NORWEST BANK WORTHINGTON AND FEDERAL LAND BANK OF ST. PAUL, PETITIONERS V. JAMES R. AHLERS AND MARY M. AHLERS No. 86-958 In the Supreme Court of the United States 4 October Term, 1987 On Writ of Certiorari to the United States Court of Appeals for the Eighth Circuit Brief for the United States as Amicus Curiae Supporting Petitioners TABLE OF CONTENTS Question presented Interest of the United States Statement Summary of argument Argument: A court may not confirm a plan of reorganization under Chapter 11 of the Bankruptcy Code without the consent of a class of unsecured creditors whose claims are impaired and who do not receive property of a value equal to the allowed amount of their claims, if the plan allows junior interests to participate on the basis of future contributions of "labor, experience, and expertise" A. Chapter 11 of the Bankruptcy Code gives an impaired, dissenting class of unsecured creditors absolute priority over equity holders B. There is no exception to the absolute priority rule that allows equity holders to participate in a plan of reorganization under Chapter 11, over the objection of a dissenting, impaired class of creditors whose claims have not been fully honored, on the basis of a contribution of future "labor, experience, and expertise" 1. Chapter 11 of the Bankruptcy Code does not contain an exception to the absolute priority rule for equity holders who contribute to the reorganized enterprise 2. Even if the Bankruptcy Code should be read to contain an exception to the absolute priority rule for equity holders who contribute money or money's worth to the reorganized enterprise, respondents' "labor, experience, and expertise" is not such a contribution Conclusion QUESTION PRESENTED Whether a plan of reorganization under Chapter 11 of the Bankruptcy Code may be confirmed without the assent of a class of unsecured creditors whose claims are impaired and who do not receive property of a value equal to the allowed amount of their claims, if the plan allows the debtor to participate on the basis of future contributions of "labor, experience, and expertise." INTEREST OF THE UNITED STATES The United States and its agencies are often creditors in bankruptcy proceedings. For example, the Internal Revenue Service is a creditor in a very high percentage of bankruptcy proceedings because of federal taxes owed by the debtor. Other agencies, such as the Farmers Home Administration of the Department of Agriculture and the Small Business Administration, make loans to private parties, some of which enter bankruptcy before repaying the loans. Still other agencies, such as the Federal Deposit Insurance Corporation, become creditors in bankruptcy proceedings because of the failure of entities that they insure. The question presented by this case affects the rights of creditors vis-a-vis debtors. The United States therefore has an interest in the proper resolution of that question. The United States filed a brief at the petition stage of this case at the invitation of the Court. STATEMENT 1. This case arises from the bankruptcy petition of respondents James and Mary Ahlers. Respondents farm land in Nobles County, Minnesota. Between 1965 and 1982, they obtained four loans from petitioner Federal Land Bank (FLB) and secured each of these loans with a separate parcel of land they owned (Pet. App. A3). Between 1982 and 1984, respondents obtained additional loans from petitioner Norwest Bank Washington (Norwest). The security for these loans was a second mortgage on the property already securing FLB's loans and a first mortgage on respondents' farm machinery, farm equipment, crops, livestock, and other farm proceeds (id. at A4). Respondents defaulted on their loans. Norwest, exercising its rights as a secured creditor, filed a replevin action in Minnesota state court seeking possession of respondents' farm equipment and machinery (Pet. App. A4). Two weeks later, respondents filed a petition for reorganization under Chapter 11 of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 1101 et seq. (Pet. App. A4-A5). This petition automatically stayed Norwest's collection efforts in state court (11 U.S.C. (& Supp. III) 362(a)). 2. a. Petitioners filed motions in the bankruptcy court for relief from the automatic stay, see 11 U.S.C. (& Supp. III) 362(d), asserting that respondents could not provide them adequate protection. The court, after examining respondents' financial situation, agreed with petitioners and lifted the stay (Pet. App. A63-A66). Respondents appealed this decision to the district court. b. The district court denied respondents' motion to stay petitioners' collection efforts pending its resolution of the appeal, but it agreed to enjoin petitioners from initiating any foreclosure proceedings pending appeal of the denial of the stay motion to the court of appeals. The court of appeals issued a stay and remanded the case to the district court for adjudication of respondents' appeal (Pet. App. A75-A77). In so doing, the court noted that respondents' 1985 crops were not subject to any liens and that those crops "have a value sufficient to reasonably insure that neither creditor will be further harmed if foreclosure and repossession proceedings are stayed" (id. at A76). The court gave petitioners a lien on those crops, ordered respondents to provide Norwest with assurances that all farm machinery and equipment was fully insured, and requested that the district court determine the merits of the request for relief from the automatic stay, including the probability of success of respondents' proposed plan of reorganization (id. at A76-A77). c. The district court affirmed the bankruptcy court's order granting petitioners relief from the automatic stay (Pet. App. A84-A86). The court held that the factual findings of the bankruptcy court, which were not clearly erroneous, required that petitioners' interests be given adequate protection, and that respondents were unable to provide such protection (ibid.). Pursuant to the instructions of the court of appeals, the district court then evaluated the likelihood of success of respondents' proposed plan of reorganization. The court found that no such likelihood existed, concluding that three facts doomed any chance that respondents would have of successfully reorganizing: respondents had an asset-to-liability ratio of .67 to 1; they had "failed to establish their ability to operate profitably in the future"; and American farmers in general face oppressive economic conditions that are unlikely to improve soon (id. at A87). 3. a. The court of appeals reversed the bankruptcy court's order that granted petitioners relief from the automatic stay. The court first held that the bankruptcy court and the district court had analyzed the adequate protection issue improperly and that petitioners were not entitled to immediate relief from the stay because of a lack of adequate protection (Pet. App. A7-A12). b. The court then addressed petitioners' argument that the automatic stay must be lifted because of the district court's finding that the respondents' proposed reorganization plan was infeasible. Section 362(d)(2) of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 362(d)(2), requires the bankruptcy court to lift the automatic stay if the debtor has no equity in the property on which the creditor seeks to foreclose and the property "is not necessary to an effective reorganization." All agreed that respondents have no equity in their property, and petitioners argued that, because respondents have no likelihood of achieving a successful reorganization, it follows that none of their property would be "necessary to an effective reorganization." The court of appeals agreed that, if no reorganization was feasible, the stay should be lifted (Pet. App. A15). The court, however, reversed the district court's finding that there was not a reasonable likelihood of a successful reorganization. The court concluded