Maybe Chapter 11 Can Work for Individuals After All

“Can individuals file for Chapter 11? I thought it was just for corporations.” That’s a question I hear frequently when I suggest that Chapter 11 might be an option for an individual. And that option became even more realistic with the Friedman case recently decided by the 9th Circuit BAP.

The issue decided by the Friedman court was whether the “absolute priority rule” applies in individual cases. The absolute priority rule comes from 11 U.S.C. Sec. 1129(b)(2)(B)(ii). It essentially provides that unless all classes consent to the plan, a lower priority claimant cannot be paid or retain anything unless all higher priority claimants are paid in full. In bankruptcy, the owner is the lowest priority claimant. So, the owner cannot retain ownership unless everyone gets paid in full. There are ways around this for corporate cases (such as the owner contributing new value), but in individual cases, this is often much more difficult.

When the 2005 amendments were passed, the consensus among bankruptcy practitioners was that a change in the code did away with the absolute priority rule for individuals and most early courts adopted that view. However, an emerging number of courts have been questioning and departing from that view over the last few years. The Friedman court examined the language in question and found that on its face the absolute priority rule did not apply to individual Chapter 11 debtors, noting that the 2005 amendments were designed to make Chapter 11 more like Chapter 13 for individual debtors.

So, yes, individuals can file Chapter 11. And now with the Friedman decision, Chapter 11 may even be a workable solution for individuals who cannot afford to pay less than 100% to all creditors.