The Absolute Priority Rule for Individuals After Maharaj, Lively, and Stephens: Negotiations or Game Over?

A husband and wife owned and operated an auto body repair shop in Virginia and, after falling victim to fraud, were left with considerable debt. The couple filed for Chapter 11 Bankruptcy—the chapter of the Bankruptcy Code typically used for corporate reorganizations—because their debt exceeded the limits for types of bankruptcies usually used by individuals. The couple filed a reorganization plan, which provided for the continued ownership and operation of their auto body business, and for the payment of the claims of unsecured creditors with future income from the business. All but one of the creditors approved the plan. Despite the creditor’s objection, the couple began a process called a “cram down” to confirm the plan.

Whether this couple would be allowed to retain their business without the consent of the dissenting creditor came down to a very specific section of the Bankruptcy Code, commonly referred to as “the absolute priority rule.” The absolute priority rule traditionally prevented businesses from retaining assets, such as stock equity, when forcing through a bankruptcy plan over the objections of creditors. However, recent amendments to the Code made it unclear whether this rule continued to apply to individuals in addition to businesses.

In Maharaj, the U.S. Court of Appeals for the Fourth Circuit denied the couple’s cram down and held that the absolute priority rule applied to individual debtors. Other courts have since addressed this issue, with the majority following Maharaj. As a result, many individual Chapter 11 debtors may be forced to liquidate their businesses and other property if not all classes of senior creditors approve their reorganization plans.

However, a large number of early decisions, and a minority of recent opinions, continue to hold that the absolute priority rule does not apply to individual debtors. This disparity has profound consequences for bankruptcy debtors and has created uncertainty within jurisdictions that have not yet had appellate decisions on the issue. This Note argues that the minority view is better reasoned from both a statutory perspective and policy standpoint, and that the absolute priority rule should not apply to individual debtors.

Note | View PDF | Appears in Volume 55, Issue 4

Comments are closed.