By: Donald L Swanson
“Subchapter V relieves small business debtors from the absolute priority rule.”[Fn. 1]
- This was the excuse for a contorted grammatical interpretation, against the debtor, of a Subchapter V statute by the Fifth Circuit Court of Appeals.
The Fourth Circuit Court of Appeals gives the same excuse for the same contorted grammatical interpretation — like this:
- “Given the elimination of the absolute priority rule” in Subchapter V,
- “Congress understandably applied limitations”:
- “to provide an additional layer of fairness and equity to creditors”; and
- “to balance against the altered order of priority that favors the debtor.”[Fn. 2]
Here’s the problem with that excuse: it’s totally unfounded. It’s a made-up excuse.
For starters:
- Congress did not “eliminate” the absolute priority rule in Subchapter V. Instead, Congress (i) codified a new-value exception that courts had refused to recognize in standard Chapter 11 cases, and (ii) thereby, overruled prior case law[fn. 3]; and
- Congress did so emphatically:
- as the main thing it wanted to accomplish; and
- not as a begrudging surrender, with a bunch of anti-debtor trade-offs hidden within the language of Subchapter V for courts to find.
I’ll try to explain with some history.
History
On October 1, 1979, the Bankruptcy Code became effective.
–1980s Farm Crisis
The 1980s began with an economic recession that turned into the 1980s Farm Crisis.
The 1980s Farm Crisis became a massive depopulation of the countryside:
- production agriculture changed, during that time, from a labor intensive process to a mechanized and high-tech industry; and
- what formerly required 10 people to accomplish . . . now takes only a few.
During the 1980s Farm Crisis, many farmers tried to keep their farms alive by filing Chapter 11 bankruptcy.
But farmers were prevented from doing so—almost universally—by the absolute priority rule. That rule says a Chapter 11 plan cannot be confirmed, with owners retaining their ownership interests, unless:
- unsecured creditors are paid in full [that could never happen]; or
- unsecured creditors agree to something less [that almost never happened].
Such a rule may make sense for the likes of General Motors, with its thousands of passive investors. But it’s a terrible rule when the business owners and managers are the same people.
The 1980s result is that Chapter 11 became, during the Farm Crisis, nothing more than this:
- hospice care for struggling farms.
That’s because creditors had an absolute veto over any and every Chapter 11 plan, under the absolute priority rule, and they exercised that veto in nearly every farm case.
Since farm debtors couldn’t confirm a Chapter 11 plan, they stayed in Chapter 11 until they ran out of cash—at which time secured creditors got relief from the automatic stay and foreclosed their liens.
- Those foreclosures, by the way, turned into economic disasters for everyone involved—for debtors and creditors alike.
Since every state in these United States has farms, the 1980s Farm Crisis became a political earthquake across the entire land. The result:
- politicians everywhere wanted to overrule the creditor veto that prevented farmers from confirming Chapter 11 plans; and
- that’s what they did–codifying in Chapter 12 a new-value exception to the absolute priority rule and overruling prior case law that refused to recognize such an exception.
–Chapter 12
Congress enacted Chapter 12 so that farmers could actually have a reorganization opportunity based on asset values, projected income and feasibility—
- instead of being forced into liquidation by creditors and their absolute veto.
Both houses of Congress approved Chapter 12 on voice votes, signifying that the approval was unanimous or nearly so.
What politicians wanted, emphatically, in enacting Chapter 12, was to change the rule (i.e., the absolute priority rule) that prevented farmers from reorganizing. It’s the main thing that Congress wanted to do—with a “Heck yeah!” emphasis added.
The idea that Congress hid a bunch of anti-debtor trade-offs within Chapter 12 for courts to find with contorted grammatical interpretations, to compensate creditors for the loss of their absolute veto, is a later-day invention and fantasy.
Here are a couple real-time explanations of what actually happened. Senator Charles Grassley:
- “pushed Chapter 12 through with his passionate mission of ‘saving the family farm.’ In only three months, Chapter 12 made the journey through the traditionally lengthy and extensive legislative process, evidencing the overwhelming bipartisan support for this mission”[fn. 4]; and
- explained, “We simply must stop the displacement. We must stop the bleeding on the farm” and noted that “farm problems are not just a problem for farmers and their lenders. There is an impact on other ‘main street’ and ‘mom and pop’ firms too, that cannot be overlooked.”[Fn. 5]
–Subchapter V
As a bankruptcy attorney who lived through the 1980s Farm Crisis in a farm state, I wondered for decades why Congress did not enact a Chapter 12 counterpart for other small and medium sized businesses.
- It always seemed like the logical next step, because main street businesses had the same difficulties that farmers experienced in reorganizing under standard Chapter 11.
And that’s exactly what Congress did in creating Subchapter V — with exactly the same policy considerations in mind that animated the creation of Chapter 12:
- to codify a new-value exception to the absolute priority rule for smaller businesses; and
- to overrule prior case law rejecting such an exception in standard Chapter 11.
As in Chapter 12, Congress did not hide a bunch of trade-offs within Subchapter V for courts to find by contorted grammatical interpretations, to compensate creditors for the new-value exception to their absolute veto.
Congress codified the new-value exception into Subchapter V as the main thing it was trying to do. And the idea of hidden creditor trade-offs within Subchapter is a later-day invention and fantasy.
Conclusion
I’m not buying the anti-debtor idea behind the Fifth Circuit and Fourth Circuit opinions.
Congress did not hide a bunch of trade-offs in Subchapter V statutes for courts to find through contorted grammatical interpretations.
The idea that Congress did such a thing to provide “an additional layer of fairness and equity to creditors” or “against the altered order” is pure fantasy.
It’s a false excuse. It’s a made-up basis for appellate judges to impose their own policy preferences upon what Congress created.
———————-
Footnote 1. This quote is from Avion Funding, L.L.C. v. GFS Industries, L.L.C., Case No. 23-50237 in the Fifth Circuit Court of Appeals, issued April 17, 2024, at 1 (emphasis added).
Footnote 2. These quotes are from Cantwell-Cleary Co., Inc., v. Cleary Packing, LLC, 36 F.4th 509, 517 (4th Cir. 2022).
Footnote 3. The two Supreme Court cases with rulings that Congress overruled, by enacting Subchapter V, are, (i) Norwest Bank Worthington v. Ahlers, 485 U.S. 197 (1988) (the “promise of future ‘labor, experience, and expertise’ . . . violated the ‘absolute priority rule'”), and (ii) Bank of America National Trust and Savings Ass’n v. 203 North LaSalle Street Part., 526 U.S. 434 (1999) (“old equity holders are disqualified from participating in such a ‘new-value’ transaction by the [absolute priority rule]”).
Footnote 4. Alexandria C. Quinn, The Next Generation of Chapter 12 Bankruptcy: Revising the Remedy, 22 Drake Journal of Agricultural Law 245, at 245 (2017).
Footnote 5. Barnes G. Kelley, Note, Chapter 12: Entrepreneur Punishment and Family Favorites, 15 Drake Journal of Agricultural Law 485, at 486 (2010).
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