A Penny Returned Is a Penny Earned Who Gets the Money Upon Conversion of a Chapter 13 Case to Chapter 7 Before Confirmation

A Penny Returned Is a Penny Earned Who Gets the Money Upon Conversion of a Chapter 13 Case to Chapter 7 Before Confirmation

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Under the Bankruptcy Reform Act of 1978,1 there was a split of authority as to the disposition of funds paid to the chapter 13 trustee after commencement of a case where the case was converted to a chapter 7 case before confirmation of a plan.2 In 1994, Congress amended §348 of the Code, adding subsection (f)(1) to ensure uniformity in returning to the debtor any property acquired after commencement of the case.3 Congress sought to encourage the use of chapter 13 over chapter 7 by removing a "penalty" for failure in the chapter 13.4

Congress provided a "backstop" against the abusive conversion of a case,5 codified in subsection (f)(2),6 which provided for forfeiture to the estate if the conversion to chapter 7 was in bad faith. Unfortunately, neither the Code nor the Bankruptcy Rules offer any guidance as to how the issue of bad faith should be framed post-conversion.7 There is neither a deadline nor a procedure established for challenging a conversion.

At least one court has suggested that raising a challenge to whether a conversion is in good faith should be done by motion.8 However, since the issue is an attempted recovery of assets to the estate, which would otherwise be presumed to be property of the debtor, it would seem that the challenge should be done through an adversary proceeding.9 One court has suggested that a matter brought before it by motion and dealing with the good-faith of a conversion should have been brought as an adversary proceeding.10 This is distinguished from a motion to compel turnover of property of the estate from the debtor.11

Commonly, the reported cases regarding the allegedly bad-faith conversion of a chapter 13 case are brought in the context of objections to exemptions or a motion for turnover.12 The standard for determination of a bad-faith conversion is the "totality of the circumstances."13

Congress created §348(f)(2) to implement specific policies encouraging the use of chapter 13 and limiting the "sting" of failure to only those cases in which bad faith was at the root of a conversion. In the 12 years since the effective date of that section, only five reported opinions actually deal with a conversion from chapter 13 to chapter 7 allegedly in bad faith.14 Of those five reported opinions, only one resulted in inclusion of the assets acquired during the chapter 13 case in the post-conversion chapter 7 estate. It is possible that this section is underutilized due to the vagueness of the statute, and the utter lack of implementation through Bankruptcy Rules.

It appears that the conversion of a chapter 13 case to a chapter 7 will almost always result in "a penny returned."



1 Hereinafter referred to as the Code.

2 Prior to the Act's amendments to §348, the issue of whether post-petition chapter 13 income remains property of the estate on conversion to chapter 7 was confusing and had created a circuit split. See Baker v. Rank (In re Baker), 154 F.3d 534, 536 (5th Cir. 1998); compare In re Bobroff, 766 F.2d 797, 803-04 (3d Cir. 1985) with In re Lybrook, 951 F.2d 136, 138 (7th Cir. 1991), and In re Lindberg, 735 F.2d 1087, 1089-90 (8th Cir. 1984). Similar dicta was contained in Lowe v. Sandoval (In re Sandoval), 103 F.3d 20, 23 (5th Cir. 1997). There we also noted that the Act was designed to resolve the circuit split on the instant issue. Stamm v. Morton (In re Stamm), 222 F.3d 216, 218 (5th Cir. 2000).

3 Except as provided in paragraph (2), when a case under chapter 13 of this title is converted to a case under another chapter under this title—

(A) property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion; and
(B) valuations of property and of allowed secured claims in the chapter 13 case shall apply in the converted case, with allowed secured claims reduced to the extent that they have been paid in accordance with the chapter 13 plan.

(2) If the debtor converts a case under chapter 13 of this title to a case under another chapter under this title in bad faith, the property in the converted case shall consist of the property of the estate as of the date of conversion. 11 U.S.C. §348(f)(1)

4 Congress amended the Bankruptcy Act in 1994 to protect property, earnings and equity interests acquired during the pendency of chapter 13 proceedings to encourage chapter 13 filings. See, e.g., In re Woodland, 325 B.R. at 585; In re Nichols, 319 B.R. at 856-57; Warren v. Peterson, 298 B.R. 322, 324-25 (N.D. Ill. 2003); In re Archie, 240 B.R. 425, 431-32 (Bankr. S.D. Ala. 1999); In re Pearson, 214 B.R. 156, 164 (Bankr. N.D. Ohio 1997) ("the legislative history makes clear that Congress was concerned that debtors would be counseled to file chapter 7 cases rather than chapter 13 cases because, in the event the plan could not be completed and the debtor would have to convert to chapter 7, debtors would lose any equity in the collateral they may have gained by making payments on the secured claim during the chapter 13"). In re Boyum, 2005 U.S. Dist. LEXIS 20054, 8-9 (D. Or. 2005).

