Converting a Chapter 7 to a Chapter 13

A second common scenario in which a debtor will seek conversion from a Chapter 7 to Chapter 13 is where a debtor seeks to avoid imposition of a denial of discharge or dischargeability of debt, or where the debtor simply seeks conversion to continue avoiding repayment of debts. This is the situation present in In re Copper, 426 F.3d 810 (6^th Cir. 2005).

This article briefly sketches the background of this issue, the approaches taken by the courts, and the effect, if any, of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) on the issue.

Traditional View

Bankruptcy Code Section 706(a) provides that a Chapter 7 debtor may convert the case to another chapter at any time if the case has not been previously converted. The traditional view is that this right is absolute. Pequeno v. Schmidt, 307 B.R. 568 (Bankr. S.D. Texas, 2004), is illustrative of this view. This case also contains a compendium of decided cases on both sides of the issue as of its March 2004 date.

In Pequeno v. Schmidt, supra, a pro se debtor failed to disclose a lawsuit against his former employer. The trustee learned of the lawsuit on the eve of trial and the trial proceeded to a $400,000 judgment in favor of the debtor. The debtor then delayed the filing of schedules, and failed to appear at his meeting of creditors, all to prevent administration of the judgment by the trustee. The debtor then sought to convert the Chapter 7 to a Chapter 13. While the motion was pending, the Chapter 7 trustees settled the lawsuit, and the settlement was approved by the court. The court then sustained the trustee's objection to the debtor's claim of exemption on the judgment at the same time that the court denied the motion to convert. The District Court remanded, holding that the right to convert is absolute: 'statutory right that is absolute cannot have court made exceptions. If that were the case, it would not be an absolute right.' 307 B.R. at 579. In so holding, the court relied upon a 1989 Fifth Circuit case, In re Martin, 880 F.2d 857, holding the right to convert is absolute in a situation involving the administration of real estate by a Chapter 7 trustee.

When a case is converted from Chapter 7 to Chapter 13, the creditors or trustee can always move to reconvert the case to a Chapter 7 pursuant to Bankruptcy Code Section 1307(c). The Pequeno court observed: ' ' as many courts have pointed out, the case may always be reconverted to Chapter 7, and this reconversion can be because of a debtor's bad faith. While one might consider it frivolous to convert only to reconvert, such a procedure allows one to comply with both the Congressional mandate of Section 706(a) and the duty to protect the bankruptcy process from abuse.' 307 B.R. at 580.

Federal Rule of Bankruptcy Procedure 1017(f)(2) requires the filing of a motion to convert. Whether or not a motion to convert may be made ex parte or by notice is left to local rules, but in any event a motion is required.

Bad Faith

The notion that the right to convert from a Chapter 7 to a Chapter 13 is not absolute first appears at the Circuit Court level with In re Caldwell, 895 F.2d 1123 (6^th Cir. 1990). Here, the debtor sought conversion after a creditor filed an objection to dischargeability under Bankruptcy Code Section 523(a)(6). The debtor sought conversion primarily because the debt could be discharged by completing a Chapter 13 plan and receiving a Chapter 13 discharge. The creditor sought to prevent the conversion on the grounds that the Chapter 13 was lacking in good faith.

The court found that the debtor's conduct in preventing collection of the underlying judgment, including failure to disclose all of his assets in his Chapter 7, was in bad faith and the conversion was denied: 'Rather than a good faith effort to repay this debt, we see an unbroken pattern of deceit and delay.' 895 F.2d at 1127. However, the court noted that converting a Chapter 7 to Chapter 13 because an underlying debt may be non-dischargeable in Chapter 7 is not per se bad faith: 'It is not conclusively bad faith for a debtor to seek to discharge a debt incurred through his own criminal or tortious conduct, but that factor may be considered ' The plan before us was not tendered in good faith, but was one more effort to avoid paying the judgment creditors.' 895 F.2d at 1127-1128.

In re Copper

In In re Copper, 426 F. 3d 810 (Cir. 6 2005), the issue was squarely faced when the bankruptcy court refused to convert a Chapter 7 to a Chapter 13. In this case, the debtor spent 9 years attempting to avoid paying his ex-wife amounts due pursuant to a divorce decree, including the filing of six bankruptcy petitions over a 5-year period, all of which were dismissed except for the last. In the sixth case, the ex-wife filed objections to dischargeability and discharge. The day before trial, the debtor sought to convert his case to a Chapter 13.

