INDIVIDUAL CHAPTER 11: A HOW-TO

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1 INDIVIDUAL CHAPTER 11: A HOW-TO Thomas Flynn and Steven Kinsella March 15, 2016

2 Chapter 11 of title 11 of the United States Code (the Bankruptcy Code ) has never been particularly well-suited to individual debtors, and the provisions specific to individual chapter 11 debtors introduced by the 2005 amendments of the Bankruptcy Abuse Prevention and Consumer Protection Act ( BAPCPA ) did not change this fact. Nevertheless, for some debtors, chapter 11 is the only option for debt relief and a fresh start. I. FILING CONSIDERATIONS Eligibility. Chapter 11 may be the only bankruptcy option for individuals who do not qualify for chapter 7 or chapter 13 or who want to retain property in exchange for paying creditors over time. For those individuals with primarily consumer debt, chapter 7 is available only to individuals whose income is below the median income and other thresholds set forth in the means test. 1 Chapter 13 is available to individuals with regular income, unsecured debts less than $383,175, 2 and secured debts less than $1,149, Thus, individuals with primarily consumer debt, above-median incomes, and debt greater than the chapter 13 limits have no other bankruptcy choice other than chapter 11. Alternatively, individuals with primarily non-consumer debt who are eligible to be chapter 7 debtors may nevertheless opt for a chapter 11 filing in order to preserve non-exempt assets that would be liquidated in a chapter 7 case. However, the individual chapter 11 debtor s ability to retain such property through the plan confirmation process may be tenuous and the costs of retaining such property may be high, as explored in several sections of these materials. Small Business Debtor. The individual chapter 11 debtor who is a sole proprietor may be a small business debtor subject to special requirements. A small business debtor is a person including an individual who is engaged in commercial or business activities... [who] has aggregate noncontingent liquidated secured and unsecured debts... in an amount not more than $2,490,925 (excluding debts owed to [one] or more affiliates or insiders) where there is no creditors committee or the committee is not sufficiently active. 4 In addition to the chapter 11 provisions specific to individual debtors, small business debtors must also comply with various unique provisions, including additional filing and monthly operating reporting requirements, an absolute deadline for plan filing and confirmation, and disclosure statement requirements. 5 Credit Counseling. In the vast majority of cases, the individual chapter 11 debtor, like chapter 7 or chapter 13 debtors, must obtain a briefing from an approved, nonprofit budget and 1 11 U.S.C. 707(b). 2 Dollar amounts provided in these materials are current as of July 2012 and are subject to periodic adjustment U.S.C. 109(e). Dollar limits will increase on April 1, 2016: increasing to $394,725 for unsecured debts and $1,184,200 for secured debts U.S.C. 101(51D). Dollar limits will increase on April 1, 2016: increasing to $2,566, U.S.C. 308, 1116, 1121(e), 1125(f)

3 credit counseling agency in the 180 days prior to filing the case. 6 The chapter 11 debtor must also complete a financial management course before receiving a discharge. 7 II. OPERATING AS DEBTOR AND DEBTOR IN POSSESSION Chapter 11 permits a debtor to remain in possession of all property of the estate, even non-exempt property, as a debtor in possession. 8 However, in an individual chapter 11 case, section 1115 of the Bankruptcy Code brings into the estate post-petition property described in section 541 and post-petition earnings from the debtor s services. 9 This change affects the individual debtor s post-petition spending and ability to employ counsel. Payment of the Debtor s Living Expenses. A debtor s use of property of the estate is governed by section 363 of the Bankruptcy Code, which provides that the debtor may enter into transactions, including the sale or lease of property of the estate, in the ordinary course of business, without notice or a hearing, and may use property of the estate in the ordinary course of business without notice or a hearing. 10 However, a debtor must seek court approval to use property of the estate outside the ordinary course of business. 11 Before the BAPCPA amendments made postpetition earnings part of the estate, cases split on whether an individual chapter 11 debtor could access any estate funds. 12 Since BAPCPA, only one court has explicitly addressed the issue, holding that section 362(c)(1) of the Bankruptcy Code should be interpreted to authorize individual debtors use of estate assets to 6 11 U.S.C. 109(h)(1) U.S.C. 1141(d)(3)(C) U.S.C U.S.C provides: (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 U.S.C. 363(c)(1) U.S.C. 363(b)(1). 12 Contrast In re Walter, 83 B.R. 14, 19 (B.A.P. 9th Cir. 1988) (holding that the debtor may not use any estate property for personal expenses) with In re Harp, 166 B.R. 740, 756 (Bankr. N.D. Ala. 1993) (ordering the debtor to present for court approval a detailed budget of reasonable personal expenses) with In re Murray, 216 B.R. 712 (Bankr. W.D.N.Y. 1998) ( [T]he Debtor is as free to spend estate monies... on his ordinary business expenses and on normal living expenses )