that the district court, in determining the extent to which petitioners' claims were secured, erred in using the valuations that the bankruptcy court had made in ruling on the adequate protection issue. The court held that the extent to which petitioners were secured creditors had to be determined according to the value of the property at the time that the plan would be confirmed (id. at A16). The court, in dictum, opined that respondents could indeed propose a feasible reorganization plan (id. at A17-A19, A37-A49). /1/ The court next rejected petitioners' contention that, because they had legitimate objections to any proposed plan that would allow respondents to retain an interest in the property, the bankruptcy court would be precluded from confirming the plan. Petitioners argued that, because their claims were substantially undersecured, any plan of reorganization would have to treat them as unsecured creditors for this portion of their claims (see 11 U.S.C. 506(a)). They noted that no realistic plan proposed by respondents would provide for full payment of these unsecured claims. Thus, petitioners concluded that any plan that included respondents' participation could not satisfy the absolute priority rule embodied in 11 U.S.C. (& Supp. III) 1129(b) and could not be confirmed over their objections. /2/ The court of appeals rejected petitioners' interpretation of Section 1129. It interpreted that section as applying a "modified version of the traditional absolute priority rule" (Pet. App. A22), under which a plan proposed by respondents could be confirmed over petitioners' objections so long as respondents retain an interest that does not exceed the value of their future "labor, experience, and expertise" (id. at A26). The court cited this Court's decision in Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1939), which it read as allowing a debtor to participate in a reorganization so long as he "contributes to the reorganization enterprise something that is reasonably compensatory and is measurable" (Pet. App. A24). The court then reasoned that respondents' promise to contribute their future labor and their expertise met this requirement, and thus respondents could retain an equity interest in the property equal to the value of those contributions (id. at A24-A25). c. Judge Gibson dissented. He criticized the majority for misinterpreting Los Angeles Lumber, which he read as allowing debtor participation in a reorganization only when the debtor contributes cash or makes contributions "distinctly capital in nature" (Pet. App. A34). /3/ Judge Gibson argued that, because respondents' labor clearly did not fall within this narrow exception to the absolute priority rule, any proposed plan that allowed them to retain an interest could not be confirmed (id. at A34-A35). 4. The court of appeals denied rehearing en banc (Pet. App. A51-A58). Four of the five judges who voted for rehearing en banc joined an opinion that labeled the court's ruling on the absolute priority issue "directly contrary to * * * Los Angeles Lumber" (id. at A54). The other dissenting judge expressed tentative agreement with the panel dissent (ibid.). SUMMARY OF ARGUMENT The absolute priority rule, which was originally a judicial gloss on the phrase "fair and equitable" as used in the old Bankruptcy Act, has now been codified in Chapter 11 of the Bankruptcy Code. Under this codification, an impaired, dissenting class of unsecured creditors may block confirmation of a plan of reorganization unless (i) members of the class receive or retain property of a value equal to the allowed amount of their claims or (ii) no junior interests (such as the debtor or equity holders in the debtor) participate in the plan. This rule recognizes that the creditors of an insolvent enterprise are the owners of that enterprise and should receive the benefit if the enterprise succeeds in reorganization. The Code allows unsecured creditors to consent to the participation of more junior interests, even though the claims of unsecured creditors have not been fully honored, in recognition of the fact that participation of the more junior interests will sometimes be advantageous to the creditors. Before passage of the Code, equity holders could in some circumstances participate in a plan of reorganization even without the consent of unsecured creditors whose claims were not fully honored. See, e.g., Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 117, 121-122 (1939) (dictum). In other words, before the Code the determination whether junior participation would be advantageous to creditors whose claims were not fully honored was not left entirely to the judgment of those creditors. But the Code does leave that determination to the creditors (voting as a class) and thus has abolished the Los Angeles Lumber exception to the absolute priority rule. The Code, for the first time, gives a statutory definition of "fair and equitable" rather than leaving the matter to judicial development, and the express terms of the Code leave no room for an exception to the absolute priority rule. Rather, any accommodation of equity holders in a plan of reorganization that does not leave each unsecured creditor with property of a value equal to the allowed amount of its claim must come through agreement among the interested parties. In any event, the exception discussed in Los Angeles Lumber is far too narrow to permit equity holders to participate in a plan of reorganization on the basis of a contribution of future "labor, experience, and expertise," over the objection of a class of unsecured creditors whose claims have not been fully honored. The Court in that very case rejected the argument that such "intangibles" as "'financial standing and influence in the community' (which) can provide a 'continuity of management'" (308 U.S. at 122 (citation omitted)) may constitute the kind of contribution that might permit unconsented-to participation by equity holders when creditor claims have not been fully honored. The Court in Los Angeles Lumber likewise rejected the argument, accepted by the court of appeals in this case, that a court may force dissenting creditors who are not receiving "fair and equitable" treatment to accept a plan of reorganization merely because, in the court's view, the plan will preserve the going-concern value of an enterprise. The final argument of the court of appeals -- that the absolute priority rule must be abrogated in order to allow farmers to reorganize -- is a policy argument that Congress has accepted in recent amendments adding Chapter 12 to the Bankruptcy Code, but it does not justify the result reached in this Chapter 11 case. ARGUMENT A COURT MAY NOT CONFIRM A PLAN OF REORGANIZATION UNDER CHAPTER 11 OF THE BANKRUPTCY CODE WITHOUT THE CONSENT OF A CLASS OF UNSECURED CREDITORS WHOSE CLAIMS ARE IMPAIRED AND WHO DO NOT RECEIVE PROPERTY OF A VALUE EQUAL TO THE ALLOWED AMOUNT OF THEIR CLAIMS, IF THE PLAN ALLOWS JUNIOR INTERESTS TO PARTICIPATE ON THE BASIS OF FUTURE CONTRIBUTIONS OF "LABOR, EXPERIENCE, AND EXPERTISE" Section 362(d)(2) of the Bankruptcy Code provides for lifting the automatic stay when (1) the debtor has no equity in the property sought to be removed from the stay's protection and (2) that property is not necessary for a successful reorganization. In this case it is undisputed that the first requirement is met. The second requirement is satisfied whenever the debtor fails to show that, with the property the creditor seeks, it is "realistically possible" that the debtor could successfully reorganize. See, e.g., Pet. App. A15; In re Albany Partners, Ltd., 749 F.2d 670, 673 n.7 (11th Cir. 1984); In re Craghead, 57 Bankr. 