Bankr. D. P.R. 2015)
Courts split.  No consensus.
In re Lucarelli, 517 B.R. 42 (Bankr. D. Ct. 2014);

Only case found follows narrow approach
Brown v. Ferroni (In re Brown), 505 B.R. 638 (E.D. Pa. 2014); In re Grasso, 497 B.R. 448 (Bankr. E.D. Pa. 2013)

Only cases found follow narrow approach
In re Maharaj, 681 F.3d 558 (4th Cir. 2012)

Definitely Narrow Approach
In re Lively, 717 F.3d 406 (5th Cir. 2013)

Definitely Narrow Approach
Ice House America, LLC v. Cardin (In re Cardin), 751 F.3d 734 (6th Cir. 2014)

Definitely Narrow Approach
In re Gerard, 495 B.R. 850 (Bankr. E.D. Wisc. 2013); In re Draiman, 450 B.R. 777 (Bankr. N.D. Ill. 2011)
In re Johnson, 402 B.R. 851 (Bankr. N.D. Ind. 2009)
Courts split.  No consensus.
Heritage Bank v. Woodward (In re Woodward), 537 B.R. 894 (8th Cir. BAP 2015)
In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007); In re O’Neal, 490 B.R. 837 (Bankr. W.D. Ark. 2013); In re Woodward, 2014 Bankr. LEXIS 1940 (Bankr. D. Neb. 2014)
Courts split.  No consensus.
Zachary v. Cal. Bank & Trust, 811 F.3d 1191 (9th Cir. 2016)

Definitely Narrow Approach
Dill Oil Company v. Stephens (In re Stephens), 704 F.3d 1279 (10th Cir. 2013)

Definitely Narrow Approach
In re Martin, 497 B.R. 349 (Bankr. M.D. Fl. 2013); In re Gelin, 437 B.R. 435 (Bankr. N.D. Fl. 2010); In re Steedley, 2010 Bankr. LEXIS 3113 (Bankr. S.D. Ga. 2010); In re Gbadebo, 431 B.R. 222 (Bankr. N.D. Cal. 2010); In re Rogers, 2016 Bankr. LEXIS 2398 (Bankr. S.D. Ga. 2016)
SPCP Group, LLC v. Biggins, 465 B.R. 316 (M.D. Fl. 2011)
Cases lean toward narrow approach

Wednesday, May 16, 2018

Creating a Circuit Split Regarding the Fair Debt Collection Practices Act: Rotkiske v. Klemm, --- F.3d ----, 2018 WL 2209120 (3d Cir. May 15, 2018)

By Hon. Judith K. Fitzgerald (Ret.)
Tucker Arensberg, P.C.

The United States Court of Appeals for the Third Circuit issued its opinion in Rotkiske v. Klemm, a unanimous, en banc decision yesterday that creates a clear split with the Fourth and Ninth Circuits.  The Third Circuit ruled that the statute of limitations for FDCPA violations is one year from the date of violation, not from the date of discovery.
Judge Hardiman, writing for the full court, stated: 

This appeal requires us to determine when the statute of limitations begins to run under the Fair Debt Collection Practices Act (FDCPA or Act), 91 Stat. 874, 15 U.S.C. § 1692 et seq. The Act states that “[a]n action to enforce any liability created by this subchapter may be brought in any appropriate United States district court ... within one year from the date on which the violation occurs.” 15 U.S.C. § 1692k(d). The United States Courts of Appeals for the Fourth and Ninth Circuits have held that the time begins to run not when the violation occurs, but when it is discovered. See Lembach v. Bierman, 528 Fed.Appx. 297 (4th Cir. 2013) (per curiam); Mangum v. Action Collection Serv., Inc., 575 F.3d 935 (9th Cir. 2009). We respectfully disagree. In our view, the Act says what it means and means what it says: the statute of limitations runs from “the date on which the violation occurs.” 15 U.S.C. § 1692k(d).

Rotkiske v. Klemm, No. 16-1668, 2018 WL 2209120, at *1 (3d Cir. May 15, 2018)

Saturday, May 12, 2018


By:  Hon. Judith K. Fitzgerald (Ret.)
Tucker Arensberg, P.C.
1500 One PPG Place
Pittsburgh, PA  15222

In an opinion that is informative although not precedential, In re AE Liquidation, Inc., No. 17-1794 (May 4, 2018)(which can be found here), the Court of Appeals for the Third Circuit considered both the ordinary course and the new value defenses to a preference action.  Regarding the ordinary course issue, the appellate court detailed facts of record that established that collection actions taken during the preference period were unilateral pressure tactics that derailed the defense. 

