Like the Bankruptcy Appellate Panel, the Ninth Circuit declined to write a precedential opinion announcing whether an individual’s chapter 11 plan may permissibly preclude enforcement of a nondischargeable claim during the life of the plan.

In a case we reported on in August 2018, the Ninth Circuit BAP issued a nonprecedential opinion setting aside confirmation of a plan where a nondischargeable claim would increase during the five years the plan would have been in effect. In a 2/1 opinion on March 16, the Court of Appeals reached the same result, barring confirmation because there was no assurance the debtor could pay the nondischargeable debt once the plan was over.

A dissenter in the Ninth Circuit would have allowed confirmation because, in her view, the plan did nothing more than enforce the debtor’s rights under the automatic stay.

Background BAP Law and the Facts

In 2003, the Ninth Circuit BAP ruled in a case where an individual’s chapter 11 plan paid a nondischargeable claim in full over the life of the plan but enjoined the creditor from otherwise enforcing the nondischargeable judgment as long as the debtor was not in default. The BAP upheld confirmation, ruling there is no per se rule prohibiting a so-called collection injunction. Computer Task Group Inc. v. Brotby (In re Brotby), 303 B.R. 177 (B.A.P. 9th Cir. 2003).

[N.B.: The BAP opinion was handed down prior to the so-called BAPCPA amendments in 2005, which added Section 1141(d)(5)(A). In the case of an individual chapter 11 debtor, the section provides that confirmation will not discharge any debts “until the court grants a discharge on completion of all payments under the plan.” More about that section when we discuss the circuit court dissent.]

In the case at hand, the debtor was saddled with a $2.2 million nondischargeable judgment. The plan precluded the creditor from enforcing the judgment during the five-year life of the plan. The creditor would have been paid about 6% to 9% of the claim over the life of the plan. Other unsecured creditors were to be paid the same percentage.

Despite payments toward the nondischargeable debt, the claim would grow to about $3 million at the end of the five-year term of the plan as a result of interest accruals.

The creditor objected, but the bankruptcy court confirmed the plan.

In the per curiam opinion on July 31, 2018, the BAP set aside confirmation, saying there was “no provision for any meaningful payment” of the nondischargeable debt. In substance, the panel said the plan “essentially neuters [the creditor’s] right to be paid, and thus does not meet the good faith requirement.” Elite of Los Angeles Inc. v. Hamilton (In re Hamilton), 17-1273, 2018 BL 272353, 2018 WL 3637905 (B.A.P. 9th Cir. July 31, 2018).

Building on Brotby, the BAP said that Section 1142(d)(2), precluding discharge of a nondischargeable debt in an individual’s chapter 11 case, “does not prohibit a plan from placing conditions on the creditor’s right to collect such a claim.” Hinting that a collection injunction might be acceptable in a proper case, the BAP said that the court may confirm “a plan that merely delays, but does not imperil, the payment of a nondischargeable claim.”

In the case at hand, however, the BAP set aside confirmation, saying that delay, “which is effectively denial of payment, is not outweighed by any benefit to” the creditor. To read ABI’s report on the BAP opinion, click here.

The Circuit Majority Opinion

The debtor appealed, but the majority on the Ninth Circuit panel upheld the BAP in a nonprecedential opinion.

The majority’s opinion was unsigned. Those in the majority were Circuit Judges Morgan B. Christen and Danny J. Boggs. Judge Boggs was sitting by designation from the Sixth Circuit.

Like the BAP, the majority noted that Brotby and a similar case from a California bankruptcy court approved collection injunctions, but both were cases where the nondischargeable debts would be paid in full during the life of the plan. The majority found “no case in which our court (or the BAP) has approved a collection injunction in . . . circumstances” where the nondischargeable debt grew over the term of the plan.

The majority decided that the plan failed the feasibility requirement under Section 1129(a)(11), because the debtor would end up owing more on the nondischargeable debt than was owed when the plan was confirmed. In that regard, the majority noted that the bankruptcy court had not said whether the debtor would need further reorganization when the plan was over.

The majority said it “appears unlikely” that the debtor could pay the nondischargeable debt at the end of the term of the plan. For that reason, the majority decided that the plan was not proposed in good faith, as required by Section 1129(a)(3).

Finally, the majority ruled that the plan violated the absolute priority rule under Section 1129(b)(1), because the debtor was not providing sufficient new value to cover nonexempt assets that the debtor would retain.

Judge Ikuta’s Dissent

The dissent by Circuit Judge Sandra S. Ikuta is worth reading to appreciate the nuances of individual chapter 11 cases.

Judge Ikuta accused the majority of reversing the bankruptcy court “based solely on its own assessment of the equities.” In her view, the plan did nothing more than enforce the debtor’s rights under the Bankruptcy Code, and the automatic stay in particular.

Under Section 362(c)(2)(C), the automatic stay in an individual’s chapter 11 case remains until “a discharge is granted or denied.”

Unlike a corporate debtor, an individual in chapter 11 does not receive a discharge on confirmation. Rather, Section 1141(d)(5)(A), added in 2005, withholds a discharge until an individual chapter 11 debtor has completed “all payments under the plan.”

Putting the two Code provisions into simple language, Judge Ikuta said that “the stay continues until the plan ends.” She went on to add that the automatic stay “bars [the creditor] from enforcing the pre-petition judgment against him until the ‘completion of all payments under the plan,’” citing Section 1141(d)(5)(A).

Judge Ikuta therefore said that the “so-called collection injunction is functionally equivalent to the Code’s automatic stay, as amended by the BAPCPA.” Furthermore, she said that the Bankruptcy Code “does not require full payment of nondischargeable debt during the life of a plan.” Indeed, she said that the “collection injunction is unnecessary,” given Section 1141(d)(5)(A).

Because the plan did nothing more than enforce the automatic stay, Judge Ikuta would have held that the bankruptcy court did not abuse its discretion in approving the plan.

On feasibility, Judge Ikuta said that the confirmation requirement only requires proof that the debtor will “fulfill its obligation under the plan.” [Emphasis in original.] In her view, feasibility is not concerned with a debtor’s ability to make payments “after the plan has ended.” In other words, the growth of the nondischargeable debt “has no bearing on feasibility,” she said.

Regarding good faith, Judge Ikuta said that availing oneself of an applicable provision of the Bankruptcy Code is not evidence of bad faith, citing Ninth Circuit precedent. Furthermore, she found nothing in the statute suggesting that a plan is filed in bad faith “merely because the debtor will only partially pay an unsecured creditor’s nondischargeable debt during the life of a plan and the debt will increase due to the accrual of interest.”

Consequently, Judge Ikuta concluded that the bankruptcy court’s good faith finding was not clearly erroneous.

Judge Ikuta ended her dissent by saying that “the Code provides relief even for debtors who carry a near insurmountable amount of debt.”