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Whether it’s “Mr. Las Vegas” or crazy actors, celebrities always seem to have financial troubles. That’s part of what makes them so entertaining. Understandably, the large amounts of money they make (and owe) can sometimes push them into consumer bankruptcies of the Chapter 11 variety. But it turns out that this is not the exclusive territory of the rich and famous. In fact, every lawyer should be aware of how Chapter 11 is playing out today—after all, you might just end up representing a debtor or creditor very soon.
One reason that even normal, non-celebrity people are interested in consumer Chapter 11 is housing. A few years ago when housing prices were high, many borrowed against their home equity with multiple mortgages, betting that housing prices would keep going up. They did not.
Today, with more than one in four U.S. mortgages still underwater, this is still leading to bankruptcies (though the situation is getting better now). If the homeowners’ secured debt exceeds $1,081,000 or their combined unsecured debt exceeds $360,475, and they want to keep their house, Chapter 11 becomes their only bankruptcy option because of limits on the amount of debt allowed in Chapter 13. Unlike those filing individual Chapter 7 bankruptcies, debtors under Chapter 11 are often able to keep their homes, sometimes eliminate their junior mortgages, and restructure other secured debts. That sounds really good for the debtors, doesn’t it? Well…
This doesn’t make Chapter 11 bankruptcies a panacea for financial trouble. Many people have shied away from this kind of filing for good reasons. First of all, there is no trustee, so debtors have to look out for themselves. These kinds of bankruptcies are also more time-consuming and expensive to file in almost every way. They can also give less control to the debtor. Chapter 13 filings are completely voluntary—you can back out at any time. Not so with Chapter 11. Once the cases are begun, it might be impossible to stop them without creditors’ approval. Unhappy creditors can vote to sink a proposed restructuring, which could lead to a liquidation. This leads us to the most crucial aspect of bankruptcies like this: the negotiation.
“Bankruptcy lawyers are lovers, not fighters,” goes the adage. This is where you can really help your clients most. Chapter 11 bankruptcies typically have a lot more stakeholders, and at least some of them need to be pleased or placated to make the whole process successful. That means communicating with the other legal representatives—early and often—to find out what the objections and options are, and how everyone is being treated.
These negotiations will be complicated in the near term. That’s because of confusion surrounding how the time-honored “Absolute Priority Rule” applies to individuals. Although the term doesn’t actually appear in the United States Bankruptcy Code (11 U.S.C. section 101 et seq.), this rule holds that debt should be repaid before any return on equity. What this means for a person, as opposed to a corporation, and whether the rule applies at all, is being debated. The Ninth Circuit Bankruptcy Appellate Panel says “no.” The Fourth Circuit Court of Appeals says “yes.” Other courts have come down on one side or the other. This may take some time.
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