The debtor asserted that his right to convert was absolute. The bankruptcy court and the Sixth Circuit Bankruptcy Appellate panel (314 B.R. 628 2004) disagreed. The BAP panel opinion noted that In re Martin, supra, although supporting the absolute right to convert, suggested in a footnote that the right would not be absolute in extreme circumstances. In affirming the BAP Panel, the Sixth Circuit cited a trend towards denying the right to convert where there is bad faith, and noting that such a finding is consistent with the principle that a Chapter 13 plan can be denied confirmation if not filed in good faith. The court held:
' ' if, upon its review of the facts, the bankruptcy court finds that the debtor's request for conversion was made in bad faith or represents an attempt to abuse the bankruptcy process, the court may deny the requested conversion.' (426 F.3d at 815). The Circuit further adopted a totality of circumstances approach in analyzing the issue.

The debtor's conduct in seeking conversion was not motivated by a desire to pay his creditors, but by a desire to avoid paying for a lengthy period, coupled with efforts to conceal his assets and file numerous bankruptcy petitions. 'Indeed, at argument counsel for the Debtor all but admitted a lack of good faith, relying solely on his legal position that good faith is irrelevant under '706(a) of the Code.' (426 F. 3d at 815).

In re Marrama

In In re Marrama, 430 F.3d 474 (Cir. 1 2005), the debtor failed to disclose a transfer of real property to a trust for no consideration in which he was the sole beneficiary and his girlfriend was the trustee. He also failed to disclose his interest as a beneficiary in the trust, claiming it was not property of the estate. At his meeting of creditors, he testified that he lived in this property in Maine although he had claimed a homestead exemption on a parcel of real estate in Massachusetts that he was using as a rental but was not living in when he filed his Chapter 7 petition. The debtor sought conversion to Chapter 13 to prevent administration of the assets by the Chapter 7 trustee.

In affirming the decisions of the bankruptcy court and the First Circuit BAP Panel, the First Circuit stated: 'The plain language of subsection 706(a) in no sense undermines the presumptive authority of the bankruptcy court to take reasonable steps to thwart debtor abuse of the bankruptcy process.' (430 F.3d at 480). The court reasoned that the word 'may' in Bankruptcy Code Section 706(a) is a discretionary, as opposed to a mandatory, term. The court also adopted the observation of other courts that the phrase 'at any time' is temporal only, and not the grant of an absolute right. It also rejected the notion that the debtor may convert and the trustee or creditors move to re-convert.

The Circuit also adopted the totality of circumstances approach to analyzing the issue of bad faith, and affirmed the lower court findings that the conversion attempt was in bad faith where the Debtor had: 1) transferred the property to the trust admittedly to protect it from his creditors; 2) failed to disclose his interest in his schedules; and 3) failed to disclose rental income.

Collateral Issues

Conversion from a Chapter 7 to a Chapter 13 raises a number of collateral issues. First, the weight of authority supports the idea that a Chapter 7 trustee is entitled to some amount of compensation for work performed or distributions made during the time the case was pending in Chapter 7. See, for example, In re Wells, 87 B.R. 732 (Bankr. N.D. Ga. 1988); In re Hages, 252 B.R. 789 (Bankr.N.D.Ca. 2000).

Second, the Chapter 7 trustee's counsel can, under the appropriate circumstances, be compensated after conversion of the case to Chapter 13 for services rendered to the Chapter 7 trustee prior to the conversion. See In re Conkle, 2005 Bankr. Lexis 299 (Bankr. ND GA, 2005). A superseded Chapter 7 trustee in the converted Chapter 13 has standing to assert claims and to pursue litigation. See In re Searles, 317 B.R. 368 (9^th BAP 2004), and In re Jennings, 31 B.R. 379 (Bankr. S.D. Oh 1983).

Third, conversion during pendency of a complaint objecting to discharge does not moot the complaint, but merely abates the case while the Chapter 13 remains pending, since the case may always be reconverted to a Chapter 7 case. See In re Searles, 317 B.R. 368 (9^th BAP 2004).

BAPCPA

The First Circuit in In re Marrama, supra, observed that the BAPCA does not affect the issue of good faith in converting a case from a Chapter 7 to a Chapter 13: 'The language of subsection 706(a) remains unchanged under the new act ' ' (430 F.3d at 481). In fact, one provision of BAPCPA may help enhance the good faith requirement. New 11 U.S.C. ' 1325(a)(7) requires, as a condition to confirming a Chapter 13 plan, that the court find that the petition was filed in good faith. Thus, if a debtor converts from a Chapter 7 to a Chapter 13, this provision can be read to mean that the court must find that the conversion was in good faith.