366, 370 (W.D. Mo. 1985). The stay in this case should therefore be lifted if there is no realistic possibility that respondents could successfully reorganize. A plan of reorganization may be confirmed only if it meets either the terms of 11 U.S.C. (& Supp. III) 1129(a)(8), which permits confirmation when every creditor class either is "not impaired" /4/ or accepts the plan, or the terms of 11 U.S.C. (& Supp. III) 1129(b), which in essence allows a plan to be imposed on an impaired, dissenting class if it is "fair and equitable." /5/ It is undisputed that respondents could not propose a plan that meets the terms of Section 1129(a)(8), because petitioners will clearly be impaired, and they have, and have said they will assert, legitimate objections to any proposed plan of reorganization (Pet. App. A19). Because of the size of their unsecured claims, their objection would prevent the class of unsecured creditors from assenting to any reorganization plan (see id. at A46). /6/ Accordingly, respondents could successfully reorganize only if they could propose a plan that meets the terms of Section 1129(b), which requires that the plan be "fair and equitable." The court of appeals recognized that, in light of respondents' financial condition, "any realistic reorganization plan proposed by (respondents) could not provide the unsecured creditors with property equal to the amount of their allowed claims" (Pet. App. A22). It is also undisputed that respondents have nothing to contribute to a plan of reorganization other than their "labor, experience, and expertise" (id. at A26). But a plan of reorganization that allows debtor participation in these circumstances cannot be "fair and equitable" within the meaning of the Bankruptcy Code. Petitioners are therefore entitled to the lifting of the automatic stay. A. Chapter 11 of the Bankruptcy Code Gives an Impaired, Dissenting Class of Unsecured Creditors Absolute Priority over Equity Holders The Bankruptcy Code delineates the criteria that must be satisfied for a plan to be "fair and equitable." /7/ If the impaired, dissenting class is unsecured, /8/ a plan is "fair and equitable" as to members of that class only if each member "receive(s) or retain(s) on account of (its) claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim" (11 U.S.C. 1129(b)(2)(B)(i)) or if no junior interests participate in the reorganization (11 U.S.C. (& Supp. III) 1129(b)(2)(B)(ii)). This requirement is the statutory embodiment of what has come to be known as the "absolute priority" rule. The absolute priority rule plays an important role in bankruptcy proceedings under Chapter 11. When an enterprise files for bankruptcy, it can either be reorganized under Chapter 11 or liquidated under Chapter 7, 11 U.S.C. (& Supp. III) 701 et seq. /9/ Whether a company should be reorganized or liquidated depends on whether it is worth more as a going concern than if it were liquidated piecemeal. See 11 U.S.C. (& Supp. III) 1129(a)(7) (allowing confirmation of reorganization plan only when each creditor is assured of receiving at least what it would receive in a liquidation, or consents to less favorable treatment). When the company is worth more as a going concern than it would be if it were liquidated, there is a going-concern surplus. The absolute priority rule requires that any such surplus be distributed to the creditors according to the priority of their claims and that the debtor share in the enterprise only after creditors' claims have been fully honored. /10/ The rationale for that rule is that when an enterprise /11/ is solvent, i.e., when its debts exceed the present value of its assets, all of its assets are properly treated as owned by the creditors. Therefore, when the assets remain in the enterprise and it is reorganized, the reorganized enterprise properly belongs to the creditors. Equity interests, whose claims against the old enterprise had no value because it was insolvent, contribute nothing to the reorganized enterprise. See Jackson, Bankruptcy, Non-Bankruptcy Entitlements, and the Creditors' Bargain, 91 Yale L.J. 857, 894 (1982) ("Reorganization proceedings provide nothing more than a method by which the sale of an enterprise as a going concern may be made to the creditors themselves."). By leaving their assets in a reorganized enterprise, creditors gamble that there will indeed be a going-concern surplus and that they will ultimately fare better than if the enterprise were liquidated. As Judge Friendly recognized, in this situation "it is hard to see why (the unsecured creditors) should not reap the entire gain if the gamble succeeds, rather than allow the stockholders to have what essentially is a free ride." SEC v. Canandaigua Enterprises Corp., 339 F.2d 14, 21 (2d Cir. 1964). /12/ This is not to say that equity holders can never participate in a reorganized enterprise. At times, it may be advantageous to the creditors to allow equity holders to participate in a plan of reorganization even though creditors' claims have not been fully honored. The participation of current equity holders may sometimes appear necessary to capture the going-concern surplus that is the raison d'etre of reorganization. This Court has suggested that this may be the case, for example, when the enterprise lacks the necessary cash to operate and equity holders are the only willing sources of such cash. Kansas City Terminal Ry. v. Central Union Trust Co., 271 U.S. 445, 455 (1926). But see p. 22, infra. Or the equity holders may also be the managers and may have experience, expertise, and management skills that make the enterprise more valuable than it would be without them. In those situations, both creditors and equity holders have an incentive to negotiate an agreement that allows continuing participation by the equity holders. The creditors realize that, if they do not allow the equity holders to participate, they will lose the value that the equity holders would otherwise contribute to the reorganized firm. The equity holders, on the other hand, realize that, if they do not engage in good-faith bargaining, they will walk away with nothing. Chapter 11 permits the creditor classes to agree to equity-holder participation, even though creditors' claims are not fully honored, when the creditors, voting as classes, believe that their best interests would be served. Rather than require every plan of reorganization to be fair and equitable (as old Chapter X did), Chapter 11 provides that a class of creditors may consent to a plan under which its members' claims are not fully honored and junior claimants nevertheless participate (11 U.S.C. 1128(a)(8)(A)). /13/ The express purpose of this is to provide a mechanism whereby the parties in interest can reach a mutually beneficial agreement as determined by the requisite vote of each class. See H.R. Rep. 95-595, 95th Cong., 1st Sess. 224 (1977) ("(N)egotiation among the parties after full disclosure will govern how the value of the reorganizing company will be distributed among creditors and stockholders. * * * Only when the parties are unable to agree on a proper distribution of the value of the company does the (Bankruptcy Code) establish a financiaL standard."); Blum & Kaplan, The Absolute Priority Doctrine in Corporate Reorganizations, 41 U. Chi. L. Rev. 651, 653 (1974) ("The absolute priority doctrine can be characterized as a way of structuring negotiations so that they are sufficiently disciplined to be held within permissible areas and to permit judicial review."). It is against this background and statutory structure that respondents' attempt to include themselves in a plan of reorganization, despite a conceded inability to honor fully the claims of an impaired, dissenting class of unsecured creditors, must be tested. Although the secured debt substantially exceeded the value of petitioners' collateral, the court of appeals concluded that a plan would be feasible if it provided for a scaling down of the secured claims to the present value of the collateral, with new secured notes to be awarded against the scaled-down secured claims, and long-term unsecured notes (bearing no interest) to be awarded against the balance. /14/ The court of