4 pay living expenses as part of their ordinary course of business. 13 This holding is consistent with dicta in prior cases addressing the use of property of the estate. 14 Even if a debtor s spending is arguably within the ordinary course of business and not subject to court approval, a debtor s spending may still create a basis for conversion or dismissal. 15 Conflicts of Interest between the Debtor and the Estate. There is tension in individual chapter 11 cases between the debtor s personal interests and his or her duties as debtor in possession to represent the interests of creditors. The individual chapter 11 debtor s fiduciary duty to maximize the value of the estate for the benefit of creditors comes ahead of his or her personal interests. 16 Bankruptcy Counsel Represents the Estate. The longstanding rule is that bankruptcy counsel employed by the estate represents the debtor in possession and not the debtor as an individual. 17 Consequently, bankruptcy counsel may only represent the individual interests of a debtor in a very few limited circumstances, such as in proposing a plan of reorganization. 18 Bankruptcy counsel cannot represent the individual interests of a debtor on matters in a case, such as objections to exemption, discharge, or dischargeability. 19 Individual debtors may only use estate assets for personal representation in a chapter 11 case if the representation benefits the estate. 20 Because section 1115 of the Bankruptcy Code includes an individual chapter In re Seely, 492 B.R. 284, 290 (Bankr. C.D. Cal. 2013). 14 In re Goldstein, 383 B.R. 496, 499 (Bankr. C.D. Cal. 2007) (finding that the debtor can buy bread and probably.. purchase a ticket to travel to a court hearing, but payment of divorce counsel was not in the ordinary course of business); In re Villalobos, No. NV HKwJU, 2011 WL , 2011 Bankr. LEXIS 4329 (B.A.P. 9th Cir. Aug. 19, 2011) (directing the bankruptcy court to apply some standard justifying its authorization of the debtor s expenses). 15 In re Murray, 216 B.R. at 713 (finding that a debtor s use of money to resolve a divorce proceeding was a risk for creating a basis for conversion or dismissal for eroding property of the estate); In re Wood, 68 B.R. 613, 617 (Bankr. D. Haw. 1986) (holding that spending large amount on the care of pets constituted gross mismanagement, one basis for dismissal). 16 In re Bowman, 181 B.R. 836 (Bankr. D. Md. 1995) (finding that the debtor holds the duty to put creditor interests first in settlement of lawsuit); In re Tel-Net Hawaii, Inc., 105 B.R. 594 (Bankr. D. Haw. 1989) (appointing a chapter 11 trustee after the debtor s failure to pursue preference actions which would have increased the debtor s exposure on guaranteed debt). 17 See, e.g., In re Perez, 30 F.3d 1209 (9th Cir. 1994). 18 In re Bame, 251 B.R. 367, 374 (Bankr. D. Minn. 2000) (citing In re Tomaiolo, 205 B.R. 10, 16 (Bankr. D. Mass. 1997)). 19 See, e.g., In re Dixon, No , 2010 WL , at *1, 2010 Bankr. LEXIS 3305, at *2 (Bankr. N.D. Cal. Sept. 19, 2010). 20 In re Goldstein, 383 B.R. 496 (concluding that joint chapter 11 debtors each authorized to employ own divorce counsel and pay them from their estate assets because it would aid administration of the estate); In re Murray, 216 B.R. at 713 (holding that chapter 11 debtor did not need authority from court to pay divorce counsel, but that court would not allow employment under 327 because there is no benefit to the estate); In re Miell, No , 2009 WL , at *4, 2009 Bankr. LEXIS 2064, at *9 (Bankr. N.D. Iowa July 27, 2009) (finding that a chapter 11 debtor was not allowed to pay criminal defense or tax attorneys out of estate funds); see also In re Kohl, 95 F.3d 713, 714 (8th Cir. 1996) (stating that attorneys fees will be denied to the extent the services rendered were for the benefit of the debtor and did not benefit the estate )

