Individual Chapter 11 Cases in the Post-BAPCPA Era

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1 Individual Chapter 11 Cases in the Post-BAPCPA Era Russell M. Blain 1 Daniel R. Fogarty 2 STICHTER, RIEDEL, BLAIN & PROSSER, P.A. Tampa, Florida INTRODUCTION Individuals, whether or not engaged in business, are and have been eligible for relief under chapter 11 3 of the Bankruptcy Code. 4 The only requirement under the Code is that a person eligible for relief under chapter 11 also be eligible under chapter 7. The legislative history is instructive: 5 [Chapter 11 cases were] primarily designed for businesses, although individuals are eligible for relief under the chapter. The procedures for chapter 11, however, are sufficiently complex that they will be used only in a business case and not in the consumer context. Between 1978 and 2005, many of the reported individual chapter 11 cases involved professionals. 6 Some had been filed as appendages to companion corporate chapter 11 cases, the debts of which had been guaranteed by the individuals, and joint plans were needed to restructure the debt. It has been estimated that from 10% to as high as 36% of all chapter 11 cases were filed by individuals in the early 2000s. 7 These percentages, as well as the overall number of individual chapter 11 filings, are likely to increase with the continuing economic malaise and the passage in 2005 of 1 rblain@srbp.com. 2 dfogarty@srbp.com. 3 Toibb v. Radloff, 501 U.S. 157 (1991) (stating that an unemployed former consultant and lawyer is eligible to file); In re Moog, 774 F.2d 1073 (11th Cir. 1985) (finding a housewife with only mortgage debt to restructure eligible to file). In Toibb, the Supreme Court overruled cases such as Wamsganz v. Boatmen s Bank of De Sota, 804 F.2d 503 (8th Cir. 1986). 4 Unless otherwise specified, all section references are to Title 11 of the United States Code, 11 U.S.C. 101, et seq. (the Bankruptcy Code or the Code ). 5 S. Rep. No , at 3 (1978), reprinted in 1978 U.S.C.C.A.N Many of the early reported individual chapter 11 cases have involved debtors with substantial assets or earnings that justified the costs associated with what are considered to be the complex procedures of chapter See Markell, Symposium: Consumer Bankruptcy and Credit in the Wake of the 2005 Act, The Sub Rosa Subchapter: Individual Chapter 11 After BAPCPA, 2007 U. ILL. L. REV. 67.

2 the Bankruptcy Abuse Prevention and Consumer Protection Act ( BAPCPA ). 8 Individuals whose debts are primarily consumer debts and whose income ratio exceeds the threshold under the means test of 707(b) may need to file a case under either chapter 13 or chapter 11 of the Bankruptcy Code if they intend to seek bankruptcy relief. Personal guaranties of business debt, coupled with mounting credit card debts, medical expenses, and escalating mortgage debt, will likely make a successful chapter 13 filing unattainable for more and more individuals who owe amounts in excess of the debt limits imposed by 109(e) or who do not have regular income. 9 Although clearly intended to steer individuals with earning potential toward chapter 13 rather than chapter 7, 10 BAPCPA in some instances has forced them into chapter 11 with its more complex and expensive requirements. 11 In addition, the economic downturn and significant drop in real estate values have contributed to a recent increase in individual chapter 11 filings. Now more than ever, when an individual with high earnings or high debt levels files for bankruptcy protection, that individual may still have significant exempt and nonexempt assets especially real estate. There is a growing risk, as the new statutes are interpreted and cases begin to reach the higher appellate levels, that some individual debtors may be left without a home under any chapter of the Bankruptcy Code, ineligible to file chapter 7 or chapter 13 and unable to confirm a nonconsensual plan in a chapter 11 case. The BAPCPA amendments have impacted every phase of an individual chapter 11 case, from prefiling considerations 8 See Bufford & Chemerinsky, Constitutional Problems in the 2005 Bankruptcy Amendments, 82 AM. BANKR. L.J. 1, 32, 33 (2008) ( The means test increases the number of consumer chapter 11 cases that we can expect to be filed. ). 9 Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $360,475 and noncontingent, liquidated, secured debts of less than $1,081,400 is eligible to be a debtor under chapter 13. A bankruptcy court may consider the unsecured portion of a secured claim when determining the eligibility requirements for chapter 13. In re Weiser, 391 B.R. 902, 908 (Bankr. S.D. Fla. 2008),citing In re Scovis, 249 F.3d 975, 983 (9th Cir. 2001); In re Balbus, 933 F.2d 246, (4th Cir. 1991);In re Buis, 337 B.R. 243, 248 (Bankr. N.D. Fla. 2006). 10 [C]hapter 7 proceedings should be dismissed or converted into chapter 13 whenever the filers earn more than the state median income. 151 CONG. REC (daily ed. Mar. 1, 2005) (statement of Sen. Charles Grassley (R-Iowa)). 11 The likelihood that more individuals would be forced by the means test into chapter 11 may account for the amendments to chapter 11. As will be discussed later in this paper in connection with the continued vitality of the absolute priority rule, courts are divided as to the congressional intention behind some of the new chapter 11 provisions. 2

