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Exempt assets not subject to absolute priority rule

A debtor who offered $15,000 in new value to retain a home in which he had exempt equity far exceeding that amount was allowed to confirm a chapter 11 plan over the objections of his unsecured creditors. Addressing an issue of first impression in the Ninth Circuit, the Bankruptcy Appellate Panel ruled that the absolute priority rule does not require an individual debtor to pay for exempt assets with a new value contribution.

The debtor was a licensed real estate broker who filed a chapter 11 case to deal with unpaid taxes and an unsecured loan that exceeded $200,000. The debtor scheduled a home and reported the property’s value as $300,000. The property was encumbered by a $156,000 tax lien. The debtor claimed an exemption in the property for $150,000.

The debtor’s plan proposed to pay unsecured creditors a little more than $20,000 over a five-year period. The plan also proposed a $10,000 new value contribution to unsecured creditors. The lenders, who were members of the unsecured creditor class and who filed a claim for more than $250,000, objected to confirmation of the plan, arguing that the plan was not fair and equitable because it did not satisfy the absolute priority rule or the new value exception.

The bankruptcy court determined that the new value contribution of $10,000 was not adequately substantial and denied confirmation. The debtor amended his plan and proposed a $15,000 new value contribution and a payout to unsecured creditors of a little more than $30,000. The bankruptcy court confirmed the amended plan over the creditors’ objections.

On appeal, the creditors argued that the plan was not fair and equitable because the new value contribution proposed by the debtor was not reasonably equivalent to the equity he would retain in the property. A chapter 11 plan is fair and equitable to dissenting creditors if it provides (1) for the full payment of the creditors’ claims, or (2) that the debtor will not receive or retain any property under the plan. There are two exceptions. First, an individual debtor may retain post-petition property and income from post-petition services. Second, a debtor may pay for and retain a prepetition asset by contributing new value to the plan that is reasonably equivalent to the value of the asset retained.

According to the creditors, the debtor’s proposed $15,000 contribution was not reasonably equivalent to the equity the debtor would retain under the plan. The bankruptcy court determined that the contribution was reasonably equivalent to the encumbered value of the home. However, the creditors insisted that new value contributions must be equal to the total value of property retained by the debtor—both exempt and nonexempt parts—because the statute says that the debtor may not retain any property absent a reasonably equivalent new value contribution.

Noting a split of authority, the BAP rejected the creditors’ argument and held that the phrase “any property” does not include exempt property. Exempt property that has been removed from the estate prior to confirmation is not property that is received or retained “under the plan,” the BAP reasoned. The debtor retains exempt property because of an exemption statute. The debtor would keep the property even if a plan was never confirmed. Consequently, the absolute priority rule does not apply to exempt property.

Also, requiring a debtor to pay for exempt assets would create a conflict between the absolute priority rule and Bankruptcy Code Secs. 522(c) and (k), the BAP said. Those sections provide that exempt property is not liable for the payment of prepetition claims or administrative expenses. However, requiring a debtor to pay for exempt assets via a new value contribution would effectively make the assets available to prepetition and administrative expense claims of creditors.

(Todeschi v. Juarez (In re Juarez), No. AZ-19-1028-FLB, 2019 Bankr. LEXIS 2639 (B.A.P. 9th Cir. Aug. 21, 2019)