In re Lucarelli

517 B.R. 42

In re Richard and Stephanie LUCARELLI, Lucarelli's Executive Answering Service, LLC, Debtors.

Nos. 13–30350 JAM

13–30443 JAM.

United States Bankruptcy Court, D. Connecticut.

Signed Sept. 4, 2014.

Kenneth Lenz, Esq., Lenz Law Firm, LLC, Orange, CT, for Richard and Stephanie Lucarelli.

Carl T. Gulliver, Esq., Coan, Lewendon, Gulliver & Miltenberger, LLC, New Haven, CT, for Lucarelli's Executive Answering Service, LLC.

Michael A. Carbone, Esq., Zeldes, Needle & Cooper, P.C., Bridgeport, CT, for unsecured creditor Sweet Delights, LLC.

MEMORANDUM OF DECISION ON SECOND AMENDED JOINT PLAN OF REORGANIZATION

JULIE A. MANNING, Bankruptcy Judge.

I. Introduction

This case raises an apparent issue of first impression in this district and this circuit: whether The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (hereinafter, “BAPCPA”) eliminated the absolute priority rule in individual Chapter 11 debtor cases.

Courts in other jurisdictions that have addressed this issue have reached opposite conclusions. However, most courts have held that the absolute priority rule in individual Chapter 11 cases was not eliminated by BAPCPA. After analyzing the statutory language and the lack of relevant legislative history in BAPCPA concerning the absolute priority rule, the court concludes that BAPCPA modified, but did not eliminate, the absolute priority rule in individual Chapter 11 cases.

II. Relevant Facts

The issue before the court arose in the context of the proposed confirmation of a single Chapter 11 plan of reorganization filed in two separate, but jointly-administered Chapter 11 bankruptcy cases, In re Richard and Stephanie D. Lucarelli, Case No. 13–30350 and In re Lucarelli's Executive Answering Service, LLC, Case No. 13–30443.

The relevant facts are not in dispute. On February 27, 2013, Richard and Stephanie Lucarelli (the “Lucarellis”), filed their individual Chapter 11 case. On March 13, 2013, Lucarelli's Executive Answering Service, LLC (“LEAS”), filed its corporate Chapter 11 case. Not surprisingly, the Lucarellis are the owners and managers of LEAS. On February 12, 2014, the Lucarellis and LEAS filed a Motion for Joint Administration of the related Chapter 11 cases (the “Motion for Joint Administration”). Following a hearing, the Motion for Joint Administration was granted by this court.

On March 5, 2014, the Lucarellis and LEAS filed a Second Amended Joint Chapter 11 Plan of Reorganization (hereinafter the “Joint Plan”). The Joint Plan as proposed contains eight (8) classes of creditors. If the Joint Plan is confirmed, it would be binding on all creditors. It is uncontested that the Joint Plan does not pay all creditors in full and therefore contains impaired classes of creditors. It is also uncontested that under the Joint Plan, the Lucarellis would retain their ownership interests in LEAS while unsecured creditors would not be paid in full.

None of the creditors of LEAS voted to reject the Joint Plan or objected to confirmation of the Joint Plan. However, three Class 8 unsecured creditors of the Lucarellis, whose claims will not be paid in full and are therefore impaired, voted to reject the Joint Plan. One of the rejecting Class 8 unsecured creditors, Sweet Delights, LLC (“Sweet Delights”), also filed a written objection to confirmation, arguing that the Joint Plan violates the absolute priority rule.

III. Discussion

A. Plan Confirmation and the Absolute Priority Rule

In a Chapter 11 case, a proposed plan of reorganization may be confirmed in only two ways: 1) if all sixteen paragraphs of 11 U.S.C. § 1129(a) are satisfied, in which case the plan can be confirmed consensually; or 2) if a plan proponent satisfies every paragraph of § 1129(a) except for the voting requirements provisions of paragraph (8), a plan can be confirmed nonconsensually (via “cram down”), if it does not discriminate unfairly and is fair and equitable with respect to each impaired dissenting class under the plan. 11 U.S.C. § 1129 ; In re Iridium Operating LLC, 478 F.3d 452, 462 (2d Cir.2007) ; In re Shat, 424 B.R. 854, 857 (Bankr.D.Nev.2010) ; In re Journal Register Co., 407 B.R. 520, 529 (Bankr.S.D.N.Y.2009). The absolute priority rule generally provides that in order for a cram down to be “fair and equitable,” every unsecured creditor in a dissenting impaired class must be paid in full before the debtor is permitted to retain “any property” under the plan. 11 U.S.C. § 1129(b)(2)(B)(ii). “The rule has been a cornerstone of equitable distributions for Chapter 11 creditors for over a century.” Ice House America, LLC v. Cardin, 751 F.3d 734, 737 (6th Cir.2014).