3 and preconfirmation use of estate or none state property to proposal and confirmation of a plan and postconfirmation and discharge provisions. I. CASE COMMENCEMENT An individual in a chapter 11 case is a debtor in possession with the functions and responsibilities of a trustee, overseeing his own case but with significantly expanded duties as specified in subparagraphs (2),(5),(7),(8),(9), (10), (11), and (12) of 704(a), as well as those enumerated in Failure of the debtor in possession to properly perform his fiduciary duties to the estate may result in the appointment of a trustee pursuant to In making a decision to take the extraordinary step of ordering the appointment of a chapter 11 trustee, the court is faced to weigh the benefit to be derived by the estate from the appointment of a trustee against the costs of such appointment. 12 Although 1102(a)(1) provides for the appointment of a creditors committee, in the typical individual chapter 11 case no committee is formed. If a committee is formed and appointed, subject to court approval, the committee may employ professionals, giving rise to an additional administrative expense that would need to be paid in full on the effective date of the plan. II. POSTPETITION PROPERTY A. Prior Law Prior to BAPCPA, there was significant litigation over the question of what constituted property of the estate in an individual chapter 11 case. Those cases looked at 541(a), which creates a bankruptcy estate comprising property of the debtor as of the commencement of the case 13 and certain property or rights the debtor acquires after commencement. 14 Earnings performed by an individual debtor after the commencement of the case, however, are not property of the estate under 541(a)(6). 15 Litigation has 12 In re Taub, 427 B.R. 208 (Bankr. E.D.N.Y. 2010) (appointing trustee 21 months following the petition date where the debtor had not filed a plan, had not made meaningful progress toward reorganization, and was on her sixth lawyer, and where considerable animosity with creditors existed). 13 Sections 541(a)(1) and 541(a)(2). 14 Sections 541(a)(3) through (a)(7). 15 The personal earnings exception was curiously placed after the inclusive phrase proceeds, product, offspring, rents, and or profits of or from property of the estate. Virtually every pre-bapcpa case held that earnings of debtors from postpetition services rendered to third parties were not property of the estate. See, Roland v. Unum Life Ins. Co. of Am., 223 B.R. 499, 502 (E.D. Va. 1998), and cases cited in 3

4 ensued regarding many issues, including whether the revenues of an individual debtor s professional association are earnings of the individual debtor or earnings of the entire professional enterprise. In a physician s case, the enterprise would comprise of nurses and other doctors and charges for equipment-related services; in a lawyer s case, paralegals, other lawyers, and assistants; and in a dentist s case, hygienists, other dentists and dental equipment. If earnings are not derived from personal services, they have been included in the chapter 11 estate. Typical of these cases is the Ninth Circuit s decision in FitzSimmons v. Walsh (In re FitzSimmons), 725 F.2d 1208(9th Cir. 1984), in which the court made the following holding: We hold that the earnings exception applies only to services performed personally by an individual debtor.... FitzSimmons is thus entitled to monies generated by his law practice only to the extent that they are attributable only to personal services that he himself performs. To the extent that the law practice s earnings are attributable not to FitzSimmons personal services but to the business invested capital, accounts receivable, good will, employment contracts with the firm s staff, client relationships, fee agreements, or the like, the earnings of the law practice accrue to the estate. 725 F. 2d at This approach requires a fact-intensive inquiry, which other courts have rejected as unduly burdensome, at the same time finding themselves unable to escape some fairly extensive factual analysis. 16 The chapter 11 debtor, however, could use income that was not property of the estate for a variety of purposes including living expenses. 17 B. The 2005 Amendments BAPCPA significantly changed the rules related to property of the estate in individual chapter 11 cases. Some of these changes are concepts taken from chapter 13. Most significant is the new 1115, which, virtually identical to 1306, provides as follows: Property of the estate n.5. In Toibb v. Radloff, 501 U.S. 157, 166 (1991), the Supreme Court stated that there is no... provision in Chapter 11 requiring a debtor to pay future wages to a creditor. 16 In re Cooley, 87 B.R. 432, (Bankr. S.D. Tex. 1988). 17 In re Goldstein, 383 B.R. 496, 498 (Bankr. C.D. Cal. 2007). 4

5 (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. (b)except as provided in section 1104 or a confirmed plan or order confirming a plan, the debtor shall remain in possession of all property of the estate. 11 U.S.C In individual chapter 11 cases, property of the estate includes both prepetition property as set forth in 541 and postpetition personal service income and other property acquired during the case up to closing, dismissal, or conversion to chapter 7, 12, or This statutory addition mirrors the 1306(a)definition of property of the estate. It may make sense to pause to consider 522(b)(1), which permits an individual debtor, notwithstanding the broad scope of 541, to exempt from property of the estate assets treated as exempt under state law, tenancy by the entireties property, and certain assets treated as exempt under federal law. Subject to narrow exceptions, exempt property is not liable during or after a case for unsecured claims pursuant to 522(c). Some states, like Florida, have unlimited exemptions for the wages of the head of a household. 19 Under 522(c) of the Bankruptcy Code, exempt assets are not available to pay creditors claims, suggesting that, in states like Florida, a debtor may use exempt wages without restriction, much as pre-bapcpa debtors could use their wages without court supervision Consider the effect of 1141(b), pursuant to which confirmation of a plan vests all property of the estate in the debtor unless otherwise provided in the plan or the confirmation order. 19 FLA. STAT (2)(b)(2012) (disposable earnings of a head of a family greater than $750 a week may not be attached or garnished unless such person has agreed otherwise in writing). A number of states have similar laws, and several use the 75%-25% formula of the federal garnishment restriction laws. 15 U.S.C In Roland, the court stated that there was no jurisdiction for the bankruptcy court to deny use of post-petition income to retain criminal defense counsel, stating [C]ongress created a distinction between 5

