Nice Tentative from Judge Houle on Converting Case from Chapter 7 to Chapter 13 Postdischarge

On February 28, 2013, Michael & Maricar Santos (“Debtors”) filed a Chapter 7 voluntary petition.  On June 17, 2013, Debtors received a standard discharge.  The Chapter 7 case, however, remained open.

On October 4, 2016, Debtors filed a motion to convert case from Chapter 7 to 13.  On October 12, 2016, Trustee filed his opposition.  On November 2, 2016, Debtors filed a reply.  A hearing on the matter was held on November 9, 2016.  The hearing was continued to allow for additional briefing on the issue whether, and in what circumstances, a Chapter 7 case could be converted to a Chapter 13 post-discharge.  Debtor filed their response on November 18, 2016.  Trustee filed their response on November 29, 2016.

The preliminary question before the Court is whether, and under what circumstances, a Debtor can convert their Chapter 7 case to a Chapter 13 postdischarge.  Debtors brief appears to not contain any direct answer to this question; instead Debtors rely on analysis applicable to conversion whether the conversion sought is before or after discharge. In Section IV of his brief, Trustee addresses the specific issues that arise when a debtor has already received a Chapter 7 discharge. No binding law has been identified with respect to this issue. It appears, however, that the majority of courts do not afford a debtor the absolute right to convert a case to Chapter 13 after a discharge has been obtained. See, e.g., In re Starling, 359 B.R. 901, 907-09 (Bankr. N.D. Ill. 2007) (conversion only authorized after vacation of discharge); In re Hauswirth, 242 B.R. 95, 96 (Bankr. N.D. Ga. 1999) (“The other courts which have considered that question have all reached the tacit conclusion that a debtor may not convert from Chapter 7 to Chapter 13 and retain the Chapter 7 discharge.”); In re Lesniak, 208 B.R. 902, 907 (Bankr. N.D. Ill. 1997) (no conversion allowed).  Other courts have held that a debtor’s right to conversion is not constrained by a discharge.  See, e.g., In re Young, 237 F.3d 1168 (10th Cir. 2001) (conversion allowed if plan is proposed in good faith).

Two related situations are when a debtor files sequential bankruptcies (i.e. the filing of a Chapter 13 upon the closing of the Chapter 7 case), and when the Debtor attempts to file simultaneous bankruptcies (the filing of a Chapter 13 case while a Chapter 7 case is pending).  The former is permissible and is commonly referred to as a Chapter 20 case.  See, e.g., In re Metz, 67 B.R. 462, 465 (B.A.P. 9th Cir. 1986).  The latter appears to be impermissible.  See, e.g., In re Sidebottom, 430 F.3d 893, 896 (7th Cir. 2005) (citing Freshman v. Atkins, 269 U.S. 121 (1925)).  The question presented to the Court, and the question considered in Starling, considers an approach between these two situations: the conversion of a case prior to closing, but post-discharge.

11 U.S.C. § 109(e) (2010) states:

(e) Only an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $394,725 and noncontingent, liquidated, secured debts of less than $1,184,200, or an individual with regular income and such individual’s spouse, except a stockbroker or a commodity broker, that owe, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts that aggregate less than $394,725 and noncontingent, liquidated, secured debts of less than $1,184,200 may be a debtor under chapter 13 of this title.

The issue here is whether § 109(e) requires that a debtor owe any debt.  Because Debtors’ personal liability has been extinguished by the Chapter 7 discharge, it would not appear that there are any claims that would be subject to a Chapter 13 reorganization plan. “Because the creditors that had their claims discharged in the Chapter 7 no longer have any right to receive payment under a Chapter 13 plan or the right to objection to confirmation, the debtor ‘no longer has any meaningful debts to repay pursuant to a Chapter 13 plan.” In re Starling, 359 B.R. at 911 (citing In re Marcakis, 254 B.R. 77, 82 (Bankr. E.D.N.Y. 2000). It is questionable whether a debtor who does not owe any debt is eligible to be a debtor under Chapter 13.