To understand the evolution of the absolute priority rule, a review of United States Supreme Court cases addressing this issue since the enactment of the Bankruptcy Code is instructive. The absolute priority rule originated as a judicially created doctrine, emerging out of several railroad cases in the early part of the last century. See, Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988), citing to N. Pac. Ry Co. v. Boyd, 228 U.S. 482, 33 S.Ct. 554, 57 L.Ed. 931 (1913) ; In re Friedman, 466 B.R. 471, 478 (9th Cir.BAP2012) ; 7 Collier on Bankruptcy ¶ 1129.LH., p. 1129–191 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. rev. 2014) (“The absolute priority rule's origins lie in the intersection between fraudulent transfer law and the rise of the railroad during the nineteenth century.”). The historical roots of the absolute priority rule thus trace back to the realm of corporate, as opposed to individual, bankruptcy cases. Friedman v. P+P, LLC, (In re Friedman), 466 B.R. 471, 479 (9th Cir. BAP 2012) (noting that a “specific mission” of the absolute priority rule historically was to “undermine corporate shareholders' advantages over unsecured creditors”).

The absolute priority rule evolved beyond a judicially created doctrine when Congress codified it as part of the Bankruptcy Code in 1978. See 11 U.S.C. § 1129(b)(2)(B)(ii) (1978). As the absolute priority rule continued to evolve after enactment of the Code, issues surrounding the rule and its application to particular cases gradually reached the Supreme Court. In 1988, the Court unanimously held that the absolute priority rule applied in individual Chapter 11 cases.

Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988).¹ In Ahlers, the Court held that the absolute priority rule barred individual Chapter 11 debtors from retaining an interest in their farm over the objection of unsecured creditors. In so holding, the Court stated:

the Court of Appeals found that respondents' promise of future “labor, experience and expertise” permitted confirmation of their Chapter 11 reorganization plan over the objections of their creditors, even though the plan violated the “absolute priority rule” of the Bankruptcy Code. Because we find this conclusion at odds with the Code and our cases, we reverse.

Norwest Bank Worthington v. Ahlers, 485 U.S. 197, 199, 108 S.Ct. 963, 99 L.Ed.2d 169 (1988). In support of its conclusion, the Court noted that the Code provides that a “fair and equitable” reorganization plan is one which complies with the absolute priority rule. The Court further noted that it is “up to the creditors—and not the courts—to accept or reject a reorganization plan which fails to provide them with adequate protection or fails to honor the absolute priority rule” Id. at 207, 108 S.Ct. 963. While the Court in Ahlers held that the absolute priority rule applied in individual Chapter 11 cases, the decision did not squarely address the unresolved issue of whether individual debtors could file a Chapter 11 case, an issue of great debate at the time. Although Ahlers did not directly address the issue, the decision certainly implied that individuals were eligible to seek relief under Chapter 11.

Following Ahlers, the Court revisited the issue of whether individuals could seek relief under Chapter 11 three years later in Toibb v. Radloff, 501 U.S. 157, 111 S.Ct. 2197, 115 L.Ed.2d 145 (1991). In Radloff, the Court explicitly held what it implied in Ahlers, namely that “[t]he plain language of the Bankruptcy Code permits individual debtors not engaged in business to file for relief under Chapter 11.” Radloff, 501 U.S. at 166, 111 S.Ct. 2197. In so concluding, the Court reasoned that:

[t]he Code defines “person” as used in Title 11 to include an individual. Under the express terms of the Code, therefore, [a] petitioner is a person who may be a debtor under [C]hapter 7 and satisfies the statutory requirements for a Chapter 11 debtor. [Further, t]he Code contains no ongoing business requirement for reorganization under Chapter 11, and we are loathe to infer the exclusion of certain classes of debtors from the protections of Chapter 11, because Congress took care in § 109 to specify who qualifies—and who does not qualify—as a debtor under the various chapters of the Code.

Radloff, 501 U.S. at 161, 111 S.Ct. 2197 (internal quotations, original brackets omitted). The Court in Radloff was explicit in its belief that Congress understood how to restrict access to various avenues of bankruptcy relief, and that Congress had deliberately chosen not to place Chapter 11 reorganization out of the reach of an individual debtor. Id.

Thus, following Ahlers and Radloff, and until BAPCPA's enactment in 2005, it was clear that individual debtors could file Chapter 11 cases and the absolute priority rule applied in those cases.

B. BAPCPA's modifications to Section 1129 and creation of Section 1115

BAPCPA's amendments to the Code upset the existing Supreme Court precedent by adding language to 11 U.S.C. § 1129 regarding the application of the absolute priority rule in individual Chapter 11 cases. Specifically, Section 1129(b)(2)(B)(ii) was modified and now provides in relevant part that:

(B) With respect to a class of unsecured claims—

(i) the plan provides that each holder of a claim of such class receive or

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