Another Court holds that Absolute Priority Rule Does Not Apply to Individual Chapter 11 Debtors Post-BAPCPA

I previously reviewed the case of In re Tegeder, ___ B.R. ___, 2007 WL 1549067 (Bkrtcy.D.Neb) which held that per BAPCPA’s amendments, the absolute priority rule no longer applies to the retention of property by individual chapter 11 debtors. The court in the recent case of In re Roedemeier, ___ B.R. ___, 2007 WL 2350184 (Bkrtcy.D.Kan.)(Somers,J.) reached the same conclusion.

In this case, the Chapter 11 Debtor, who was a dentist, proposed a Chapter 11 plan that would, inter alia, allow him to retain ownership of his interest in his LLC which operated his dental practice and proposed to pay $30,000 on general unsecured claims totaling about $875,000. The court noted that prior to the enactment of BAPCPA in 2005, the absolute priority rule applied to all Chapter 11 debtors, but that BAPCPA added the “except” clause to section 1129(b)(2)(B)(ii) with the addition of the phrase “except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115…” The court stated that the “except” clause created an exception for individual Chapter 11 debtors to the absolute priority rule. The court construed this exception and section 1115 broadly to allow a debtor to exempt both pre- and postpetition property under a plan even though a class of unsecured creditors are not paid in full.

The court stated that a various changes were made to Chapter 11, including the exception to the absolute priority rule, so that it could function for individual Chapter 11 debtors much like Chapter 13. These include section 1115 which bring postpetition property into the estate, section 1123(a)(8) which calls for the debtor’s plan to provide for payment to creditors from the debtor’s postpetition earning from services or other future income, section 1129(b)(2)(B)(ii)’s allowance to the debtor to keep property included in the estate under section 1115 without paying in full a class of rejecting unsecured creditors, section 1129(a)(15) which authorizes the debtor to overcome an objection by an unsecured creditor by meeting the projected income test, section 1141(d)(5) which generally delays entry of the discharge until completion of all payments under the plan, and section 1127(e) which permits post-confirmation plan modification.

The court also made some other interesting conclusions in the case. The court found that section 1129(a)(15), which was added by BAPCPA, only applies if a holder of an allowed unsecured claim objects to confirmation. As the involved creditor did not so object, the Debtor was not required to meet the requirements of section 1129(a)(15)(A) or (B). Section 1129(a)(15)(A) would have required the claim to have been paid in full and section 1129(a)(15)(B) would have imposed a disposable income test. But the court found that the requirements of the section 1129(a)(15)(B) disposable income test were met in any event. The court concluded that the disposable income test should be performed with the expenses side judicially determined for this above-median income debtor (as per Form 22B) and not by the use of the I.R.S. standards as per section 707(b)(2).

In approving the debtor’s disclosure statement, the court concluded that disclosure statements for smaller businesses are not required to be as extensive as those of a medium to large reorganization which often involve the issuance of securities. The court referred to the list for smaller businesses in 7 Collier on Bankruptcy, para. 1125.02[2] at pp. 1125-12 to 1125-13 (citing In re Malek, 35 B.R. 443 (Bankr.E.D.Mich.1983)). The court stated that the minimum information should include a description of the business, its history, financial information, description of the plan, facts respecting its execution, a liquidation analysis, identification of management and its compensation, transaction with insiders, and tax consequences of the plan.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

No Constitutional Right to Counsel for Chapter 7 Debtor

In the case of In re Eagle, ___ F.3d ___, 2007 WL 2278902 (C.A.8(Ark.)), the court held that under the circumstances the Chapter 7 Debtor did not have a constitutional right to counsel. The Debtor had filed a pro se Chapter 7 case. As the Debtor failed to file the necessary schedules and statements, the court dismissed his case. The court granted the Debtor’s motion to reinstate his case and advised the Debtor to obtain counsel. In subsequent proceedings, the court sustained a Creditor’s exemption objection. The Debtor appealed the order sustaining the exemption objection.

The Court of Appeals held that the Debtor did not have a right to counsel as his physical liberty was not at issue in the bankruptcy case. Lassiter v. Dep’t of Soc. Servs. of Furham County, 452 U.S. 18 (1981). The court further noted that although it had no duty to do so, the court had advised the Debtor to obtain counsel.

