In order to confirm a Chapter 11 plan, the debtor must meet the requirements of 11 U.S.C. §1129(a). In connection therewith, subject to the exception contained in Section 1129(a)(8), all impaired classes under the plan must vote in favor of acceptance of the plan. In the event one impaired class votes to reject the plan, the debtor is left with the alternative of achieving confirmation through the means of the cramdown provisions of Section 1129(b). In order to cramdown a dissenting class of unsecured creditors, the debtor must satisfy the “fair and equitable” requirements of Section 1129(b)(2)(B)(ii). This section, commonly referred to as the “absolute priority rule,” provides:
With respect to a class of unsecured creditors * * * (ii) the holder of any claim and interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property.
Id. In other words, Section 1129(b)(2)(B)(ii) prohibits a debtor from receiving or retaining property “on account of” an interest that is junior to claims held by unsecured creditors.
A dispute among the courts exists as to whether an individual’s retention of exempt property is on account of an interest “junior” to the claims of unsecured creditors. This issue was dealt with in In re Gosman, 282 B.R. 45 (Bankr.S.D.Fla.2002), where the court started its analysis by noting that a debtor’s ownership interest in property is “junior” to the claims of unsecured creditors. Id. at 48. The court then stated that when a debtor proposes to retain property pursuant to an exemption, he or she does so on account of his or her ownership interest, i.e., on account of that junior interest. In fact, Gosman noted that it is the debtor’s ownership interest in the asset that gives him an exemption under Section 522(b) and state law.
According to Gosman, the question centered on whether the term “any property,” as used in Section 1129(b)(2)(B)(ii), encompasses covers “exempt property.” The court answered this question by first noting that there is no dispute that if a debtor were to retain property of the estate, i.e., non-exempt property, then the debtor would be in violation of the absolute priority rule if the dissenting class of unsecured creditors was not paid in full, i.e., he would be the holder of a “junior interest” retaining property at the expense of unsecured creditors. The court noted that the foregoing result is no different where the debtor proposes to retain exempt property as opposed to non-exempt property.
Had Congress intended to exclude exempt property from the effect of the “absolute priority rule,” then the term “property” would not have been used under section 1129(b)(2)(B)(ii), rather Congress would have used “non-exempt property” or “property of the estate.” Congress could also have used any other qualifying word to indicate its desire to provide a distinction between exempt and non-exempt property. For example, Congress could have referred to 11 U.S.C. §522 if it meant to exclude exempt property. Instead section 1129(b)(2)(B)(ii) uses the term “property” and such a term is modified by the word “any,” a word which, in any definition, sets no boundaries.
Id.
In re Haas, 195 B.R. 933 (Bankr.S.D.Ala.1996), and In re Egan, 142 B.R. 730 (Bankr.E.D.Pa.1992), came to the opposite conclusion. Both courts followed an analysis which focuses on the nature of exempt property and because the retention of exempt property is an absolute right already afforded to a debtor by way of 11 U.S.C. Section 522, the “absolute priority rule” does not come into play. Essentially, the argument is that Section 522 trumps Section 1129(b)(2)(B)(ii). A similar conclusion was reached in In re Henderson, 341 B.R. 783 (M.D.Fla.2006). In this case, the court found that exempt property did not implicate the absolute priority rule. The bankruptcy court stated that it was “axiomatic” “that exempt property, once allowed, is no longer property of the Debtor’s estate, but nonexempt properties are properties of the a Debtor’s estate.” The court noted that:
Debtor’s interest in exempt property can never be junior to the interest of creditor’s including the claim of dissenting unsecured creditors * * * 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.
Id. at 790.
In re Jaurez, 2020 WL 7398994 (9th Cir. December 17, 2020), came to the same conclusion. It noted that the phrase “on account” as used in Section 1129(b)(2)(B)(ii) has significant meaning and “some particular limiting effect”. Id. at *3.
[Section] 1129(b)(2)(B)(ii) is not implicated when a debtor retains exempt property as a debtor does not “receive or retain” exempt property “under the plan on account of [a] junior claim or interest.” Rather, “[i]t is widely accepted that property deemed exempt from a debtor’s bankruptcy estate revests in the debtor” under 11 U.S.C. §522. In fact, the bankruptcy estate “consists of all the interests in property, legal and equitable, possessed by the debtor at the time of filing,” but “an interest [is] withdrawn from the estate” where an exemption is allowed. Owen v. Owen, 500 U.S. 305, 308, 111 S.Ct. 1822, 114 L.Ed.2d 350 (1991). A debtor therefore obtains exempt property from the bankruptcy estate by virtue of the right to exempt certain property under §522, not “under the plan on account of [a] junior claim or interest” such that §1129(b)(2)(B)(ii) is triggered.
Id. at *3.
Matthew T. Gensburg
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