Conclusion

Although it has long been the view that there is a one time absolute right to convert a Chapter 7 to a Chapter 13, the case law trend is that the conversion must be in good faith, generally determined by the totality of circumstances. This evolution in the case law is unaffected by BAPCPA, which may have rendered support to the proposition through the enactment of 11 U.S.C. ' 1325(a)(7). When a case may be converted, collateral issues will arise, such as the standing of the former Chapter 7 trustee, compensation due to the former Chapter 7 estate's professionals, and the abatement of pending litigation in the superseded Chapter 7 case.

David L. Buchbinder, a member of this newsletter's Board of Editors, is a trial attorney with the Office of the United States Trustee, Region 3, Wilmington, DE, a member of the California, New Jersey and Pennsylvania bars, and the author of Basic Bankruptcy for Paralegals, published by Aspen Publishing Co. The opinions expressed herein are the personal opinions of the author and not of the Department of Justice or United States Trustee Program. Kathleen A. Cashman-Kramer is with Pyle Sims Duncan & Stevenson in San Diego, CA. She is a member of the California, Massachusetts and District of Columbia bars, co-chair of the San Diego County Bar Association Bankruptcy Section and a Board Member of the San Diego Bankruptcy Forum.

It has been a prevailing view in practice under the Bankruptcy Code that a Debtor has an absolute one-time right under Section 706(a) to convert a case from Chapter 7 to another Chapter, the most common scenario involving conversion from Chapter 7 to Chapter 13. However, two recent circuit level cases, reflecting the case law trend, have found that a motion to convert a Chapter 7 to a Chapter 13 may be denied if not made in good faith.

One scenario generally involves a Chapter 7 trustee's efforts to administer assets that are either not disclosed in the schedules but are discovered by the trustee in the performance of her duties, or which the trustee determines have a value different from that represented by the debtor. This is the situation present in In re Marrama, 430 F.3d 474 (1^st Cir. 2005). The assets in question are frequently parcels of real estate or personal injury claims that debtors do not want sold or settled by the trustee. In In re Kuhn, 322 B R. 377 (Bankr. N.D. Ind. 2005), the court stated: 'Most debtors don't seek to convert to Chapter 13 from a Chapter 7 to pay their creditors. They convert to preserve property which would otherwise be lost in the Chapter 7, or to avoid the determination of ' 523(a) nondischargeable debts that is mooted by the superdischarge provision of 11 U.S.C. ' 1328(a).' 322 B R. at 393.

Debtors will attempt conversion from Chapter 7 to Chapter 13 to avoid administration of the assets by a bankruptcy trustee, since under Chapter 13, a debtor's plan needs to account for the value of any non-exempt asset, but does not require liquidation of the asset. This is consistent with the so-called 'best interests of creditors' test of Bankruptcy Code Section 1325
(a)(4) that requires creditors to receive at least as much as they would receive if the case were a Chapter 7.

A second common scenario in which a debtor will seek conversion from a Chapter 7 to Chapter 13 is where a debtor seeks to avoid imposition of a denial of discharge or dischargeability of debt, or where the debtor simply seeks conversion to continue avoiding repayment of debts. This is the situation present in In re Copper, 426 F.3d 810 (6^th Cir. 2005).

This article briefly sketches the background of this issue, the approaches taken by the courts, and the effect, if any, of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) on the issue.

Traditional View

Bankruptcy Code Section 706(a) provides that a Chapter 7 debtor may convert the case to another chapter at any time if the case has not been previously converted. The traditional view is that this right is absolute. Pequeno v. Schmidt , 307 B.R. 568 (Bankr. S.D. Texas, 2004), is illustrative of this view. This case also contains a compendium of decided cases on both sides of the issue as of its March 2004 date.

In Pequeno v. Schmidt, supra, a pro se debtor failed to disclose a lawsuit against his former employer. The trustee learned of the lawsuit on the eve of trial and the trial proceeded to a $400,000 judgment in favor of the debtor. The debtor then delayed the filing of schedules, and failed to appear at his meeting of creditors, all to prevent administration of the judgment by the trustee. The debtor then sought to convert the Chapter 7 to a Chapter 13. While the motion was pending, the Chapter 7 trustees settled the lawsuit, and the settlement was approved by the court. The court then sustained the trustee's objection to the debtor's claim of exemption on the judgment at the same time that the court denied the motion to convert. The District Court remanded, holding that the right to convert is absolute: 'statutory right that is absolute cannot have court made exceptions. If that were the case, it would not be an absolute right.' 307 B.R. at 579. In so holding, the court relied upon a 1989 Fifth Circuit case, In re Martin, 880 F.2d 857, holding the right to convert is absolute in a situation involving the administration of real estate by a Chapter 7 trustee.

