BAPCPA: Absolute Priority Rule No Longers Applies to Individual Chapter 11 Debtor

As previously mentioned, Chief Judge Paul G. Hyman held in the Gosman case that the retention of exempt property by an individual debtor in a chapter 11 violates the absolute priority rules unless unsecured creditors are paid in full. In re Gosman, 282 B.R. 45 (Bankr. S.D. Fla. 2002). Also as previously noted, some courts disagree with the Gosman decision and hold that the debtor’s retention of his exempt property is not subject to the absolute priority rule. See eg. In re Bullard, 358 B.R. 541 (Bankr. D.Conn. 2007)(the retention of exempt property is not on account of the debtor’s junior interest in property).

Since the passage of BAPCPA and its amendments to 11 USC 1129(b)(2)(B)(ii), there has been some commentary (Hon. Norton, Hon Drake, etc.) that the absolute priority rule is no longer applicable to an individual chapter 11 debtor’s retention of property. Judge Saladino’s decision in In re Tegeder, ___ B.R. ____, 2007 WL 1549067 (Bkrtcy.D.Neb.) is apparently the first decision to end this speculation, at least in his courtroom.

The court in Tegeder held that new 1129(b)(2)(B)(ii) provides an exception to the absolute priority rule for the retention of property by individual chapter 11 debtors and that the “absolute priority requirements imposed by Code 1129(b)(2)(B)(ii) were waived by permitting a debtor to retain property included in the estate under 1115. BAPCPA added the following to 1129(b)(2)(B)(ii) “except that in a case in which the debtor is an individual, the debtor may retain property included in the estate under section 1115, subject to the requirements of subsection (a)(14) of this section”. New section 1115 defines property of the estate to include property specified in section 541 as well as property acquired post-petition and earnings from services performed post-petition.

The court states that interpreting new 1129(b)(2)(B)(ii) any narrower would cause the amendment to have little effect.

Non-Rented Partially Detached Unit Held Part of Exempt Homestead

In reviewing the recent decision of In re Ensenat, Case No. 06-15979-BKC-LMI (S.D. Fla. Isicoff 2007), one is reminded how fact specific may be the determination of the extent of a Florida homestead exemption under Article X, Section 4(a)(1) of the Florida Constitution. The case involved a parcel of real property with two buildings. The first building was the debtors’ home and the second building was a partially detached unit that was occupied by the debtors’ niece, her son, and her boyfriend. The partially detached unit was a separate building with its own kitchen and utility meters that was attached to the main house by a covered patio. The Court found that there was no payment of rent, but that the boyfriend paid their separate water and electric bill, mowed the lawn, and made various contributions, including the buying of groceries.

The Chapter 7 trustee argued that the second building was not part of the Debtors’ “residence” and that the Debtors’ niece (actually “half-niece”) was not a member of the Debtors’ “family.” Article X, Section 4(a)(1) limits the homestead exemption to that of the residence of the owner or his family.

The Court stated that a separate structure on what is otherwise homestead property is not disqualified merely because it is a separate structure. The Court cited a 1917 Florida Supreme Court Decision that observed that the homestead exemption would “doubtless include outhouses, barns, wagon houses, wood or coal sheds, chicken houses, fences, etc. as were appurtenant and subsidiary to and used in connection with the residence as conveniences and auxiliaries.” Armour & Co. v. Hulvey, 74 So. 212 (Fla. 1917). Such improvements would be protected as “improvements” to the homestead. The Court also cited another decision that held that the homestead included a garage and overhead apartment used for storage and laundry. White v. Posick, 150 So. 2d 263, 265 (Fla. 2d DCA 1963).

The Court observed that “to the extent court have found abandonment or waiver of the homestead exemption in a separate structure it was because the homeowner at some time used that portion of the property to generate income.” But the Court further noted that if the business purpose ceases, the homestead status may be regained.

After noting that Florida law recognizes “families-at-law” and “families-in-fact”, the Court held that it was not clear whether or not the niece, son, and boyfriend qualified as the Debtors’ “family” under the Article X Section 4(a)(1) of Florida Constitution. But the Court concluded that whether are not these persons qualified as the Debtors’ “family”, the debtors were entitled to claim the entire parcel as exempt homestead as the second structure was not used for a business purpose.

One might query how the holding may have been different had the court found the boyfriend’s payment of the electric bill, mowing of the lawn, and various contributions, including the buying of groceries to be a form of constructive rent. Apparently this would have rendered the second structure to be considered as used for a business business and therefore non-exempt.

One may also note that the Trustee had initially argued that the two structures constituted a duplex, but at trial acknowledged that they were actually two separate structures joined by a roofed patio. Perhaps, the Court’s decision would have been the same even if the two structures constituted a duplex as long as the second unit was not rented out. The majority of the bankruptcy courts in Florida would not allow an exemption for a side of a duplex that is rented out. In re Bornstein, 335 B.R. 462 (Bkrtcy. M.D. Fla. 2005, In re Dudeney, 159 B.R. 1003 (Bankr.S.D.Fla. 1993).