appeals then ruled that such a plan could be imposed on a nonassenting class of unsecured creditors because it would be "fair and equitable": it would not violate the requirement of Section 1129(b)(2)(B) that, unless unsecured creditors receive property of a value equal to their claims, junior interests may receive nothing. The court of appeals reached that conclusion because, it said, there is an uncodified exception to that rule when the junior interests make a contribution in "money or money's worth," and contributions of "labor, experience, and expertise" satisfy that requirement. We submit that both conclusions are wrong: no such exception to the creditors' entitlement to "absolute priority" is permitted by the Bankruptcy Code, and the contribution suggested by the court of appeals would not have satisfied the requirements of pre-Code cases. B. There Is No Exception to the Absolute Priority Rule That Allows Equity Holders to Participate in a Plan of Reorganization Under Chapter 11, over the Objection of a Dissenting, Impaired Class of Creditors Whose Claims Have Not Been Fully Honored, on the Basis of a Contribution of Future "Labor, Experience, and Expertise" 1. Chapter 11 of the Bankruptcy Code does not contain an exception to the absolute priority rule for equity holders who contribute to the reorganized enterprise Before the passage in 1978 of the Bankruptcy Code, 11 U.S.C. (& Supp. III) 101 et seq., there were circumstances in which an equity holder could participate in a reorganized enterprise even though the claims of the creditors of the enterprise were not fully honored and those creditors did not consent to such participation. See, e.g., Case v. Los Angeles Lumber Products Co., 308 U.S. 106, 117, 121-122 (1939) (dictum). The court of appeals assumed, without ever explaining where its rule of law could be found in the Bankruptcy Code, that such participation is still possible. It then went on to hold -- erroneously (see pp. 23-30, infra) -- that the necessary conditions for shareholder participation were met in this case. We submit, however, that the court's first error was its failure to recognize thagt the Code has changed prior law and that, under Chapter 11 of the Code, equity owners can never participate in a reorganized enterprise over the dissent of a class of creditors whose claims are impaired and who do not receive or retain property of a value equal to the allowed amount of their claims. /15/ a. The opinion of Justice Douglas for a unanimous Court in Case v. Los Angeles Lumber Products Co., supra, strongly reaffirmed the principle that "'creditors are entitled to priority over stockholders against all the property of an insolvent corporation.'" 308 U.S. at 116 (quoting Kansas City Terminal Ry. v. Central Union Trust Co., 271 U.S. 445, 455 (1926)). The Court in Los Angeles Lumber reviewed a plan of reorganization, which had been approved by the lower courts, that allowed stockholders to participate in the reorganized company, although the claims of bondholders were not to be fully honored. The bankruptcy court had found, and the court of appeals had affirmed, that participation would "be an asset of value" to the new corporation "because of the familiarity of these stockholders with the business * * * and because of their financial standing and influence in the community." In re Los Angeles Lumber Products Co., 100 F.2d 963, 965 (9th Cir. 1939). The lower courts concluded that these findings allowed the plan to be confirmed despite the objection of certain bondholders. /16/ This Court, while not disagreeing with the factual findings of the lower courts, held that the old stockholders did not contribute anything to the plan that would allow the old stockholders to retain an interest in the company. The Court noted that the reorganization statute required a plan to be "fair and equitable." /17/ This term had been interpreted to mean that "'any arrangement of the parties by which the subordinate rights and interests of stockholders are attempted to be secured at the expense of the prior rights of either class of creditors comes within judicial denunciation.'" 308 U.S. at 116 (quoting Louisville Trust Co. v. Louisville, N.A. & C. Ry., 174 U.S. 674, 684 (1899)). Under this test, the Court held that the plan offered by the shareholders should not have been confirmed (308 U.S. at 122-132). Despite its holding that the plan could not be confirmed, the Court suggested that there were limited circumstances in which a plan should be confirmed even though shareholders participated and creditors' claims were not fully honored. The Court "stress(ed) the necessity, at times, of seeking new money 'essential to the success of the undertaking' from the old stockholders" (308 U.S. at 121 (footnote omitted) (quoting Kansas City Terminal Ry. v. Central Union Trust Co., 271 U.S. at 455)). "Where that necessity exists and the old stockholders make a fresh contribution and receive in return a participation reasonably equivalent to their contribution, no objection can be made" (308 U.S. at 121). The Court thus stated that there was an exception to the judicially developed absolute priority rule -- specifically, that it might confirm a plan over the objection of a creditor whose claim was not fully honored if "the stockholder's participation (was) based on a contribution in money or in money's worth, reasonably equivalent in view of all the circumstances to the participation of the stockholder" (id. at 122). It is the exception to the absolute priority role, as stated in this last passage, on which the court of appeals in this case relied (Pet. App. A23-A24). Although that reliance was misplaced in light of the holding of Los Angeles Lumber (see pp. 23-28, infra), we also submit that these dicta from Los Angeles Lumber do not accurately state the law under the Bankruptcy Code. b. The Bankruptcy Code modified the law governing confirmation of plans of reorganization in two relevant respects. First, whereas Chapter X of the old Bankruptcy Act provided that a plan had to be "fair and equitable" (11 U.S.C. (1976 ed.) 621(2)) but did not define that term, the Bankruptcy Code provides an elaborate definition. Second, as previously noted, the Bankruptcy Code permits a creditor class, by a class vote that overrides the objections of minority members, to assent to a plan that is not "fair and equitable." Together, these two changes leave no room to allow an equity holder to buy his way into the reorganized company over the objections of an impaired class of creditors who do not receive or retain property of a value equal to the allowed amount of their claims. The Bankruptcy Code has replaced the judicially developed "fair and equitable" test of the old Bankruptcy Act with a statutorily prescribed one. The Code provides that a plan is fair and equitable, with respect to an impaired, dissenting class of unsecured creditors, in two -- and only two -- circumstances (11 U.S.C. (& Supp. III) 1129(b)(2)(B)): (i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property. Even when equity holders make new capital contributions as part of the plan, the interest that they "receive or retain under the plan" is received or retained on account of their pre-petition claim or interest in property of the estate. /18/ It is therefore forbidden by the express terms of Section 1129(b)(2)(B) unless all unsecured creditors in the dissenting class receive "property of a value, as of the effective date of the plan, equal to the allowed amount of (their) claim(s)." The language of the Code admits of no other conclusion. Nothing in the legislative history suggests a congressional intention to maintain the exception discussed in Los Angeles Lumber. The House report, in describing proposed Section 1129(b), states: "The general principle of the subsection permits confirmation notwithstanding non-acceptance by an impaired class if that class and all below it in priority are