When a case is converted from Chapter 7 to Chapter 13, the creditors or trustee can always move to reconvert the case to a Chapter 7 pursuant to Bankruptcy Code Section 1307(c). The Pequeno court observed: ' ' as many courts have pointed out, the case may always be reconverted to Chapter 7, and this reconversion can be because of a debtor's bad faith. While one might consider it frivolous to convert only to reconvert, such a procedure allows one to comply with both the Congressional mandate of Section 706(a) and the duty to protect the bankruptcy process from abuse.' 307 B.R. at 580.

Federal Rule of Bankruptcy Procedure 1017(f)(2) requires the filing of a motion to convert. Whether or not a motion to convert may be made ex parte or by notice is left to local rules, but in any event a motion is required.

Bad Faith

The notion that the right to convert from a Chapter 7 to a Chapter 13 is not absolute first appears at the Circuit Court level with In re Caldwell, 895 F.2d 1123 (6^th Cir. 1990). Here, the debtor sought conversion after a creditor filed an objection to dischargeability under Bankruptcy Code Section 523(a)(6). The debtor sought conversion primarily because the debt could be discharged by completing a Chapter 13 plan and receiving a Chapter 13 discharge. The creditor sought to prevent the conversion on the grounds that the Chapter 13 was lacking in good faith.

The court found that the debtor's conduct in preventing collection of the underlying judgment, including failure to disclose all of his assets in his Chapter 7, was in bad faith and the conversion was denied: 'Rather than a good faith effort to repay this debt, we see an unbroken pattern of deceit and delay.' 895 F.2d at 1127. However, the court noted that converting a Chapter 7 to Chapter 13 because an underlying debt may be non-dischargeable in Chapter 7 is not per se bad faith: 'It is not conclusively bad faith for a debtor to seek to discharge a debt incurred through his own criminal or tortious conduct, but that factor may be considered ' The plan before us was not tendered in good faith, but was one more effort to avoid paying the judgment creditors.' 895 F.2d at 1127-1128.

In re Copper

In In re Copper, 426 F. 3d 810 (Cir. 6 2005), the issue was squarely faced when the bankruptcy court refused to convert a Chapter 7 to a Chapter 13. In this case, the debtor spent 9 years attempting to avoid paying his ex-wife amounts due pursuant to a divorce decree, including the filing of six bankruptcy petitions over a 5-year period, all of which were dismissed except for the last. In the sixth case, the ex-wife filed objections to dischargeability and discharge. The day before trial, the debtor sought to convert his case to a Chapter 13.

The debtor asserted that his right to convert was absolute. The bankruptcy court and the Sixth Circuit Bankruptcy Appellate panel (314 B.R. 628 2004) disagreed. The BAP panel opinion noted that In re Martin, supra, although supporting the absolute right to convert, suggested in a footnote that the right would not be absolute in extreme circumstances. In affirming the BAP Panel, the Sixth Circuit cited a trend towards denying the right to convert where there is bad faith, and noting that such a finding is consistent with the principle that a Chapter 13 plan can be denied confirmation if not filed in good faith. The court held:
' ' if, upon its review of the facts, the bankruptcy court finds that the debtor's request for conversion was made in bad faith or represents an attempt to abuse the bankruptcy process, the court may deny the requested conversion.' (426 F.3d at 815). The Circuit further adopted a totality of circumstances approach in analyzing the issue.

The debtor's conduct in seeking conversion was not motivated by a desire to pay his creditors, but by a desire to avoid paying for a lengthy period, coupled with efforts to conceal his assets and file numerous bankruptcy petitions. 'Indeed, at argument counsel for the Debtor all but admitted a lack of good faith, relying solely on his legal position that good faith is irrelevant under '706(a) of the Code.' (426 F. 3d at 815).