6 If all prepetition and postpetition earnings are property of the estate, what rules apply to the debtor s use of this property? What are the standards and procedures for authorizing or prohibiting post filing, preconfirmation use of estate property? 21 Section 363(c)(1) allows a trustee, without notice and a hearing, to enter into transactions and [to] use property of the estate in the ordinary course of business. Section 1115(b) permits the debtor to remain in possession of all property of the estate. The court in In re Goldstein, 383 B.R. 496 (Bankr. C.D. Cal. 2007), determined that 1115(a), when read in conjunction with 363(c), permits an individual debtor to pay ordinary-course living expenses but deprives him of the ability to use postpetition property and income to pay for nonordinary transactions. The court took note that an individual chapter 11 debtor may buy bread and probably purchase a ticket to travel to a court hearing but not hire divorce counsel without court approval. 22 In chapter 11 cases, the guidelines of the United States Trustee require the filing of monthly operating reports, which enable creditors and parties in interest to monitor the debtor s expenditures. Furthermore, the prescribed schedules require an itemization of monthly expenditures. Given the general authorization allowing a debtor to use money in the ordinary course, perhaps cases such as Goldstein should be limited to their facts something like hiring counsel, which customarily requires court approval in any event. Does it make any difference whether an individual chapter 11 debtor is using prepetition nonexempt assets to live, as opposed to using only postpetition earnings? In the former case, the debtor may be harming creditors by depleting assets that would have been available for distribution to them in a chapter 7 case. In the latter case, the debtor is maintaining the status quo as long as there is no asset value loss, such as would be the estate property, which must be used for the protection of creditors, and non estate funds, which may be disposed of as the debtor sees fit, without having to further account to the bankruptcy estate, his creditors, or any subsequently appointed trustee... [and can be used] to buy food, shelter, clothing, or, if he chose, to unwisely invest in penny stocks in gold mine ventures. Roland at , quoting In re Reed, 184 B.R. 733, 740 (Bankr. W.D. Tex. 1995). 21 Official Form 22B is required of a chapter 11 individual debtor to calculate the debtor s Current Monthly Income. Only Schedule J, however, includes information on an individual chapter 11 debtor s expenses B.R. at 499 (Bankr. C.D. Cal. 2007). The Goldstein court nonetheless approved retention of counsel as being in the best interest of the estate. See In re Bradley, 185 B.R. 7, 8 (Bankr. W.D.N.Y. 1995) ( When a chapter 11 debtor-in-possession is a natural person, his personal expenses and his obligations for incidents of his personal life are every bit as much a part of the ordinary course of his business and financial affairs as are expenses incident to the operation of [his businesses]. ). 6

7 case if the debtor s expenses exceed her income. 23 Does it make sense to monitor the use of postpetition earnings of a hard-working and productive debtor who confers at least some benefit on the estate, like the California debtor who worked 12 hours a day, six days a week, to make his sole proprietorship successful? 24 Should there be a different test if the debtor intends to spend money that is newly created from postpetition earnings rather than existing funds that would have gone to a chapter 7 trustee had a liquidating case been filed? Is another way of analyzing this issue to view the debtor and debtor in possession as separate entities, as the Internal Revenue Code does, 25 treating the debtor as an employee of the debtor-in-possession with respect to postpetition wages? 26 The legislative history of 541(a)(6)states as follows: Postpetition payments to an individual debtor for services rendered to the estate are administrative expenses, and are not property of the estate when received by the debtor. This situation would most likely arise when the individual was a sole proprietor and was employed by the estate to run the business after the commencement of the case. An individual debtor-in-possession would be so employed, for example. See Local Loan Co. v. Hunt, 292 U.S. 234, 243 (1934). 27 In Local Loan, the Supreme Court refused to recognize an assignment of a debtor s future wages in payment of a discharged debt, as follows: When a person assigns future wages, he, in effect, pledges his future earning power. The power of the individual to earn a living for himself and those dependent upon him is in the nature of a personal liberty quite as much if not more than it is a property right. To preserve its free exercise is of the utmost importance, not only because it is a fundamental private necessity, but because it is a matter of great public concern. From the 23 Even if there is a cash-flow loss after the payment of the debtor s expenses, some of those expenses may benefit the estate by insuring and maintaining physical assets that are property of the estate or by paying principal on secured debt. 24 In re Angobaldo, 160 B.R. 140 (Bankr. N.D. Cal. 1993). 25 The Internal Revenue Code, in 26 U.S.C 1398, contains special tax provisions for an individual filing chapter 11, creating two distinct taxpayers postpetition: the trustee or debtor-in-possession files a return (Form 1041) for all income which belongs to the estate, and the individual debtor files a return (Form 1040) for all income of the debtor which is not part of the estate U.S.C Section 503(b)(1)(A)(i) permits the payment of actual, necessary costs and expenses of preserving the estate. See In re Herberman, 122 B.R. 273 (Bankr. W.D. Tex. 1990) (finding that all income of sole proprietorship was property of the estate and then determining the fair wage to be paid to the debtor and excluded from the estate). 27 REPORT OF THE COMM. ON THE JUDICIARY, HOUSE OF REPRESENTATIVES, TO ACCOMPANY H.R. 8200, H.R. REP. NO , 95th Cong., 1 st Sess. (1978). 7

