The Absolute Priority Rule: Zachary v. California Bank & Trust
By Mary Jo Heston and Skyler M. Tanner
The Ninth Circuit Court of Appeals has now joined the Courts of Appeals from the Fourth, Fifth, Sixth and Tenth Circuits, and the Eighth Circuit Bankruptcy Appellate Panel (BAP) in holding that the absolute priority rule found in 11 U.S.C. § 1129(b)(2) (“the Absolute Priority Rule”) applies to limit individual debtors’ rights to retain prepetition property of their estate where their Chapter 11 plans propose to pay unsecured creditors less than the full amount of their allowed unsecured claims. Zachary v. California Bank & Trust (“Zachary”), — F.3d — (9th Cir. Jan. 28, 2016). In so holding, the Ninth Circuit overruled the Ninth Circuit BAP’s holding in In re Friedman, 466 B.R. 471 (9th Cir. B.A.P. 2012), which declined to apply the Absolute Priority Rule in an individual Chapter 11 case. Friedman has been followed by some bankruptcy courts within the Ninth Circuit and rejected by others. The Zachary holding enhances the leverage of unsecured creditors in Chapter 11 cases to receive larger distributions on account of their unsecured claims which may affect a secured creditor’s strategic decision on whether or not to make the 1111(b) election to be paid the full amount of its secured claim and not receive distributions as an unsecured creditor.
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