In re Marrama

In In re Marrama, 430 F.3d 474 (Cir. 1 2005), the debtor failed to disclose a transfer of real property to a trust for no consideration in which he was the sole beneficiary and his girlfriend was the trustee. He also failed to disclose his interest as a beneficiary in the trust, claiming it was not property of the estate. At his meeting of creditors, he testified that he lived in this property in Maine although he had claimed a homestead exemption on a parcel of real estate in Massachusetts that he was using as a rental but was not living in when he filed his Chapter 7 petition. The debtor sought conversion to Chapter 13 to prevent administration of the assets by the Chapter 7 trustee.

In affirming the decisions of the bankruptcy court and the First Circuit BAP Panel, the First Circuit stated: 'The plain language of subsection 706(a) in no sense undermines the presumptive authority of the bankruptcy court to take reasonable steps to thwart debtor abuse of the bankruptcy process.' (430 F.3d at 480). The court reasoned that the word 'may' in Bankruptcy Code Section 706(a) is a discretionary, as opposed to a mandatory, term. The court also adopted the observation of other courts that the phrase 'at any time' is temporal only, and not the grant of an absolute right. It also rejected the notion that the debtor may convert and the trustee or creditors move to re-convert.

The Circuit also adopted the totality of circumstances approach to analyzing the issue of bad faith, and affirmed the lower court findings that the conversion attempt was in bad faith where the Debtor had: 1) transferred the property to the trust admittedly to protect it from his creditors; 2) failed to disclose his interest in his schedules; and 3) failed to disclose rental income.

Collateral Issues

Conversion from a Chapter 7 to a Chapter 13 raises a number of collateral issues. First, the weight of authority supports the idea that a Chapter 7 trustee is entitled to some amount of compensation for work performed or distributions made during the time the case was pending in Chapter 7. See, for example, In re Wells, 87 B.R. 732 (Bankr. N.D. Ga. 1988); In re Hages, 252 B.R. 789 (Bankr.N.D.Ca. 2000).

Second, the Chapter 7 trustee's counsel can, under the appropriate circumstances, be compensated after conversion of the case to Chapter 13 for services rendered to the Chapter 7 trustee prior to the conversion. See In re Conkle, 2005 Bankr. Lexis 299 (Bankr. ND GA, 2005). A superseded Chapter 7 trustee in the converted Chapter 13 has standing to assert claims and to pursue litigation. See In re Searles, 317 B.R. 368 (9^th BAP 2004), and In re Jennings, 31 B.R. 379 (Bankr. S.D. Oh 1983).

Third, conversion during pendency of a complaint objecting to discharge does not moot the complaint, but merely abates the case while the Chapter 13 remains pending, since the case may always be reconverted to a Chapter 7 case. See In re Searles, 317 B.R. 368 (9^th BAP 2004).

BAPCPA

The First Circuit in In re Marrama, supra, observed that the BAPCA does not affect the issue of good faith in converting a case from a Chapter 7 to a Chapter 13: 'The language of subsection 706(a) remains unchanged under the new act ' ' (430 F.3d at 481). In fact, one provision of BAPCPA may help enhance the good faith requirement. New 11 U.S.C. ' 1325(a)(7) requires, as a condition to confirming a Chapter 13 plan, that the court find that the petition was filed in good faith. Thus, if a debtor converts from a Chapter 7 to a Chapter 13, this provision can be read to mean that the court must find that the conversion was in good faith.

Conclusion

Although it has long been the view that there is a one time absolute right to convert a Chapter 7 to a Chapter 13, the case law trend is that the conversion must be in good faith, generally determined by the totality of circumstances. This evolution in the case law is unaffected by BAPCPA, which may have rendered support to the proposition through the enactment of 11 U.S.C. ' 1325(a)(7). When a case may be converted, collateral issues will arise, such as the standing of the former Chapter 7 trustee, compensation due to the former Chapter 7 estate's professionals, and the abatement of pending litigation in the superseded Chapter 7 case.

David L. Buchbinder, a member of this newsletter's Board of Editors, is a trial attorney with the Office of the United States Trustee, Region 3, Wilmington, DE, a member of the California, New Jersey and Pennsylvania bars, and the author of Basic Bankruptcy for Paralegals, published by Aspen Publishing Co. The opinions expressed herein are the personal opinions of the author and not of the Department of Justice or United States Trustee Program. Kathleen A. Cashman-Kramer is with Pyle Sims Duncan & Stevenson in San Diego, CA. She is a member of the California, Massachusetts and District of Columbia bars, co-chair of the San Diego County Bar Association Bankruptcy Section and a Board Member of the San Diego Bankruptcy Forum.