Furthermore, to allow a conversion in this situation would be to create a loophole that could potentially lead to abuse of the bankruptcy system. See, e.g., In re Lesniak, 208 B.R. 902, 906 (Bankr. N.D. Ill. 1997) (“[T]he Court finds that it would be an abuse of process to permit the Debtors to convert to Chapter 13 at this stage of their Chapter 7 case.”). If “a debtor converts to Chapter 13 after the Chapter 7 discharge, but before the estate property is liquidated, he has received all of the benefits of Chapter 7 without any of the burdens, because he regains his nonexempt property, and his debts have all been discharged.” In re Rigales, 290 B.R. 401, 407 (Bankr. N.M. 2003).

Debtors contend that Marrama provides a “very narrow” exception to their “absolute” right of conversion. While Marrama is noted for establishing the bad faith exception to conversion, it is important to note that Marrama’s holding was that conversion could be denied when grounds existed to “re-convert” or dismiss the case under 11 U.S.C. §1307(c) (2010):

There are at least two possible reasons why Marrama may not qualify as such a debtor, one arising under § 109(e) of the Code, and the other turning on the construction of the word “cause” in § 1307(c). The former provision imposes a limit on the amount of indebtedness that an individual may have in order to qualify for Chapter 13 relief.  More pertinently, the latter provision, § 1307(c), provides that a Chapter 13 proceeding may be either dismissed or converted to a Chapter 7 proceeding “for cause” and includes a nonexclusive list of 10 causes justifying that relief. . . . In practical effect, a ruling that an individual’s Chapter 13 case should be dismissed or converted to Chapter 7 because of prepetition bad-faith conduct, including fraudulent acts committed in an earlier Chapter 7 proceeding, is tantamount to a ruling that the individual does not qualify as a debtor under Chapter 13. That individual, in other words, is not a member of the class of “honest but unfortunate debtor[s]” that the bankruptcy laws were enacted to protect.  The text of § 706(d) therefore provides adequate authority for the denial of his motion to convert.
Marrama v. Citizens Bank of Mass., 549 U.S. 365, 373-74 (2007) (citation omitted).

Therefore, Marrama concluded that an individual whose potential Chapter 13 case was subject to dismissal or conversion under § 1307(c) was not entitled to a right to convert. Because § 1307(c) provides for conversion or dismissal “for cause”, it follows that the Court has the authority to deny conversion “for cause.” “For cause” is an expansive standard and many different findings could lead to a dismissal for cause. See, e.g., Marrama, 549 U.S. 365 (abuse of process); In re Molitor, 76 F.3d 218 (8th Cir. 1996) (“unfair manipulation of Code”); Matter of Love, 957 F.2d 1350, 1357 (7th Cir. 1992) (fairness to creditors). “A judge should ask whether the debtor ‘misrepresented facts in his [petition or] plan, unfairly manipulated the Bankruptcy Code, or otherwise [filed] his Chapter 13 [petition or] plan in an inequitable manner.’” In re Eisen, 14 F.3d 469, 470 (9th Cir. 1994) (quoting In re Goeb, 675 F.2d 1386, 1390 (9th Cir. 1982).

The Court agrees with the reasoning presented by the Starling court and finds that cause would exist to convert or dismiss a Chapter 13 case that was converted to Chapter 13 post-discharge, prior to closing, when administration of the estate was still occurring.  Bankruptcy relief involves a “quid pro quo.”  See In re Jeffrey, 176 B.R. 4, 6 (Bankr. D. Mass. 1994).  To obtain a discharge in a Chapter 7 case and then convert the case to Chapter 13 while assets are being administered is unfair to creditors, and is a manipulation and abuse of the Bankruptcy Code.  Therefore, cause would exist to convert the case under § 1307(c).  It is unclear whether any circumstances would permit conversion of a Chapter 7 case to a Chapter 13 prior to case closing, but, if so, those circumstances are not present here.  See David Guess, Exposing the Convert’s Loophole: Postdischarge Conversion as an Abuse of the Bankruptcy Process, 2005 Ann. Surv. of Bankr. Law 19 (2005) (strongly questioning whether there is a good faith reason to convert to Chapter 13 post-discharge).

Because Marrama allows a court to deny conversion “for cause”, the Court is inclined to deny the motion to prevent an inequity.  In the absence of any direct argument on the issue of post-discharge conversion by Debtors, the Court is inclined to agree with the analysis and concerns presented by the Starling court.

Subject to discussion regarding any efforts by Debtors to seek to vacate their discharge, the Court is inclined to DENY the motion.

Leave a Reply

× five = 15