The issue to use bankrutpcy estate funds to employ criminal counsel in a bankruptcy case was previously addressed in the Miami, Florida bankruptcy case of In re Duque, 48 B.R. 965 (DC Fla. 1984)(Hastings, J.). In this case involving an individual chapter 11 debtor, the District Court held that the Debtor did not under the circumstances have the right to use bankruptcy estate money to pay for his criminal counsel. The court set forth three underlying principles in its determination. First, the employment of special criminal counsel must be in the best interest of the estate. That is, there must be an actual need for the services based upon a actual not hypothetical or speculative threat to the estate or its property. Second, special criminal counsel must not be for the personal benefit of the debtor, but must be for the benefit of protecting the assets of the estate or furthering its interests. Third, potential violations of the debtor’s constituational rights posed by criminal investigations or prosecutions occurring after the filing are of concern to the criminal forum and not the bankruptcy court.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

In re Tegeder: Per BAPCPA Absolute Priority Rule No Longer Applicable to the Rentention of Property by Individual Chapter 11 Debtor

As previously mentioned, one Bankruptcy Judge in the Southern District of Florida held in the Gosman decision (pre-BAPCPA) that the retention of exempt property by an individual debtor in a chapter 11 plan violates the absolute priority rule unless unsecured creditors are paid in full. In re Gosman, 282 B.R. 45 (Bankr. S.D. Fla. 2002)(Hyman, J.). Also as previously noted, some courts disagree with the Gosman decision and hold that a chapter 11 debtor’s retention of his exempt property is not subject to the absolute priority rule. See e.g. In re Bullard, 358 B.R. 541 (Bankr. D.Conn. 2007)(the retention of exempt property is not on account of the debtor’s junior interest in property).

Since the passage of BAPCPA and its amendments to 11 USC 1129(b)(2)(B)(ii), there has been some commentary (Hon. Norton, Hon. Drake, etc.) that the absolute priority rule is no longer applicable to an individual chapter 11 debtor’s retention of property. Judge Saladino’s decision in In re Tegeder, ___ B.R. ____, 2007 WL 1549067 (Bkrtcy.D.Neb.) is apparently the first decision to end this speculation – at least in his courtroom.

The court in Tegeder held that the new amendments to 1129(b)(2)(B)(ii) provide an exception to the absolute priority rule for the retention of property by individual chapter 11 debtors and that the “absolute priority requirements imposed by Code 1129(b)(2)(B)(ii) were waived by permitting a debtor to retain property included in the estate under 1115″. BAPCPA added the following to 1129(b)(2)(B)(ii) “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”. New section 1115 defines property of the estate to include property specified in section 541 as well as property acquired post-petition and earnings from services performed post-petition.

The court states that interpreting new 1129(b)(2)(B)(ii) any narrower would cause the amendment to have little effect.

It should be noted the Tegeder decision is broader than the Bullard decision as it holds that the absolute priority rule is inapplicable to the rentention of all types of property by the chapter 11 debtor. The Bullard case was limited to the retention of exempt property by the chapter 11 debtor.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983

Federal Taxation of Individual Chapter 11 Debtor

The IRS released Internal Revenue Bulletin 2006-40, Notice 2006-83 on October 2, 2006 to provide guidance to individuals filing bankruptcy under Chapter 11 on or after October 17, 2005. It further provides guidance for the employers of these individuals, persons filing Forms W-2, 1099 or other information returns that report payment to these individuals, and Chapter 11 trustees in cases filed by an individual.

The bankruptcy estate of an individual who files under Chapter 11 is a separate taxable entity under section 1398 of the Internal Revenue Code. In general, the estate, rather than the individual, must include in its gross income all of the debtor’s income to which the estate is entitled under the Bankruptcy Code. As a result of the enactment of section 1115 of the Bankruptcy Code by BAPCPA, the bankruptcy estate rather than the individual must include in its gross income both 1. the debtor’s gross earnings from post-petition services and 2. the gross income from post-petition acquired property. IRC Section 1398(e)(1).

Because the bankruptcy estate is a separate taxable entity, the trustee or debtor in possession must obtain an employer identification number for the estate and use it on any tax returns filed for the estate.

The individual must continue to file his own individual tax returns during the bankruptcy proceedings. IRC Section 6012(a)(1). The trustee or debtor in possession must prepare and file the income tax returns of the bankruptcy estate if required under IRC Section 6012(a)(9).

Although post-petition wages earned by a debtor are generally treated for income tax purposes as gross income of the estate rather than the individual, the reporting and withholding obligations of a debtor’s employer however have not changed as a result of the enactment of section 1115 of the Bankruptcy Code. Section 1115 has no effect on the determination of wages under FICA, FUTA, or for income tax withholding purposes. See IRC Section 3306(b) and 3401(a). An employer should continue to reflect such wages and accompanying tax withholding on a Form W-2 issued to the debtor under the debtor’s name and social security number.

Jordan E. Bublick, Attorney at Law, Practice Limited to Bankruptcy Law, Board Certified Specialist in Consumer Bankruptcy Law (American Board of Certification), Member of the Florida Bar since 1983