treated according to the absolute priority rule. The dissenting class must be paid in full before any junior class may share under the plan." H.R. Rep. 95-595, supra, at 413. /19/ No exceptions to this rule seem to be contemplated. /20/ It is not surprising that the Code has dropped the infusion-of-new-capital exception to the absolute priority rule. The exception reflected two conditions that have since changed. First, the Court believed in 1939 (and earlier) that new capital to fund a reorganization beneficial to creditors might be available only from old equity holders. See Los Angeles Lumber, 308 U.S. at 117; Kansas City Terminal Ry., 271 U.S. at 455. In today's capital markets, which make it far easier for worthwhile ventures to obtain financing, that is a much less realistic concern. See Blum & Kaplan, The Absolute Priority Doctrine in Corporate Reorganizations, 41 U. Chi. L. Rev. 651, 672 (1974). Indeed, the ability of a reorganized company to convince anyone other than a pre-petition equity holder to lend it money today suggests not a failure of the capital markets as much as a realistic assessment that the reorganization is not likely to succeed. Second, the underlying philosophy of the Code is to allow classes of creditors to determine what is in their own best interest. See pp. 14-15, supra. When a class of creditors dissents from a proposed plan that provides for equity-holder participation, that indicates that the necessary percentages of the class do not believe that the equity holders' participation in a reorganization would increase the value of their claims. The Bankruptcy Code leaves that decision to the creditors, /21/ and there is no longer any need for a court to decide whether, in a particular case, continuing participation by equity holders might be in their best interests. The creditors own the assets, it is their money that is at stake, and they are in the best position to ascertain whether a reorganization including the former equity owners would be to their advantage. Were such owners allowed to participate in a reorganization over creditors' objections, the negotiations envisioned by the absolute priority rule would be altered. Creditors, instead of deciding whether a reorganized company would be worth more with equity holders participating, would instead have to consider whether they should reach a compromise with the equity holders to avoid having a bankruptcy judge decide whether the equity holders should participate. /22/ Thus, although we will show in the next section that the judgment of the court of appeals conflicts with pre-Code law, there is a more fundamental reason to reverse that judgment. The exception to the absolute priority rule on which the court of appeals relied does not exist under the Bankruptcy Code. 2. Even if the Bankruptcy Code should be read to contain an exception to the absolute priority rule for equity holders who contribute money or money's worth to the reorganized enterprise, respondents' "labor, experience, and expertise" is not such a contribution Whatever basis there may be for assuming that the Bankruptcy Code carried forward the exception to the absolute priority rule enunciated in dicta in Los Angeles Lumber -- and we see none -- there is no basis whatever for any contention that the Bankruptcy Code expands that exception beyond the bounds contemplated in Los Angeles Lumber. Because respondents' proposed contribution of "labor, experience, and expertise" (Pet. App. A26) is exactly the kind of contribution that the Los Angeles Lumber court held would not suffice to overcome the absolute priority rule, the judgment of the court of appeals should be reversed. When it noted the existence of an exception to the absolute priority rule, the Court in Los Angeles Lumber made it clear that equity-holder participation is permissible only when it is necessary to preserve going-concern value and the interests of the creditors are protected. The Court said that such participation is permissible only if the old stockholders are the only available source of capital to keep the reorganized corporation operating (308 U.S. at 117, 121). Even then, the Court was concerned that "the creditor's rights (not) be easily diluted by inadequate contributions by stockholders" (id. at 122). /23/ Thus, the Court stated (ibid.): In view of these considerations we believe that to accord "the creditor his full right of priority against the corporate assets" where the debtor is insolvent, the stockholder's participation must be based on a contribution in money or in money's worth, reasonably equivalent in view of all the circumstances to the participation of the stockholder. /24/ The Court illustrated the narrowness of this exception by refusing to apply it to the facts of Los Angeles Lumber. The former shareholders argued that their participation in the new corporation was appropriate even though not all of the creditors' claims were fully honored, on the ground, among others, that they were contributing their financial standing in the business community. The Court held that such "intangibles" simply could not be used to overcome the dictates of the absolute priority rule. "They have no place in the asset column of the balance sheet of the new company. They reflect merely vague hopes or possibilities." 308 U.S. at 122-123. The Court in Los Angeles Lumber was clear: either the shareholders contribute new capital that is necessary to the reorganization of the insolvent enterprise, or they do not participate in the reorganization. No court of appeals other than the court below has suggested that an equity holder can participate in the reorganization of an insolvent debtor even though he does not contribute necedssary capital to the reorganization. See, e.g., In re U.S. Truck Co., 800 F.2d 581, 588 (6th Cir. 1986) ("If (the debtor) were retaining an interest without contributing any capital, the plan would clearly violate the Code."); In re Potter Material Serv., Inc., 781 F.2d 99, 101 (7th Cir. 1986) ("An equity-interest owner may retain an interest in the debtor corporation so long as the owner invests new capital into the corporation"); In re Muskegon Motor Specialties, 366 F.2d 522, 525 (6th Cir. 1966); Highland Towers Co. v. Bondholders' Protective Comm., 115 F.2d 58, 60 (6th Cir. 1940); Metropolitan Holding Co. v. Weadock, 113 F.2d 207, 209 (6th Cir. 1940); see also Price v. Spokane Silver & Lead Co., 97 F.2d 237, 245 (8th Cir. 1938). The decision of the court of appeals constitutes a marked departure from this accepted teaching. /25/ The court of appeals sanctioned participation of junior interests so long as they contribute "something that is reasonable compensatory and is measurable" (Pet. App. A24). Thus, the court expanded permissible contributions to embrace any promise that has a determinate value. /26/ The court found such value in respondents' promise to contribute their future labor and their expertise to the reorganized company. The first contribution certainly is not a capital contribution as envisioned by Los Angeles Lumber. Similarly, respondents' farming expertise is not a contribution of capital. Indeed, the Court in Los Angeles Lumber expressly disapproved allowing an equity holder to participate in a reorganized company based on such a contribution. See 308 U.S. at 112-113 (citation omitted) (disapproving treatment of "'(equity holders') familiarity with the operation' of the business and their 'financial standing and influence in the community' (and) * * * 'continuity of management'" as "consideration" for equity-holder participation in the plan of reorganization); id. at 123 n.16 (approving court of appeals decision not allowing participation based on supposed management skills). The court of appeals opined that respondents should be allowed to participate in a reorganization because their participation would preserve the farm's going-concern value (Pet. App. A24-A25). That