8 viewpoint of the wage-earner, there is little difference between not earning at all and earning wholly for a creditor. 28 Under this analysis, a bankruptcy court would have no say as to the use of money once paid to the debtor, since these funds would no longer be property of the estate. The court still could look at the total payout of funds to determine whether the estate was benefitting from the debtor s services. The questions, however, would become, what are the debtor s services worth to the estate, and what benefit is the debtor conferring upon the estate not whether the debtor is also getting a good deal by being able to drive a nice car or send her children to private schools. Finally, in In re Powell, 187 B.R. 642 (Bankr. D. Minn. 1995), the court noted as follows: Nowhere is the threat of impinging upon the protection afforded by the Thirteenth Amendment to the United States Constitution more real than in the case such as this where a creditor is attempting to harness the postpetition wages of individual debtors in a Chapter 11 proceeding [case]. 187 B.R. at 646. The constitutional issues that arise in the case of a creditor-proposed plan that proposes to harness the debtor s postpetition wages might equally apply during the case when a creditor objects to the expenditure of wages. 29 There is little recent case law dealing with the preconfirmation use of funds for living expenses. 30 One recent case involving a proposed loan, as opposed to earnings, addressed without resolving the lifestyle issues. In re Villalobos, 2011 WL (9th Cir. BAP 2011).Villalobos involved a high net-worth, high-end lifestyle debtor, who 28 Local Loan Co. v. Hunt, 292 U.S. 234, 245 (1934). 29 For an extensive discussion of the constitutional issues, see Keach, Dead Man Filing Redux: Is the New Individual Chapter Eleven Constitutional?, 13 AM. BANKR. INST. L.R. 483 (2005). 30 Most of the case law dealing with the so-called lifestyle issues in chapter 11 has arisen at the time of plan confirmation. Section 1115(a) incorporates 1325(b)(2) for the definition of projected disposable income, which means current monthly income received by the debtor less amounts reasonably expended (A)(i) for the maintenance or support of the debtor or a dependent of the debtor. But there is no provision in chapter 11 analogous to 1325(b)(3), which requires that amounts expended under 1325(b)(2) are determined in accordance with subparagraphs (A) and (B) of 707(b)(2). Postconfirmation, 1129(a)(15) allows a judicial determination of the expenses that are reasonably necessary for the support of the debtor and the debtor s dependents. In re Roedemeier, 374 B.R. 264 (Bankr. D. Kan. 2007). See also In re Gray, 2009 WL (Bankr. N.D. W.Va. 2009) (stating that the lifestyle issue is left entirely to the court s discretion ). In Gray, the debtor, a physician with gross monthly income of approximately $19,000 and take-home pay of $10,000, proposed to make monthly payments under the plan of $4,500. The court cut $750 from the debtor s monthly budget for her care of 15 dogs and another $300 for items like Direct TV service and monthly cellular phone service. 8

9 listed assets valued in excess of $62 million. Several months into the case, the debtor sought to incur debt from an affiliated company, along with a monthly budget and a nunc pro tunc motion seeking payment of ordinary course expenses dating back to the petition date. The Internal Revenue Service filed an objection to these motions, maintaining that the payment of personal expenses was not necessary to preserve the estate and noting that the debtor had failed timely to file monthly operating reports, thereby precluding creditors from having the information with which to evaluate and object to ongoing expenses. The IRS also argued that the debtor was violating his fiduciary duties by improperly attempting to pay personal expenses ahead of priority creditors. In response, the debtor asserted that the vast majority of the budgeted expenses involved costs of preserving and administering the debtor s estate and, to the extent the expenses included personal living expenses (among them was college tuition for the debtor s grandchildren), the debtor could not survive without them. The bankruptcy court granted both of the debtor s motions, and the IRS appealed. On appeal, the Ninth Circuit BAP addressed the lifestyle expenditures as follows: There is scant authority regarding how individual chapter 11 debtors may pay expenses post-bapcpa. Prior to BAPCPA, individual chapter 11 debtors were generally permitted to pay expenses from their postpetition income, which was not property of the estate. See, e.g., In re Goldstein, 383 B.R. 496, 498 (Bankr. C.D. Cal. 2007); Cusano v. Klein, 264 F.3d 936, 945 (9th Cir. 2001). However, with BAPCPA s addition of 1115, individual chapter 11 debtors no longer have the option to pay expenses with postpetition income because virtually all property, including postpetition income from personal services, is property of the estate. Instead, individual chapter 11 debtors must now seek payment of personal expenses from estate property, which may create problems considering the resulting diminution in estate assets and the fact that personal expenses do not always neatly fall within the scope of actual, necessary expenses under 503(b)(1) or ordinary course of business expenses under WL The BAP described several possible tests for determining whether a debtor may use postpetition income to pay personal expenses. First, a court could use the disposable income test of 1129(a)(15) as the proper test for approving a preconfirmation budget and personal expenses. Alternatively, a court could authorize expenditures if the debtor can articulate a business justification for using property outside the ordinary course of business. The Villabolos BAP did not reach the merits and remanded the case to 9

10 the bankruptcy court to make findings of fact and conclusions of law in support of the underlying order. The BAP did state that the debtor s historical payment of tuition was insufficient, without more, to support an appellate review regarding whether the bankruptcy court abused its discretion in approving that item. The BAP again noted the uncertainty in this area of law. A related issue in this context is the use of property of the estate to employ counsel. The individual debtor under chapter 11, as a debtor in possession, is authorized to employ professionals in the case. 31 One commentator has suggested that ethical issues may arise when representing an individual in a chapter 11, commenting that [r]epresenting a debtor s bankruptcy estate in an individual chapter 11 is almost an out-of-body experience....it stretches the bounds of legal fiction to comprehend the difference between the bankruptcy estate of an individual (your client) and the individual himself (not your client). 32 Courts have noted that an individual chapter 11 case creates an odd legal entity because the debtor acts for both herself as an individual and the creditors and other parties in interest. 33 This fiction may be most apparent in situations in which there is significant litigation over exemption issues and the debtor takes property from the estate administered by the debtor in possession For chapter 13 debtors, the Bankruptcy Code specifically provides for reasonable compensation to the debtor s attorney for representing the interests of the debtor in connection with the bankruptcy case (a)(4)(B). It does not, however, make the same allowance for attorneys in an individual chapter 11 case, and BAPCPA did not include any amendment to 330(a)(4)(B) to account for the inclusion of post-petition earnings of an individual chapter 11 debtor in property of the estate. Courts have rejected attempts to use 105 to fashion a payment mechanism to address this problem. In re Miell, 2009 WL (N.D. Iowa Aug. 19, 2009). Are attorney s fees for individual chapter 11 debtors governed by the U.S. Supreme Court ruling in Lamie v. U.S. Trustee, 540 U.S. 526 (2004) (holding that in chapter 7 cases deletion of reference to debtor s attorney from 330(a) eliminated ability of counsel to be paid from estate assets)? 32 Bowles, Ghosts of Individual Chapter 11 Debtors: Ethical Issues in Representing Debtors in Individual Chapter 11s Under BAPCPA: Part I, AM. BANKR. INST. J., Dec Jan (quoting In re McClelland, 418 B.R. 61, 67 (Bankr. S.D.N.Y. 2009)). Related issues include the control of attorney client privilege with respect to communications prior to or during the chapter 11 filing. In re Bame, 251 B.R. 367, 372 (Bankr. D. Minn. 2000) (applying balancing test to determine privilege of preconversion communications where attorney representing interests of debtor, and holding the chapter 7 trustee controlled privilege where representing interests of debtor in possession). 33 In re Harp, 166 B.R. 740, (Bankr. N.D. Ala. 1993). 34 In addition to the ethical issues is the question of payment, including whether the services of counsel for the debtor in possession in litigating exemption and dischargeability issues can qualify under either 503 or 330(a)(3)(C), for example, in resolving issues necessary to confirmation of a plan. 10