Saturday, May 5, 2018

No Monkeying Around With This Opinion - Naruto v. Slater, No. 16-15469, 2018 WL 1902414 (9th Cir. Apr. 23, 2018)

By Hon. Judith K. Fitzgerald (Ret).
Tucker Arensberg, P.C.
In case you are curious about the extent of animal rights under the law, take a look at this new decision in the Ninth Circuit, Naruto v. Slater, 2018 WL 1902414 (9th Cir. Apr. 23, 2018).  Naruto, an Indonesian macaque, picked up a camera that was left unattended in a reserve by David Slater, a photographer, and took some selfies back in 2011.  The pictures were apparently worthy of publication, so Mr. Slater published them in 2014.  The monkey sued.  Well, actually, the People for the Ethical Treatment of Animals, Inc. (“PETA”) sued as Naruto’s Next Friend, for copyright infringement.  The case worked its way to the Court of Appeals for the Ninth Circuit, where the court framed the issue this way:
We must determine whether a monkey may sue humans, corporations, and companies for damages and injunctive relief arising from claims of copyright infringement. Our court's precedent requires us to conclude that the monkey's claim has standing under Article III of the United States Constitution. Nonetheless, we conclude that this monkey—and all animals, since they are not human—lacks statutory standing under the Copyright Act. We therefore affirm the judgment of the district court.
 Naruto v. Slater, No. 16-15469, 2018 WL 1902414 (9th Cir. Apr. 23, 2018) (footnote omitted).

Friday, April 13, 2018

Better Think Twice Before You Tell Your Debtor Client to Pay You with a Credit Card

Jeffrey N. Schatzman
Schatzman & Schatzman, P.A.
Miami, Florida

If you represent individual debtors and take credit cards for payment of your fees, you might want to re-think that policy.  On March 30, 2018, the Eleventh Circuit Court of Appeals in Cadwell v. Kaufman, Englett & Lynd, PLLC, Case No. 17-10810, reinstated a suit against Kaufman, Englett & Lynd (“KEL”) for violation of 11 U.S.C. Sec. 526(a)(4).   You can find the opinion here.

Requiring Credit Cards Concerns Client

Loyd Cadwell had sought the services of KEL to file a chapter 7 bankruptcy case.  Following the initial meeting, Cadwell entered into a retainer agreement with KEL that provided for KEL to be paid a fee of $1,700.00 to represent Cadwell in the chapter 7 case.  The agreement provided for payments to be made in installments over several months.  Cadwell alleged in his complaint that he was instructed by KEL to make the installment payments by credit card. Cadwell made the initial payment and three additional installments with two different credit cards.  Thereafter, Cadwell terminated the engagement with KEL and sought the services of another firm to assist him with his bankruptcy.

Cadwell’s new attorneys noticed the credit card payments and filed suit on behalf of Cadwell for violation of 11 U.S.C. § 526(a)(4), seeking return of fees paid to KEL and punitive damages of $1 million.  The lawsuit is also proposed as a class action.   

Thursday, March 1, 2018


Hon. Judith K. Fitzgerald (Ret.)
Tucker Arensberg, P.C.
Professor in Practice, University of Pittsburgh School of Law

Once in a while, a Supreme Court opinion crosses my desk that I cannot ignore. Such was the case today. The United States Supreme Court issued its opinion in Merit Management, LP v. FTI Consulting, Inc., a unanimous opinion made more exciting by the fact that it affirmed the Seventh Circuit’s decision regarding the scope of the safe harbor provisions of 11 U.S.C. § 546(e) in a case that arose from a failed harness racing endeavor. (The opinion can be found here). Perhaps even more surprising, the Court interpreted a section of the Bankruptcy Code that led to a split in the circuits using a “plain meaning” approach.

Saturday, November 11, 2017

Secured Lenders Take Note! In re Sunnyslope is something you want to know about

Hon. Judith K. Fitzgerald (Ret.)