justification, however, was rejected by the Court in Los Angeles Lumber. See 308 U.S. at 123 (citation omitted) ("fact that (creditors) might fare worse as a result of a foreclosure and liquidation than they would be taking a debtor's plan (has) no relevant bearing on whether a proposed plan is 'fair and equitable'"). /27/ It is also thoroughly inconsistent with the principle that the creditors themselves, rather than a court, are in the best position to determine whether they will fare better under a plan of reorganization than they would through exercise of their state-law foreclosure rights or through liquidation. See pp. 14-15, supra. The reason for requiring any Los Angeles Lumber contribution to be in money or marketable property is, of course, that without that limitation the "reorganization" becomes simply a forced scaling down of the creditors' rights, after which creditors and debtor continue as before -- which is transparently what the court of appeals sanctioned here. The equity-holder contributions contemplated by Los Angeles Lumber place immediate additional value in the enterprise, where it is subject to the superior claims of creditors, immediately improving their chances of ultimately being paid. In the present case, apart from the question just how much assurance can be taken from the debtors' (unenforceable) promise to work for many years for the reorganized enterprise, /28/ if the debtors go into default on their new secured debt three months after reorganization, their "yearly contributions of labor, experience, and expertise" (Pet. App. A26) will not have contributed any significant value that is available to meet creditors' claims. The creditors, having been forced to give up substantial rights against the promise that the debtors will farm their land more successfully in the future than in the immediate past, will be back in bankruptcy court with substantially reduced legal claims. Nothing in old Chapter X, present Chapter 11, or Los Angeles Lumber permits a court to force them to take that risk. The court of appeals attempted to justify its result on the ground that "(a)ny other view would deny to most farmers the opportunity to take advantage of the reorganization provisions of the Bankruptcy Act" (Pet. App. A25). That is simply to assert (whether or not correctly) that "most farmers" in straitened circumstances need a partial forgiveness of debt, abrogating the absolute priority rule; and indeed abrogation of the absolute priority rule is the means Congress has chosen in Chapter 12 to respond to farmers' plight. See 100 Stat. 3111 (to be codified at 11 U.S.C. 1225(b)); 132 Cong. Rec. S5556 (daily ed. May 7 1986) (statement of Sen. Grassley). But this is a Chapter 11 case. /29/ Congress in enacting Chapter 11 rejected a suggestion that it do away with the absolute priority rule (see note 19, supra). The manifest sympathy that the court of appeals had for farmers may be understandable (although the wisdom of making it harder for farmers to enter into enforceable contracts of indebtedness may be questionable), but the court did not have the power to rewrite Chapter 11. /30/ The holding of the court of appeals is in irreconcilable conflict with both the Bankruptcy Code and this Court's decision in Los Angeles Lumber. It should be reversed. CONCLUSION The judgment of the court of appeals should be reversed. Respectfully submitted. CHARLES FRIED Solicitor General RICHARD K. WILLARD Assistant Attorney General LOUIS R. COHEN Deputy Solicitor General ROY T. ENGLERT, JR. Assistant to the Solicitor General ROBERT S. GREENSPAN ROBERT K. RASMUSSEN Attorneys AUGUST 1987 /1/ The court said (Pet. App. A17-A18), "it appears probable that once their secured debt is restructured to reflect present values of land and equipment as Section 506(a) requires, (petitioners) can repay that debt over a reasonable period of time with interest and make substantial payments (but without interest) to unsecured creditors." The "feasible reorganization plan," as more fully spelled out in an appendix to the court's opinion (see id. at A47), consists in essence of scaling down the secured debt to the value of the collateral, issuing various new secured notes against that portion of the debt, issuing non-interest-bearing unsecured notes for the remainder, payable over a 30-year period, and allowing the debtors to retain the equity. /2/ Section 1129(b) in relevant part provides: (1) * * * the court * * * shall confirm the plan * * * if the plan does not discriminate unfairly, and is fair and equitable (to impaired, dissenting creditor classes). (2) * * * (T)he condition that a plan be fair and equitable * * * includes the following requirements -- * * * * * (B) With respect to a class of unsecured claims -- (i) the plan provides that each holder of a claim of such class receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim; or (ii) the holder of any claim or interest that is junior to the claims of such class will not receive or retain under the plan on account of such junior claim or interest any property. /3/ Judge Gibson also dissented on the ground that he, unlike the majority, agreed with both the bankruptcy court and the district court that, because respondents could not provide petitioners with adequate protection, the automatic stay should be lifted (Pet. App. A28-A30). /4/ The term "impaired" is defined, for purposes of the Code, in 11 U.S.C. (& Supp. III) 1124. A claim is "impaired" unless (1) the legal, equitable, and contractual rights to which the claim entitles its holder are unaltered; (2) the plan cures a prior default by specified means and leaves the holder of the claim with the legal, equitable, and contractual rights to which the claim entitled the holder before the event of default; or (3) the holder of the claim receives cash equal to the allowed amount of the claim. /5/ Section 1129(b), which allows confirmation of a plan that meets all of the requirements of Section 1129(a) except paragraph (8), is quoted in note 2, supra. In addition to meeting the terms of either Section 1129(a)(8) or Section 1129(b), every plan of reorganization must meet the terms of 11 U.S.C. (& Supp. III) 1129(a)(7), which requires that each creditor (regardless of the class to which that creditor belongs) either assent to the plan or receive or retain under the plan property at least equal in value to what it would receive or retain if the debtor were liquidated. /6/ A class of creditors is deemed to have accepted a plan of reorganization when two-thirds of the total dollar amount of the claims within that class and one-half of the actual number of creditors within that class have agreed to the plan. 11 U.S.C. 1126(c). /7/ Under Chapter X of the old Bankruptcy Act of 1898, 11 U.S.C. (1976 ed.) 501 et seq., and its predecessor, Section 77B (added by Act of June 7, 1934, ch. 424, Section 1, 48 Stat. 911-922) (repealed 1938), a plan could be confirmed only if it was "fair and equitable." Unlike the present Bankruptcy Code, the old Act did not define "fair and equitable." This Court held that those words were a term of art that required creditors' claims to be fully honored before equity holders could participate in the reorganized enterprise. Marine Harbor Properties, Inc. v. Manufacturers Trust Co., 317 U.S. 78, 85 (1942) (construing Chapter X); see also Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1939) (construing Section 77B). On the other hand, Chapter XI of the old Act, 11 U.S.C. (1976 ed.) 701 et seq., did not require a plan to be "fair and equitable." Instead, it had only to be in the best interests of the creditors. Under this test, a plan could be confirmed so long as the creditors received the liquidation value of their claims. See H.R. Rep. 95-595, 95th Cong., 1st Sess. 223 (1977). /8/ To the extent that FLB's and Norwest's claims exceeded the value of their collateral, they were entitled to be treated as unsecured creditors. 