11 III. PLAN AND CONFIRMATION In chapter 11, 1121(b) gives the individual chapter 11 debtor the exclusive right to file a plan for the first 120 days, subject to being extended for up to 18 months. 35 Upon the expiration of exclusivity, any party in interest, including a creditor or a creditors committee, may file a plan. Section 1125(b) requires the plan proponent to submit to the court with the plan a disclosure statement that provides adequate information of a kind and in sufficient detail about the nature and history of the debtor, the condition of the debtor, and potential federal tax consequences of the plan that would enable a party to make an informed decision regarding the plan. IV. DESIGNING AND FUNDING PLAN PAYMENTS Individual chapter 11 debtors must comply with the same set of rules and may avail themselves of the same arsenal of enabling provisions that apply to corporate or partnership debtors. 36 In addition to the mandatory provisions applicable to all chapter 11 debtors found in 1123(a), however, BAPCPA added subsection 1123(a)(8), which provides as follows: In a case in which the debtor is an individual, [a plan shall] provide for the payment to creditors under the plan of all or such portion of earnings from personal services performed by the debtor after the commencement of the case or other future income of the debtor as is necessary for the execution of the plan. 11 U.S.C. 1123(a)(8). To be confirmed, the individual debtor s plan must, in addition to satisfying all of the other mandatory conditions of 1129(a), meet additional tests, the most important of which is found in 1129(a)(15): 35 Individual debtors may also be small business debtors, in which instance different rules apply. For example, exclusivity cannot be extended beyond 180 days. 11 U.S.C. 1121(e). 36 Although the anti-modification provision in 1123(b)(5) prohibits modification of a claim secured only by a security interest in real property that is the debtor s principal residence, a wholly unsecured junior mortgage on a debtor s principal residence may be stripped off under 1123(b)(5), just as they are in chapter 13 cases. See In re Tanner,217 F.3d 1357 (11th Cir. 2000). 11

12 In a case in which the debtor is an individual and in which the holder of an allowed unsecured claim objects to the confirmation of the plan (A) the value, as of the effective date of the plan, of the property to be distributed under the plan on account of such claim is not less than the amount of such claim; or (B) the value of the property to be distributed under the plan is not less than the projected disposable income of the debtor (as defined in section 1325(b)(2)) to be received during the 5-year period beginning on the date that the first payment is due under the plan, or during the period for which the plan provides payments, whichever is longer. 11 U.S.C. 1129(a)(15). Under 1325(b)(3), applicable to above-median debtors, projected disposable income is defined by incorporating the means test, determined in accordance with subparagraphs (A) and (B) of 707(b)(2). Section 1325(b)(2), incorporated into 1129(a)(15), is the test applicable to chapter 13 debtors whose income is below the median income level for their household sizes in their state. Under 1325(b)(2), disposable income means current monthly income received by the debtor less amounts reasonably expended for the maintenance or support of the debtor or a dependent of the debtor. The term current monthly income is defined with reference to the debtor s income during the six-month period preceding the bankruptcy filing. 37 A split in the caselaw has developed as to whether a court, in determining projected disposable income, can take into account reductions in a debtor s income level between the six-month period and the time of confirmation. One test, utilizing a forward-looking approach, holds that courts have discretion in exceptional cases where changes in circumstances are present. The mechanical test, on the other hand, holds that the definition of current monthly income is a static value determined with reference to past events and is not subject to discretionary alterations. In Hamilton v. Lanning, 130 S.Ct (2010), the Supreme Court adopted the forward-looking rather than the mechanical test with respect to the calculation of projected disposable income. Although the issue in Lanning involved alterations to current monthly income, the Court stated that as follows: [A]court taking the forward-looking approach should begin by calculating disposable income, and in most cases, nothing more is required. It is only 37 See 11 U.S.C. 101(10A)(A)(i). 12

