Ninth Circuit Rules Absolute Priority Applicable to All Individual Chapter 11 CasesThe Ninth Circuit Bankruptcy Appellate Panel (“BAP”) has ruled that the absolute priority rule — which requires debtors to pay dissenting creditors in full before they can retain pre-petition property — applies to all individual Chapter 11 bankruptcy reorganizations.

In Zachary v. California Bank & Trust, debtors David Zachary and Annmarie Snorsky filed a joint Chapter 11 bankruptcy petition in 2011, listing $1.6 million in assets and $1.2 million in liabilities. In 2012, they filed an amended reorganization plan that would allow them to keep their primary residence as well as a rental property in Lake Tahoe. Their largest creditor, California Bank & Trust, objected to the amended plan, saying it violated the absolute priority rule.

In a departure from the Ninth Circuit’s 2012 ruling in In re: Friedman — which held that a 2005 Bankruptcy Code amendment to the priority rule allowed Chapter 11 debtors to retain all their property — the bankruptcy court sustained the bank’s objection. Zachary and Snorsky appealed to the Ninth Circuit, which upheld the bankruptcy court’s ruling.

In its January 28, 2016, ruling, the Ninth Circuit made note of the different judicial applications of the absolute priority rule since the 2005 amendments to the Bankruptcy Code. A majority of courts have taken a narrow view, while a few have taken a broad view of the rule. At issue was the joint interpretation of Section 1115, which expanded a Chapter 11 debtor’s estate to include property acquired post-petition, and Section 1129(b)(2)(B)(ii), which provides that individual Chapter 11 debtors may retain property included in the estate under Section 1115.

The majority of courts that have taken a narrow view have interpreted Sections 1115 and 1129(b)(2)(B)(ii) to allow individual Chapter 11 debtors to retain only that property which was acquired post-petition. The Ninth Circuit concurred with the narrow view, holding that individual Chapter 11 debtors may not retain pre-petition property when creditors are not fully paid. In doing so, the Ninth Circuit joined the Fourth, Fifth, Sixth and Tenth Circuits in adopting the narrow view of the absolute priority rule.

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