5 11 U.S.C. §348(f)(2) eliminates the policy concern that debtors may use conversion to abuse the bankruptcy process... This provision provides a deterrent and remedy if debtors seek conversion in an abuse of the bankruptcy process. DiBraccio v. Ferretti (In re Ferretti), 230 B.R. 883, 889 (Bankr. S.D. Fla. 1999).

6 See Note 3 supra.

7 The latest version of the Rules provide only the following guidance for conversions:

B.R. 1017(f) Procedure for dismissal, conversion and suspension.
(1) Rule 9014 governs a proceeding to dismiss or suspend a case, or to convert a case to another chapter, except under §1307(a) or (b).
(2) Conversion or dismissal under §1307(b) shall be on motion filed and served as required by Rule 9013.
(3) A chapter 13 case shall be converted without court order when the debtor files a notice of conversion under §1307(a). The filing date of the notice becomes the date of the conversion order for the purposes of applying §348(c) and Rule 1019. The clerk shall promptly transmit a copy of the notice to the U.S. Trustee.
B.R. 1019 (5)(b) Conversion of chapter 13 case. Unless the court directs otherwise, if a chapter 13 case is converted to chapter 7,

(I) the debtor, not later than 15 days after conversion of the case, shall file a schedule of unpaid debts incurred after the filing of the petition and before conversion of the case, including the name and address of each holder of a claim; and
(ii) the trustee, not later than 30 days after conversion of the case, shall file and transmit to the U.S. Trustee a final report and account;
(c) Conversion after confirmation of a plan.

Unless the court orders otherwise, if a...chapter 13 case is converted to chapter 7 after confirmation of a plan, the debtor shall file:

(I) a schedule of property not listed in the final report and account acquired after the filing of the petition but before conversion, except if the case is converted from chapter 13 to chapter 7 and §348(f)(2) does not apply;
(ii) a schedule of unpaid debts not listed in the final report and account incurred after confirmation but before the conversion; and
(iii) a schedule of executory contracts and unexpired leases entered into or assumed after the filing of the petition but before conversion.

Emphasis added.

8 Though the statute is silent about procedure, someone (presumably the chapter 7 trustee in most cases) would have to bring a "timely motion" to obtain a determination of bad faith, and presumably "timely" would mean some time before the chapter 13 trustee disburses funds on hand to the debtor. There is no requirement in the statute (or the rules) for the chapter 13 trustee to hold the funds for some period to see whether such a motion might be filed by some interested party. In re Zamora, 274 B.R. 268, 270 n.3 (Bankr. D. Tex. 2002).

9 Bankruptcy Rule 7001, provides, in pertinent part:

An adversary proceeding is...a proceeding (1) to recover money or property, except a proceeding to compel the debtor to deliver property to the trustee or a proceeding under §554(b) or §725 of the Code, Rule 2017 or Rule 6002, (2) to determine the validity, priority or extent of a lien or other interest in property, other than a proceeding under Rule 4003(d)...(7) to obtain an injunction or other equitable relief, (9) to obtain a declaratory judgment relating to any of the foregoing....

10 In re Carter, 260 B.R. 130, 131 n.2 (Bankr. D. Tenn. 2001).

11 The Code includes an affirmative duty upon the debtor to turn over property of the estate. 11 U.S.C. §521 provides, in pertinent part, "The debtor shall...(4) if a trustee is serving in the case, surrender to the trustee all property of the estate...."

12 Unified People's Fed. Credit Union v. Yates (In re Yates), 2005 Bankr. LEXIS 1889 (Bankr. Fed. App. 2005) (motion for turnover by undersecured creditor denied). In re Bejarano, 302 B.R. 559 (Bankr. N.D. Ohio 2003) (objection to exemption overruled). In re Carter, 260 B.R. 130, 131 (Bankr. D. Tenn. 2001) (motion by chapter 7 trustee seeking a judicial determination denied). In re Wiczek-Spaulding, 223 B.R. 538 (Bankr. D. Minn. 1998) (objection to exemption with respect to severance pay and stock options from employment, overruled as to alleged bad-faith conversion). In re Siegfried, 219 B.R. 581, 582 (Bankr. D. Colo. 1998) (creditor's motion to determine that debtor's conversion from chapter 13 to chapter 7 was in bad faith granted).

13 Warren v. Peterson, supra at 327, 328; In re Siegfried, supra at 584, 585.

14 See note 12, supra.

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Saturday, July 1, 2006