5 debtor s prepetition and postpetition property in the estate, individual debtors cannot use postpetition earnings to employ individual counsel and individual debtors seeking personal representation may be forced to use exempt assets or outside funding. III. PLAN AND CONFIRMATION ISSUES Absolute Priority Rule. One of the reasons individual debtors file for chapter 11 bankruptcy is to retain prepetition assets, such as ownership interests in companies or real property. If the debtor is unable to obtain the acceptance of every class of unsecured creditors, there is an open question whether the debtor is able to retain that property. The result depends on whether the court finds that the absolute priority rule applies in the individual chapter 11 context. Courts have split on whether the absolute priority rule applies. At issue is the interpretation of section 1129(b) of the Bankruptcy Code, which requires that a plan must be fair and equitable to a non-accepting class of unsecured creditors. 21 Prior to BAPCPA, a plan was fair and equitable if the holder of any claim or interest that is junior to the claims of such [unsecured] class will not receive or retain under the plan on account of such junior claim or interest any property. 22 BAPCPA added 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, subject to the requirements of subsection (a)(14) of this section. 23 Section 1115 of the Bankruptcy Code provides that: (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. 24 When reading the two sections together, the question becomes: what does section 1129(b)(2)(B)(ii) s property included in the estate under section 1115 mean? Certain courts have adopted a narrow view, interpreting the phrase to mean only the postpetition property specified in sections 1115(a)(1) and (2). Other courts have adopted a broad view, interpreting the phrase to mean such postpetition property plus the section 541 prepetition property. Under U.S.C. 1129(b)(1) U.S.C. 1129(b)(2)(B)(ii) (2004) U.S.C. 1129(b)(2)(B)(ii) U.S.C (emphasis added)

6 the narrow view, the absolute priority rule remains and the debtor may not retain prepetition assets under the plan without paying the rejecting class of unsecured creditors in full or contributing new value. Under the broad view, the absolute priority rule is eliminated and a plan meeting all of the other confirmation requirements will be able to re-vest those prepetition assets in the debtor without satisfying the cram down test. The majority of courts have adopted the narrow view and determined that BAPCPA did not eliminate the absolute priority rule for individual chapter 11 debtors and they may not receive or retain estate property under the plan. 25 The minority of courts, including all three opinions on the issue from bankruptcy courts in the Eighth Circuit, have followed the broad view and concluded that BAPCPA eliminated the absolute priority rule. 26 There have been no published decisions on this issue from the 8th Circuit, the Minnesota bankruptcy court, or the Minnesota district court. It is important to note that the Fourth, Fifth, Sixth, and Tenth Circuits have adopted the narrow view and that no circuit court has yet adopted the broad view. In light of the majority of cases adopting the narrow view, it is unlikely that an individual chapter 11 debtor can cram down a reorganization plan and keep prepetition property. Therefore, before filing, the debtor should consider whether he or she can negotiate with unsecured creditors and whether creditors will vote in favor of a plan. Even if the absolute priority rule does not apply, the debtor will still need to meet the fair and equitable standard. 27 Plan Objections and Projected Disposable Income. If a holder of an allowed unsecured claim objects to confirmation of a plan, section 1129(a) of the Bankruptcy Code requires that the plan must either pay the claim in full or distribute property with a value of at least the debtor s projected disposable income for five years or the period the plan provides payments, whichever is longer. 28 Projected disposable income is the difference between projected income and expenses. 29 For individual chapter 11 debtors, Official Bankruptcy Form 22B calculates current monthly income based on historical income. However, an individual debtor need not use Form 22B or other bankruptcy forms to calculate projected disposable income for purposes of section 1129(a)(15) when there are known or virtually certain changes to income. 30 The debtor must provide proof of changes, and speculative changes in income or expenses do not merit 25 Ice House Am., LLC v. Cardin, 751 F.3d 734 (6th Cir. 2014); In re Stephens, 704 F.3d 1279 (10th Cir. 2013); In re Lively, 717 F.3d 406 (5th Cir. 2013); In re Maharaj, 681 F.3d 558 (4th Cir. 2012). 26 In re Woodward, No , 2014 WL , 2014 Bankr. LEXIS 1940 (Bankr. D. Neb. Apr. 29, 2014); In re Tegeder, 369 B.R. 477 (Bankr. D. Neb. 2007); In re O Neal, 490 B.R. 837 (Bankr. W.D. Ark. 2013). 27 In re Tucker, 479 B.R. 873, 879 (Bankr. D. Or. 2012) U.S.C. 1129(a)(15) U.S.C. 1325(b)(2). 30 In re Villalobos, 2014 Bankr. LEXIS 978, at *42; Hamilton v. Lanning, 560 U.S. 505, 524 (2010)