13 in unusual cases that a court may go further and take into account other known or virtually certain information about the debtor s future income or expenses. 130 S.Ct. at The forward-looking approach does not shackle either the debtor or her creditors to the debtor s actual earnings and expenditures during the six-month period prior to the petition date but instead allows the court to look at the debtor s current prospects and expenses as of the confirmation date. Prior to the Lanning decision, several courts had interpreted 1129(a)(15) as allowing a judicial determination of the actual expenses that are reasonably necessary for the support of a debtor and a debtor s dependents 38 rather than mandating a formulaic approach for those expenses, creating additional flexibility for individual chapter 11 debtors. Two additional confirmation requirements for individuals were added by BAPCPA. First, the amendments elevated the priority status of domestic support obligations ( DSO ), defined generally to include alimony, maintenance, or support of a former spouse or child of the debtor, to first priority from seventh priority. 39 A plan may not be confirmed until all postpetition DSO payments are brought current. 40 This is consistent with the preferred treatment given to DSO claims under 1106(c) and 507(a)(1).In addition, pursuant to 1129(a)(9)(C), priority tax claims must be paid in full but may be paid in installments with interest over a period of up to five years following entry of the order for relief. Priority tax claims now include ad valorem property taxes last payable without penalty within the last year, under 507(a)(8)(B), and are payable at rates determined according to applicable nonbankruptcy law under 511 of the Code. To meet the requirements of 1129(a)(15) and 1123(a)(8), a debtor does not necessarily have to contribute all of her projected disposable income. Section 1129(a)(15) requires the contribution of only property equal in value to the amount of the projected disposable income. This distinction will also be impacted by the best interest of creditors test of 1129(a)(7), to the extent that property is being contributed in lieu of 38 In re Roedemeier, 374 B.R 264 (Bankr.D. Kan. 2007); In re Gray, 2009 WL (Bankr. N.D. W. Va. 2009). 39 Section 507(a)(1). 40 Section 1129(a)(14).Prepetition arrearages may be paid over the term of the plan in accordance with 1129(a)(9)(B).See also In re Sanders, 341 B.R. 47, 50 (N.D. Ala. 2006). 13

14 earnings, as well as the feasibility test of 1129(a)(11), to the extent that debt service payments necessitate use of these earnings. Additionally, the debtor must satisfy the good faith requirement of 1129(a)(3). Courts are authorized under Bankruptcy Rule 3020(b)(2)to presume that this element has been met in the absence of objection. Creditors can argue, however, that a plan has not been proposed in good faith if lifestyle issues remain unresolved. 41 V. CONFIRMATION, CRAMDOWN, ABSOLUTE PRIORITY, AND NEW VALUE The most significant issue will likely be whether a debtor is able to propose a plan that is accepted by all impaired classes of unsecured claims. If an individual chapter 11 debtor cannot obtain the affirmative acceptance of the plan by each impaired class of creditors, he can confirm the plan only under the cramdown provisions of 1129(b), which in turn incorporate the absolute priority rule. Individual chapter 11 cases following the BAPCPA amendments may end up falling into two categories: those in which a debtor needs a breathing spell, perhaps to allow asset values to recover, but can pay and wants to pay all debts in full over time, and those in which a debtor can pay only a portion of his debts. The first type of debtor may satisfy 1129(b)(2)(B)(i) or the payment-in-full prong of the cramdown test, thus making chapter 11 a viable option. Contrariwise, for the individual debtor unable to pay more than a percentage often small of his debts, the uncertainties that now surround individual chapter 11 cases render it more important than ever to achieve a consensual plan. The basic rules for obtaining plan confirmation are the same for individuals as for corporations. A disclosure statement must be approved and served with the plan and ballots upon creditors and parties in interest. Each class of impaired claims must accept the plan by two-thirds in amount and one-half in number. Except with respect to loans secured by the debtor s principal residence, the cramdown of a secured claim is similar for individual and corporate debtors and generally involves a valuation of the collateral and the issuance of a new note paying the secured claim over time. With respect to a nonconsenting class of unsecured creditors, the debtor under the absolute priority rule cannot confirm her plan unless unsecured 41 E.g., In re Kemp, 134 B.R. 413 (Bankr. E.D. Cal. 1991). 14

15 claims are to be paid in full or junior claims or interests do not retain anything under the plan. Although it is easier to think about junior claims or interests in the context of a corporate case, in which debt is senior to equity, the equivalent of the equity holder in the individual case is the debtor herself. If classes of unsecured claims reject the plan and the plan does not meet the payment-in-full prong of 1129(b)(2)(B)(i), the court may confirm the plan only if the requirements of 1129(b)(2)(B)(ii) are met. Prior to BAPCPA, courts had been divided over the issue of whether a debtor can retain exempt property under a nonconsensual plan and whether the provisions of 1129(b)(2)(B)(ii) require contribution of the value of exempt assets to the plan. One line of cases interpreted 1129(b)(2)(B)(ii) to mean that an individual debtor cannot satisfy the absolute priority rule and at the same time retain any exempt property. 42 These courts reasoned that, had Congress intended to exclude exempt property from the calculation, then it could have used the term nonexempt property or property of the estate rather than property. Under this reasoning, the debtor could not confirm a plan by means of cramdown unless he contributed all of his property, including exempt property, since by definition any means every and all. Other courts argued that the retention of exempt property does not run afoul of the absolute priority rule, since retention is not on account of [the debtor s] junior interest in property. 43 The court in In re Henderson, 321 B.R. 550 (Bankr. M.D. Fla. 2005),aff d, 341 B.R. 783 (M.D. Fla. 2006), reasoned as follows: The ordinary meaning of the term junior means a claim or interest that is subordinate to other claims or interests which enjoy a higher rank. The word junior is defined in Black s Law Dictionary, at p. 851 (6th Ed. 1990), as [a] legal right which is subordinate to another s right as applied to property... The same meaning of junior is applied throughout the entire Bankruptcy Code. It is clear that the Debtor s interest in exempt property can never be junior to the interest of creditor s including the claim of dissenting unsecured creditors. This is so because unsecured creditors could never reach exempt property outside of bankruptcy, and such properties are immune and not subject to liquidation under any of the operating chapters of the Code. 42 In re Gosman, 282 B.R. 45 (Bankr.S.D. Fla. 2002); In re Ashton, 107 B.R. 670 (Bankr. D.N.D. 1989) (dicta); In re Yasparro, 100 B.R. 91 (Bankr. M.D. Fla. 1989). 43 In re Bullard, 358 B.R. 541 (Bankr.D. Conn. 2007); In re Egan, 142 B.R. 730 (Bankr. E.D. Pa. 1992). 15