In re Sunnyslope Hous. Ltd. P’ship, 859 F.3d 637 (9th Cir. 2017), as amended (June 23, 2017)(“Sunnyslope”), is a noteworthy case for secured lenders.  The case involves confirmation of the cram down plan proposed by Sunnyslope Housing Limited Partnership (the “Debtor” or “Sunnyslope”) in its Chapter 11 bankruptcy case. The dispute now in the courts concerns what a debtor must pay under a plan if the debtor proposes to keep real property over the objection of a secured lender.
In Sunnyslope, the United States Court of Appeals for the Ninth Circuit, sitting en banc, created a split with the Seventh Circuit and other lower courts in finding that Associates Commercial Corp. v. Rash, 520 U.S. 953, 965, 117 S.Ct. 1879, 1886, 138 L.Ed.2d 148 (1997) (“Rash”), mandated the application of the replacement-value standard. The Supreme Court defined that standard as the amount a willing buyer would pay on the open market for like property.
Sunnyslope involved a low income housing project.   So long as the Debtor owned it, it could only be used for that purpose.  However, if the lender foreclosed, it would be free to dispose of the property as it wished.  Thus, the case posed the paradox of a property worth less as a going concern than in a liquidation.
The Sunnyslope Decision. In Sunnyslope, the secured lender, First Southern National Bank (“FSNB”), argued that the foreclosure value of the property should have been used to determine the amount of its secured claim under §506(a)(1). Before the bankruptcy was filed a state court receiver had obtained a purchase offer that was much higher than the value that the debtor attributed to the property in its plan. The key difference for valuation was that Sunnyslope proposed to continue using the property for low-income housing and valued it that way. FSNB objected, contending that the use restrictions would be divested through foreclosure, thereby enabling the property to be used for a higher and better purpose. The valuation difference was significant. Without use restrictions, the purchase offer was $7.65 million. In its bankruptcy, Sunnyslope proposed a value of $3.9 million because of the use restrictions. The bankruptcy court confirmed the debtor’s plan that proposed to pay the secured lender only $3.9 million, with interest at 4% (a lower rate than in the original loan), over 40 years, with a balloon at the end. Through this plan, the lender would recover significantly less that the $7.65 million foreclosure value.
The Split on the Correct Test for Value. Whether a bankruptcy court is required to apply only replacement value is open to debate and academics and judges strongly disagree. Some feel that Rash is limited to Chapter 13 cram down cases and/or to personal property valuation.  Rash involved a chapter 13 plan and the proposed retention of a truck, so foreclosure value was significantly lower than replacement value. But other courts have not conceded that Rash applies in Chapter 11 cases or in cases involving real property. For example, in United Air Lines, Inc. v. Reg’l Airports Imp. Corp., 564 F.3d 873 (7th Cir. 2009), in valuing airline terminal gates that the debtor had improved, the Court of Appeals for the Seventh Circuit determined that foreclosure value operates to set a floor on the secured creditor’s recovery. That court stated: “[i]f the Lender foreclosed and took over the space, it could rent the gates to United or some other airline at more than $17 a square foot- at perhaps four times that much, to go by prices at the airport’s one terminal that leases fully built-out gates.” Id. at 876-77.
The Third Circuit Court of Appeals has articulated a somewhat different standard.  In In re Heritage Highgate, Inc., 679 F.3d 132 (3d Cir. 2012), the court adopted the replacement value standard identified in Rash, and applied it in a case that involved real property. However, that court equated replacement value with the asset’s fair market value, as “most respectful of a property’s anticipated use.” Id. at 142.
The variation in approaches leads to a lack of uniformity in the bankruptcy process and calls into question what valuation standard applies to confirmation of a cram down plan.  When a debtor chooses to retain the collateral rather than to return it to the secured creditor, the Bankruptcy Code requires the plan to provide the creditor “deferred cash payments totaling at least the allowed amount of such claim, of a value, as of the effective date of the plan, of at least the value of such holder’s interest in the estate’s interest in such property.” § 1129(b)(2)(A)(i)(II). Does Rash mandate the use of replacement value even when that valuation method returns less to the secured creditor than it could obtain on its own using its state law rights? Until the Supreme Court decides the issue, debtors and secured creditors are in limbo.
Supreme Court Review. In an effort to have uniformity added to asset valuation in cram downs, as an amicus party, I initiated a brief that has been filed  with the United States Supreme Court, asking that Court to accept a writ of certiorari to the Ninth Circuit and decide the question.  I have been joined by several academics who specialize in bankruptcy law and other retired bankruptcy judges.  The amici take no position on the merits of this question but join together in an effort to have the Supreme Court clarify whether Rash applies to Chapter 11 cases where real property is retained by the debtor.
A copy of our brief can be accessed here Amicus Brief
The amici are represented by Beverly Weiss Manne, Richard Tucker III, and Matthew Burne of Tucker Arensberg, P.C. with offices in Pittsburgh, Harrisburg and Manhattan.