7 adjustment. 31 An individual chapter 11 debtor s expenses are judicially determined in amounts reasonably necessary for the support of the debtor and his or her dependents, without a requirement that the court reference the expense guidelines in section 1325(b)(3) of the Bankruptcy Code. 32 IV. AT AND AFTER CONFIRMATION Discharge. After BAPCPA, the discharge for individual chapter 11 debtors moved from the time of plan confirmation to the time all payments under the plan are completed. 33 The Bankruptcy Code is unclear whether discharge can be granted during the period of payment of long-term debt, such as home mortgages and student loans, if such period is longer than the payment period for unsecured creditors. Several courts have found that such outstanding debts would not preclude a grant of discharge if the payment of general unsecured debts has been completed or is sufficiently secured. 34 There are two circumstances under which the court may grant an earlier discharge. First, the court may grant an early discharge for cause, after notice and a hearing. Cause is not defined and is a fact-intensive inquiry. Courts have considered several factors and no one single factor has been held sufficient to constitute cause: 1) whether the plan has been substantially consummated, which takes place upon (A) transfer of all or substantially all of the property proposed by the plan to be transferred, (B) assumption by the debtor or by the successor to the debtor under the plan of the business or of the management of all or substantially all of the property dealt with by the plan, and (C) commencement of distribution under the plan 35 ; 2) whether the plan provides assurances that remaining plan payments will be made 36 ; and 3) whether the discharge is required for the debtor to conduct business. 37 Second, the court may grant a discharge before plan payments are completed if the debtor has, under the plan, distributed to holders of unsecured claims property of a value not less than 31 Educ. Assistance Corp. v. Zellner, 827 F.2d 1222 (8th Cir. 1987), (8th Cir. 1987); In re Schyma, 68 B.R. 52, 63 (Bankr. D. Minn. 1985). 32 In re Roedemeier, 374 B.R. 264, (Bankr. D. Kan. 2007); see also In re Woodward, 2014 Bankr. LEXIS U.S.C. 1141(d)(5). 34 In re Belcher, 410 B.R. 206, 218 (Bankr. W.D. Va. 2009); In re Johnson, 402 B.R. 851, 855 (Bankr. N.D. Ind. 2009) U.S.C. 1101(2). 36 In re Sheridan, 391 B.R. 287, 291 (Bankr. E.D.N.C. 2008). 37 In re Detweiler, No , 2012 Bankr. LEXIS 5501, *5-7 (Bankr. N.D. Ohio Nov. 27, 2012)

8 would have been distributed under a chapter 7 liquidation and modification of the plan is not practicable. 38 Modification of the Plan. Section 1127(e) permits the modification of the plan after substantial consummation and prior to completion of plan payments. 39 Modification may be requested by the debtor, the trustee, the U.S. Trustee, or any holder of an allowed unsecured claim. Discharge and Dischargeability. Individual chapter 11 debtors may not know whether debts will be dischargeable through the bankruptcy case, even until after confirmation of the plan. All of the discharge exceptions under section 523 of the Bankruptcy Code apply to individual chapter 11 debtors. 40 The deadline for complaints to determine dischargeability of sections 523(a)(2), (4), and (6) debts is the standard 60 days after the date set for the meeting of creditors, subject to extension upon motion and hearing. 41 Complaints objecting to the chapter 11 debtor s discharge may be filed up and through the confirmation hearing. 42 Closing the Case. Individual chapter 11 cases are closed after the estate is fully administered and the court has discharged the trustee. 43 The Eighth Circuit Bankruptcy Appellate Panel has held that closing a chapter 11 case is within the discretion of the bankruptcy judge s analysis of the particular facts and circumstances of the case. 44 The bankruptcy court thus has the authority to either hold open the case to oversee plan distributions or close the case and reopen it upon completion of plan payments to enter the discharge order. To close a case, the debtor must still comply with the requirements of section 350(a) of the Bankruptcy Code and Rule 3022 of the Federal Rules of Bankruptcy Procedure and will have to pay a court fee to reopen the case for entry of the discharge U.S.C. 1141(d)(5)(B) U.S.C. 1127(e) U.S.C. 1141(d)(2). 41 FED. R. BANKR. P. 4007(C). 42 FED. R. BANKR. P. 4004(A) U.S.C. 350(a); FED. R. BANKR. P In re Shotkoski, 420 B.R. 479, 483 (B.A.P. 8th Cir. 2009) U.S.C. 350(a); FED. R. BANKR. P

CHAPTER 11 CRAMDOWN FOR AN INDIVIDUAL AND THE ABSOLUTE PRIORITY RULE (as of 2015)

CHAPTER 11 CRAMDOWN FOR AN INDIVIDUAL AND THE ABSOLUTE PRIORITY RULE (as of 2015) Lee M. Kutner KUTNER BRINEN GARBER, P.C. 1660 Lincoln St., Suite 1825 Denver, CO 80264 303-832-2400 lmk@kutnerlaw.com CHAPTER