11 U.S.C. 506(a). /9/ Some individual debtors also have the option of proceeding under Chapter 13, 11 U.S.C. (& Supp. III) 1301 et seq. Since November 26, 1986, family farmers have had the option of proceeding under a new Chapter 12. See Bankruptcy Judges, United States Trustees, and Family Farmer Bankruptcy Act of 1986 (1986 Act), Pub. L. No. 99-554, Section 255, 100 Stat. 3105-3114 (to be codified at 11 U.S.C. 1201 et seq.); see also note 29, infra. /10/ We use "fully honored" as a shorthand phrase for the statutory requirement that the holder of an unsecured claim "receive or retain on account of such claim property of a value, as of the effective date of the plan, equal to the allowed amount of such claim" (11 U.S.C. 1129(b)(2)(B)(i)). The Code, unlike prior law, does not "require the impossible and make it necessary to pay an unsecured creditor in cash as a condition of stockholders retaining an interest in the reorganized company. His interest can be preserved by the issuance, on equitable terms, of (for example) income bonds or preferred stock." Northern Pacific Ry. v. Boyd, 228 U.S. 482, 508 (1913). /11/ Respondents owned the assets of their farm in their individual capacities rather than as shareholders in a corporation. Chapter 11, however, does not make any relevant distinction between corporate and individual debtors. Although the analogy does not apply in all respects (see note 28, infra), it is convenient to think of respondents as the equity owners of a farming enterprise of which petitioners are creditors. /12/ Before he went on the bench, Judge Friendly put the matter more pointedly: "A plan which gives to creditors securities with a market value of less than one hundred cents on the dollar of the creditors' claims and permits stockholders without assessment to retain a substantial share in the enterprise is, in the language of the Supreme Court in (First National Bank v. Flershem, 290 U.S. 504, 519 (1934)), an attempt to invoke the power of the court 'not to enforce rights of creditors, but to defeat them.' Such a transaction, as pointed out in the opinion of Mr. Justice Brandeis, is simply a fraudulent conveyance." Friendly, Some Comments on the Corporate Reorganizations Act, 48 Harv. L. Rev. 39, 77-78 (1934) (footnote omitted). /13/ Under Chapter X and its predecessor, Section 77B, a plan that was not fair and equitable could not be confirmed even if it had the requisite approval of all classes of creditors. See Coogan, Confirmation of a Plan Under the Bankruptcy Code, 32 Case W. Res. L. Rev. 301, 325-326 (1982) (discussing this change between pre- and post-Code law). For example, in Case v. Los Angeles Lumber Products Co., 308 U.S. 106 (1939) (applying Section 77B), the plan of reorganization was denied confirmation as not fair and equitable, notwithstanding bondholder consent that would be sufficient under the Code to confirm the plan under Section 1129(a)(8)(A) without reaching the question of fairness and equity under Section 1129(b). See 308 U.S. at 114-115. /14/ The court of appeals seems to have believed (see Pet. App. A47) that giving the secured creditors new secured notes equal in face amount to the present market value of their collateral, plus an unsecured (and non-interest-bearing) note for the balance of their debt, would necessarily leave them as well off or as better off than liquidation. That is, of course, exactly the fallacy that the absolute priority rule was designed to combat. The present value of any income-producing property is a weighted average of the range of possible future values. Giving the creditor a secured (nonrecourse) note in an amount equal to the present value of the property gives it only the bottom portion of the range, which is necessarily worth less (frequently -- and apparently here -- much less) than the property itself or the proceeds of a present sale. An unsecured note of the kind envisioned here will not make up the difference: it will not give the creditor the equivalent of ownership. That is why Section 1129(b)(2)(A) requires that dissenting secured creditors receive payments with a present value equal to the value of their collateral and Section 1129(b)(2)(B) requires that dissenting unsecured creditors receive property of a value equal to their claims before junior interests may receive anything. /15/ The lower courts appear to be divided on this question. Two other courts of appeals and some bankruptcy courts have agreed with the implicit conclusion of the court below. See In re U.S. Truck Co., 800 F.2d 581, 587-588 (6th Cir. 1986) (allowing stockholder to participate in plan of reorganization based on new payment of $100,000); In re Potter Material Serv., Inc., 781 F.2d 99, 101 (7th Cir. 1986); In re Sawmill Hydraulics, Inc., 72 Bankr. 454, 456 & n.1 (Bankr. C.D. Ill. 1987); In re Landau Boat Co., 13 Bankr. 788, 792-793 (Bankr. W.D. Mo. 1981); In re Marston Enterprises, 13 Bankr. 514, 518 (Bankr. E.D.N.Y. 1981). Some bankruptcy courts have implied, if not held, that it is no longer possible for equity holders to retain ownership over the objection of a class of creditors whose claims are not fully honored. See In re Pine Lake Village Apartment Co., 19 Bankr. 819, 834 (Bankr. S.D.N.Y. 1982) (holding plan that included retained ownership by partners unconfirmable even though partners proposed to contribute $700,000 in cash); In re Pecht, 57 Bankr. 137 (Bankr. E.D. Va. 1986). Although, as we argue below, the judgment of the court of appeals is plainly wrong under the Los Angeles Lumber dictum and other pre-Code cases, we also believe that the Bankruptcy Code has superseded those cases in this regard. /16/ A substantial majority of the bondholders had voted to accept the plan (308 U.S. at 111-112, 115). Under the Bankruptcy Code, this assent would have been sufficient to permit confirmation of the plan (as far as this class was concerned) notwithstanding the departure from "fairness and equity." See 11 U.S.C. (& Supp. III) 1125. /17/ Unlike the present Bankruptcy Code, neither Section 77B (which was applied in Los Angeles Lumber) nor Chapter X (which replaced Section 77B in 1938) defined this term. See note 7, supra. /18/ That is clear because there is no provision of the Bankruptcy Code that could even conceivably be read to allow, over the objection of a class of creditors, the participation in a plan of a person or entity that contributed new capital but had no prior claim or interest in any property of the estate. Any rule that allowed equity holders, over the objection of a class of creditors, to participate in the plan by contributing new capital would thus necessarily create a special rule for them on account of their prior claim or interest in property of the estate. /19/ The Bankruptcy Commission, the congressionally appointed committee charged with evaluating the need for bankruptcy reform, had suggested to Congress that the absolute priority rule be abandoned. The Commission had urged that the result in Los Angeles Lumber be statutorily overturned, and that junior classes be allowed to participate to the extent that they contribute anything of value to the reorganization. This proposal was criticized in the academic literature. See, e.g., Brudney, The Bankruptcy Commission's Proposed "modifications" of the Absolute Priority Rule, 48 Am. Bankr. L.J. 305 (1974); Note, The Proposed Bankruptcy Act: Changes in the Absolute Priority Rule for Corporate Reorganizations, 87 Harv. L. Rev. 1786 (1974). As is apparent from the Bankruptcy Code, it was flatly rejected by Csongress. /20/ Indeed, even if the legislative history were altogether silent on the subject, the language of the statute would be a sufficient indication that prior law had been changed. "It would be extraordinary to require legislative history to confirm the plain meaning of (Section 1129(b)(2)(B))." Bourjaily v. United States, No. 85-6725 (June 23, 1987), slip op. 6. /21/ See Blum, The "Fair and