16 321 B.R. at Most of these pre-bapcpa cases, however, saw no harm in the individual debtor s retention of property acquired from postpetition earnings, which has not been regarded as constituting property of the estate. 44 Then came along BAPCPA, which added to the language of 1129(b)(2)(B)(ii) the clause except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section Courts were called upon to decide whether the absolute priority rule still applies in individual chapter 11 cases. The issue is the subject of significant discussion in the caselaw. 45 Some courts, adopting a broad interpretation of the revised statute, have held that an individual debtor in chapter 11 may retain even prepetition property that is property of the estate under 541, as well as property acquired from prepetition and postpetition earnings, thus concluding that the BAPCPA amendments abrogated the absolute priority rule in individual chapter 11 cases. The cases adopting the broad interpretation generally have found that, if a plan provides that the debtor will contribute sufficient disposable income, both to satisfy the requirement of 1129(a)(15) and to meet the best interest of creditors requirement of 1129(a)(7), the plan may be confirmed. 46 Other courts, constituting what appears to be an emerging majority, have adopted a narrower interpretation of 1129(b)(2)(B)(ii), holding that the maximum amount of property that an individual debtor may retain is postpetition property and earnings. The courts that have taken the narrower position have inferred congressional intent to make it harder not easier for debtors to be discharged from debts and have rejected the argument that the changes to chapter 11 were made to make it function more like chapter 13. The first court to adopt the narrow view, in In re Gbadebo, did so by finding it likely that the phrase in addition to in 1115 was added to indicate an intent to add property to an individual debtor s bankruptcy estate that had been previously been excluded Roland v. Unum Life Ins. Co. of Am., 223 B.R. 499 (E.D. Va. 1998); see also cases cited in n See In re Lee Min Ho Chen, 482 B.R. 473, 477 (Bankr. D.P.R. 2012) (collecting cases). 46 In re Roedemeier, 374 B.R. 264, (Bankr. D. Kan. 2007); see also In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007); In re Johnson, 402 B.R. 851 (Bankr. N.D. Ind. 2009)(stating in dicta that an individual s plan does not need to satisfy the absolute priority rule ); In re Shat, 424 B.R. 854 (Bankr. D.Nev. 2010). 47 In re Gbadebo, 431 B.R. 222 (Bankr. N.D. Cal. 2010). See also In re Lindsey, 453 B.R. 886, 887 (Bankr. E.D. Tenn. 2011); In re Gelin, 437 B.R. 435, (Bankr. M.D. Fla. 2010)( If Congress meant to eliminate the absolute priority rule of 1129(b)(2)(B)(ii) for individual debtors, it could have simply stated that 1129(b)(2)(B)(ii) is inapplicable in a case in which the debtor is an individual. );In re Mullins, 16

17 Appellate decisions on this issue are split. The Ninth Circuit BAP in Friedman v. P+P, LLC (In re Friedman),466 B.R. 471 (B.A.P. 9th Cir. 2012),and the Middle District of Florida in SPCP Group, LLC v. Biggins, 465 B.R. 316, (M.D. Fla. 2011),ruled in favor of the broad view. More recently, in the first ruling at the court of appeals level, the Fourth Circuit in In re Maharaj, 681 F.3d 558 (4th Cir. 2012), following the narrow approach, determined that BAPCPA does not abrogate the absolute priority rule in individual chapter 11 cases. 48 In a recent decision, without citing any of these cases, the Eleventh Circuit seems to suggest in dicta a preference for the narrow approach. Ala. Dep t of Econ. & Cmty. Affairs v. Lett (In re Lett), No , 2011 WL (11th Cir. Feb. 10, 2011). In Lett, the narrow holding of the court was that the failure to object in the bankruptcy court case to a plan did not prevent a dissenting creditor from raising an absolute priority rule objection on appeal. Id. at *8. Although there is no discussion of the narrow versus broad view, the court cites in two footnotes to pre-bapcpa lower court cases applying the absolute priority rule, stating that an individual chapter 11 debtor s interests in property are junior to all creditors 49 and that retention of any property, even property encumbered by liens and in which the debtor lacks equity, violates the absolute priority rule. Id. at *11, n.26. The Lett court remanded the substantive issue to the district court, which had declined to decide it under principles of mootness and waiver. The prohibition against retention by a junior class of any property was subject to the court-created new value exception under which the junior class could essentially buy back an interest in the debtor. 50 The buyback price must consist of a contribution in money or money s worth, reasonably equivalent in view of all the circumstances to the 2010 WL (Bankr. W.D. Va. June 22, 2010)(finding that, under the broad view, courts were straining to find ambiguity in the statute in order to arrive at a construction that is more in keeping with the broader intent of certain BAPCPA provisions intended to make individual chapter 11 cases more similar to chapter 13 cases, which are not subject to the absolute priority rule); In re Steedley, 2010 WL (Bankr. S.D. Ga. Aug. 27, 2010). 48 See also In re Lindsey, 3:11-cv-00445, 2012 WL (E.D. Tenn. 2012) (affirming bankruptcy court following narrow approach and citing Maharaj). A particularly thorough analysis of the text of the statutes is contained in In re Arnold, 471 B.R. 578 (Bankr. C.D. Cal. 2012). 49 Id. at *3, n.13 (citing In re East, 57 B.R. 14, 17 (Bankr. M.D. La. 1985)). In East, the court rejected arguments that cramdown relief was unavailable, reasoning that the new value exception may be an alternative. 50 See Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) (also holding that the retention of an interest in property in which the debtors had no interest was violative of the absolute priority rule). 17

