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In re Maharaj, No. 11-1747

Decided: June 14, 2012

In this case, the Fourth Circuit resolved a longstanding division among bankruptcy and district courts, holding that the “absolute priority” rule remains applicable to individual debtors who file a Chapter 11 bankruptcy despite the 2005 enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”).

The court began its opinion by providing a history of the absolute priority rule.  In essence, the rule states that in a Chapter 11 business reorganization, the “stockholders are not entitled to any share of the capital stock nor to any dividend of the profits until all the debts of the corporation are paid.”  The court next described how the “cram down” procedure can be utilized by a debtor intending to retain property to achieve confirmation of a reorganization plan, but only if the absolute rule is complied with in regards to any dissenting creditors.  After Congress passed BAPCPA, however, there was disagreement over the application of the absolute priority rule “when the Chapter 11 debtor is an individual.”  While some courts read the amendments to BAPCPA as abrogating the absolute priority rule in individual debtor cases, other courts interpreted the statute narrowly to “merely have the effect of allowing individual Chapter 11 debtors to retain property and earnings acquired after the commencement of the case.”

In the dispute before the court, Ganess and Vena Maharaj (“Debtors”) filed a petition for bankruptcy under Chapter 11 after their auto body repair shop became burdened by significant debt.  The debtors submitted a Plan of Reorganization with the bankruptcy court that proposed dividing the creditors into four separate classes.  Class III was composed of general unsecured creditors whose claims would be impaired under the Debtors’ plan, and one of its members, Discover Bank, voted to reject the plan.  Due to Discover Bank’s opposition, the Debtors sought a cram down to confirm the plan, a move which would still allow the Debtors to retain and operate their business if, as the Debtors requested, the bankruptcy court ruled that the BAPCPA amendments abrogated the absolute priority rule.  If the court found that the absolute priority rule remained in effect, the Debtors “would have to liquidate their business to effectuate [the] cram down.”

The Fourth Circuit held that the plain language of the BAPCPA amendments was ambiguous and could be interpreted in multiple ways.  Despite the ambiguity of the statutory text, however, the court affirmed the bankruptcy court’s ruling that the absolute priority rule had not been abrogated by the BAPCPA provisions.   According to the court, viewing the specific circumstances surrounding the statute’s enactment along with the broader context of modern bankruptcy law, demonstrated Congress’ intent to preserve “the absolute priority rule as it operated prior to the passage of BAPCPA.”  As it related to a Chapter 11 proceeding, the BAPCPA provisions simply allowed an individual debtor requesting a cram down to “retain post-petition acquired property and earnings.”  The court relied on the Supreme Court’s view that the implied repeal of a longstanding bankruptcy doctrine, such as the absolute priority rule, “is strongly disfavored.”  The court stated that if Congress intended such a major change to the reorganization process, it would have been more clearly expressed in the statute.

Full Opinion

-John C. Bruton, III