Equitable" Standard for Confirming Reorganizations under the New Bankruptcy Code, 54 Am. Bankr. L.J. 165, 172 (1980) ("The main protection theme in reorganizations under the new Bankruptcy Code is that adequately informed classes of creditors and shareholders can look after their own interests in the processes of negotiating plans."). /22/ The idea that creditors, rather than a judge, can best make the determination whether shareholder participation is beneficial to the creditors is not new. See Friendly, Some Comments on the Corporate Reorganizations Act, 48 Harv. L. Rev. 39, 75 (1934) (footnote omitted) (quoting In re English, Scottish & Australian Chartered Bank, (1893) 3 Ch. 385, 409) ("As said by Lord Justice Lindley in the Australian Chartered Bank case: 'If the creditors are acting on sufficient information and with time to consider what they are about, and are acting honestly, they are, I apprehend, much better judges of what is to their commercial advantage than the Court can be.'"). /23/ See also Consolidated Rock Products Co. v. Du Bois, 312 U.S. 510, 530 n.27 (1941) (Douglas, J.). /24/ The court of appeals based its interpretation on the phrase "money's worth" in this passage. It is clear, however, that the full import of this passage is to limit equity owner participation to cases in which the equity owner has infused the debtor with fresh capital, such as cash or marketable property. See also 308 U.S. at 117 ("necessity at times of permitting the inclusion of stockholders on payment of contributions"); id. at 121 (emphasis added) ("necessity * * * of seeking new money"); id. at 121 n.15 (emphasis added) ("This new money was commonly necessary in equity reorganizations not only to provide new working capital but also to pay dissenting creditors."); Consolidated Rock Products Co. v. Du Bois, 312 U.S. 510, 529 n.27 (1941) (emphasis added) ("it should have been shown that there was a necessity of seeking new money from (old common stockholders) and that the participation accorded them was not more than reasonably equivalent to their contributions"). Indeed, before Los Angeles Lumber the Court had already made it clear in Kansas City Terminal Ry. v. Central Union Trust Co., supra, that only contribution of "additional funds * * * essential to the success of the undertaking" would allow shareholders to overcome the absolute priority rule. 271 U.S. at 455; see Friendly, supra, 48 Harv. L. Rev. at 76-77. Los Angeles Lumber did not purport to alter that rule. /25/ See also In re Baugh, 73 Bankr. 414, 418 (Bankr. E.D. Ark. 1987) ("The Ahlers decision radically expanded the exception to the absolute priority rule * * *."); In re Sawmill Hydraulics, Inc., 72 Bankr. 454, 456-457 (Bankr. C.D. Ill. 1987) (declining to follow decision below); In re C & P Gray Farms, Inc., 70 Bankr. 704, 710 n.21 (Bankr. W.D. Mo. 1987) (emphasis added) ("(T)he universally occur(r)ing * * * doctrine of 'sweat equity' * * * is so artificial and inappropriate that it can exist only where the debtor's operations are in reality so unpromising that an honest and conscientious court would be obliged to find the plan infeasible. The court in the Ahlers case is to be admired for groping for some device, however unsound, which will ameliorate the desperate plight of the American farmer."); In re Big Dry Angus Ranch, Inc., 69 Bankr. 695, 698 n.3, 700 n.6 (Bankr. D. Mont. 1987) (decision below was designed to "circumvent" the absolute priority rule and to say that the "absolute priority rule means something different than intended by 1129(b)"); In re Stegall, 64 Bankr. 296, 300 (Bankr. C.D. Ill. 1986) ("the solution proposed by the Ahlers majority is contrary to the Bankruptcy Code and a long line of case law"); Koger & Acconcia, In re Ahlers: Capitalizing on Sweat, 42 J. Mo. B. 455, 458 (1986) (footnotes omitted) ("Case law has developed a narrow exception to the absolute priority rule * * *. As Judge Gibson pointed out in his dissent, this exception has never been extended to contributions of labor. In fact, previous attempts to qualify non-capital equity in the absolute priority context have been unanimously rejected."); C. Fortgang & T. Mayer, 1986 Interest and Costs for the Secured Creditor in Bankruptcy 2 (1986) (paper presented to 1986 New York University Workshop on Corporate Reorganization) ("the Eighth Circuit has rejected 45 years of learning on the rights of a dissenting creditor class by ruling that pre-petition equity holders may retain their equity merely by continuing to work"); id. at 110-116; Note, In re Ahlers: The Farm Reorganization Exception to the Absolute Priority Rule, 32 S.D.L. Rev. 167, 179 (1987) ("The Eighth Circuit's decision in Ahlers diverges significantly from the statutory absolute priority rule enacted in the Bankruptcy Code and from the Supreme Court's interpretation of the absolute priority rule in Los Angeles Lumber."). /26/ The court also ignored the requirement of Los Angeles Lumber that the equity holder's contribution be necessary to a successful reorganization. See 308 U.S. at 121. There is nothing in the record that suggests, contrary to common sense, that it is necessary to have respondents, as opposed to someone else, operate the farm properties in question. /27/ Likewise, in SEC v. United States Realty & Improvement Co., 310 U.S. 434, 454 (1940), the Court noted that a difference between Chapter X cases, in which the absolute priority rule applied, and Chapter XI cases, in which it did not, was that in the latter "the preservation of going-concern value through (subordinate creditors' or stockholders') continued management of the business may compensate for reduction of the claims of the prior creditors without alteration of the management's interests, which would otherwise be required by" Northern Pacific Ry. v. Boyd, 228 U.S. 482 (1913). /28/ Los Angeles Lumber was of course a corporate reorganization, in which the Court could meaningfully speak of "the old stockholders mak(ing) a fresh contribution (from their separate assets) and receiv(ing) in return a participation reasonably equivalent to their contribution" (308 U.S. at 121). The very concept is not easy to apply to the Chapter 11 plan of an individual debtor. Since he is the debtor, he cannot have any means of making a "fresh contribution" in cash or property. His promise of unsalaried future labor is, as Judge Gibson noted in dissent (Pet. App. A35), not specifically enforceable. And even if permissible indirect means of enforcement would suffice to satisfy the rights of the creditor, it is fundamental to American bankruptcy law that an individual debtor may not be compelled to indenture himself to work off a debt; at least some of the same considerations suggest that he should not be permitted to do so either. /29/ This case does not arise under Chapter 12, and it is unlikely that respondents could convert this proceeding into one under Chapter 12. That new provision appears on its face not to apply to proceedings begun before the effective date of the Act. 1986 Act Section 302(a) and (c), 100 Stat. 3119. But see In re Big Dry Angus Ranch, Inc., 69 Bankr. 695 (Bankr. D. Mont. 1987) (allowing conversion of pending Chapter 11 case to Chapter 12); In re Erickson Partnership, 68 Bankr. 819 (Bankr. D.S.D. 1987) (same). /30/ Commentators have observed about this case: "Hopefully the case can be limited to its facts -- a farmer relief measure which is no more than premature judicial enactment of the new chapter 12 * * *. Unfortunately, Ahlers purports to apply the absolute priority rule. No principle of jurisprudence prevents corporate debtors from using precedents in farm Chapter 11s. In a corporate chapter 11, Ahlers would entrench management shareholders at the expense of unsecured creditors." C. Fortgang & T. Mayer, 1986 Interest and Costs for the Secured Creditor in Bankruptcy 116 (1986) (paper presented to 1986 New York University Workshop on Corporate Reorganization).