18 [continued] participation of the junior class. 51 Courts considering the new value exception in individual chapter 11 cases pre-bapcpa typically held that, although it can apply, it is very difficult to meet because the new value must come from a source other than the debtor. 52 Courts under BAPCPA have held that a plan in which the debtor proposes to retain exempt property can still comply with the absolute priority rule. 53 Can the inclusion of exempt property, however, constitute new value? What about proceeds from borrowings secured by exempt assets? What about funds borrowed on a secured basis by a company wholly owned by the debtor, to be repaid from debtor distributions? What if a doctor moves from her mansion, saving $5,000 per month in living expenses, and contributes that amount to fund the plan, bringing the total distribution to unsecured creditors up to $340,000? 54 VI. DISCHARGE AND CASE CLOSING Prior to BAPCPA, after chapter 11 plan confirmation, an individual debtor would immediately file a motion for final decree to obtain a discharge and close the case. Revised 1141 changes that course with the following language: In a case in which the debtor is an individual... unless... the court orders otherwise for cause, confirmation of the plan does not discharge any debt provided for in the plan until the court grants a discharge on completion of all payments under the plan. 11 U.S.C. 1141(d)(5)(A). Few courts have addressed what constitutes cause for purposes of an early discharge. 55 In at least two cases, debtors have argued that continuing payment of quarterly fees to the United States Trustee Program causes economic hardship that prevents them from making plan payments. Although the monthly reporting 51 Case v. L. A. Lumber Prods. Co., 308 U.S. 106 (1939). 52 In re Draiman, 450 B.R. 777, 822 (Bankr. N.D. Ill. 2011) (citing In re Rocha, 179 B.R. 305, 307 (Bankr. M.D. Fla. 1995));In re Cipparone, 175 B.R. 643, 643 (Bankr. E.D. Mich. 1994); In re Harman, 141 B.R. 878, 888 (Bankr. E.D. Pa. 1992). 53 In re Bullard, 358 B.R. 541, (Bankr. D. Conn. 2007) (citing In re Henderson, 321 B.R. 550, (Bankr. M.D. Fla. 2005), aff d, 341 B.R. 783 (M.D. Fla. 2006)) (declining to follow In re Gosman, 282 B.R. 45 (Bankr. S.D. Fla. 2002)). 54 A similar hypothetical was discussed in In re Lively, 467 B.R. 884, 892 (Bankr. S.D. Tex. 2012). 55 It also appears that courts have analyzed cause under 1141(d)(5)(A) rather than 1141(d)(5)(B). E.g., In re Beyer, 433 B.R. 884 (Bankr. M.D. Fla. 2009) (denying debtor s postconfirmation request for early discharge to avoid possible IRC 1099C income during life of plan, finding lack of cause under 1141(d)(5)(A)). 18

19 requirements and the quarterly United States trustee fees can be burdensome for individual chapter 11 debtors, 56 bankruptcy courts have determined this to be insufficient cause, finding that the payment of chapter 11 quarterly fees is simply the cost of doing business under chapter Subsequently, however, the Executive Office of U.S. Trustees reversed its position, and as a result, United States trustees now presumably will not object to an individual chapter 11 debtor s request to temporarily close a case on an administrative basis. 58 Some courts have adopted a procedure, in some instances implemented upon negative notice, to allow individual chapter 11 cases to be administratively closed and have authorized the inclusion in the confirmation order of a provision stating that, upon filing of a Notice of Completion of Plan Payments and Request for Entry of Discharge, accompanied by a certificate of service, the case will automatically be reopened pursuant to 350(b) without the payment of the customary fee. 59 VII. PLAN MODIFICATION Another BAPCPA amendment provided for an individual chapter 11 case to mirror the modification provisions of chapter The added language of 1127(e)provides that the plan of an individual chapter 11 debtor may be modified at any time after confirmation but before the completion of payments under the plan, regardless of whether the plan has been substantially consummated, at the request of the debtor, the trustee, the United States trustee, or the holder of an allowed unsecured claim, to increase or reduce payments on claims of a particular class, to extend or reduce the time period for making payments, or to alter the amount of the distribution to a creditor whose claim is 56 See, e.g., In re Johnson, 402 B.R. 851, (Bankr. N.D. Ind. 2009) (United States trustee fees estimated to be paid over five-year life of the plan totaled $13,000 out of approximately $51,250, or 25.4%, of the funds available for unsecured creditors and the United States trustee). 57 In re Belcher, 410 B.R. 206 (Bankr. W.D. Va. 2009); In re Ball, 2008 WL (Bankr. N.D. W. Va. May 23, 2008). 58 See Theus, Individual Chapter 11s: Case Closing Reconsidered, AM. BANKR. INST. J., Feb. 2010, at There is no requirement for an individual chapter 11 debtor to complete the personal financial management course in order to receive a discharge, unless 1141(d)(3) is applicable (i.e., where there is a liquidation of all or substantially all assets and the debtor is not engaging in business). 60 Section 1329(a) itself is the subject of disagreement among the circuits as to whether a showing of an unanticipated change in circumstances is required. Compare In re Murphy, 474 F.3d 143, 150 (4th Cir. 2007), with In re Meza, 467 F.3d 874 (5th Cir. 2006). It seems likely that this caselaw will be relevant to the interpretation of 1127(e). 19