Slavery + Chapter 11

I loved reading this case.  Felt like a Grimms’ fairy tale.

Picture this — you earn a paycheck, right?  Now put yourself in a position that when you receive your paycheck, an invisible hand (no not Uncle Sam) comes and takes a big chunk of that paycheck to pay your creditors, and you cannot do anything about it!   Kind of like an involuntary wage garnishment.  This is what a bankruptcy court was faced with in a Chapter 11 case in New Jersey.

Here’s what happened — a successful doctor filed chapter 11 and a chapter 11 trustee was appointed.  The doctor wanted to convert to a chapter 7, but the judge said he lacked standing since the trustee was running the show now.   So the doctor was stuck in a chapter 11.  As you might know, post-petition income in a chapter 11 is property of the estate, so the trustee demanded the doctor to continually turnover his hard-earned money over so he (the trustee) can pay the doctor’s creditors.

So, here you have a person literally trapped in a situation where he must turnover his income to this third-party who will pay his creditors.  That is legalized robbery!  That is involuntary servitude – slavery!   Rather than calling slavery, the court called it a “peonage,” which is a subset of involuntary servitude meaning “the status of compulsory service based upon a debt of the peon to the master.   Now I know what a “peon” is — someone who is forced to work for his or her creditor until their debt is paid.  In my book, these creditors are mom and dad.

In a Chapter 13, there are safety valves in place that are intended to resolve this so as to not violate the Thirteenth Amendment (i.e. a chapter 13 debtor has an absolute right to convert or dismiss his or her case at anytime), but no such protection is available in a chapter 11.  Oh oh.

Let’s cite some code provisions shall we….§1115(a)(2) and §1112(a)(1).  Section 1115(a)(2) says the doctor’s future income is property of the estate which can be used to pay the creditors.  Section 1112(a)(1) says that a trustee or debtor-in-possession can convert his or her case.  But the doctor in this case was no longer the debtor-in-possession, it was the chapter 11 trustee, so the doctor does not have standing.   So you have someone (the chapter 11 trustee) standing in your shoes, and if he or she does not want to convert your case to a chapter 7 – your effectively up a creek without a paddle.   You are stuck in the chapter 11, and you must continually contribute your post-petition income.   Yikes.

My favorite quote in this case, “the Debtor realized that he was between the Charybdis of §1115 and the Scylla of §1112.”   For my greek mythology geeks, see here:

So, how does a court reconcile §1115(a)(2) and §1112(a)(1)?   It reaches into its bag of tools called the “Doctrine of Constitutional Avoidance.”   This doctrine is the result of the great Justices Brandeis and Marshall, which holds that when a judge is faced with reconciling two statutes, he or she must do so by trying to save the statute and at the same time interpret the statutes with an eye towards giving deference to what Congress might have meant (::receiving phone call from J. Scalia::).   So a judge should interpret §§1115(a)(2) and 1112(a)(1) in a way to save both statute but also to avoid constitutional violations.

How did the bankruptcy judge use this doctrine to resolve this?

Here’s the punch line — §1105!  The judge treated the doctor’s motion to convert his case as a “request to terminate the ch. 11 trustee.”

Under this approach, per §1105, the judge first terminated (i.e. fired) the chapter 11 trustee, and by doing so, the doctor is put back as the debtor-in-possession and regains control of his case.  Then immediately the court grants the motion to convert to a chapter 7.  Section 1105 provides the tool to allow the bankruptcy judge to terminate the chapter 11 trustee.  Even though §1105 says a “party in interest” may bring a request, the judge used his equitable powers under §105(a) to issue an order granting debtor’s request — and nothing is more equitable here than abolishing slavery by a stroke of the pen.

So, the case was converted to a chapter 7, where humorously…wait for it…. a Chapter 7 trustee was immediately appointed!   The circle of life.


Here’s the case:


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