Couple Lacking Income Can't Convert Ch. 7 Case to Ch. 13

By Diane Davis

Feb. 9— The right of a debtor to convert from a bankruptcy filing under Chapter 7 to one under Chapter 13 is not an absolute right, and the bankruptcy court correctly denied the debtor's conversion motion, a district court in Delaware held Feb. 5.

Affirming the judgment of the bankruptcy court on the conversion order, Judge Leonard P. Stark of the U.S. District Court for the District of Delaware concluded that the bankruptcy court had a basis for denying the debtor's conversion motion. A bankruptcy court may deny a Chapter 7 debtor's motion to convert to Chapter 13 if the Chapter 7 debtor doesn't qualify as a “debtor” under Chapter 13.

In Chapter 7 bankruptcy, a debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors. Chapter 13 bankruptcy, on the other hand, allows individuals receiving regular income to obtain debt relief while retaining their property. To do so, the debtor must propose a plan that uses future income to repay a portion of his debts over a three to five year period.

Conversion motions are frequently subject to litigation, and the court’s ruling will help future litigants understand that they don't have an absolute right to convert their case from Chapter 7 to Chapter 13. Debtors must qualify as a “debtor” under Chapter 13, according to the court. Debtors also can't expect to make last minute filings that aren't in good faith and achieve the results that they are seeking.

According to the court, the debtors failed to meet their burden to establish regular income and there was no evidence presented from which the bankruptcy court could conclude that the debtors could make payments under a Chapter 13 plan. The court also found a lack of good faith on the part of the debtors based on the totality of the circumstances.

The court looked at the “eleventh hour request” to convert and the reason stated behind the conversion, which was “to remove the power of the Chapter 7 Trustee to sell Debtor's property.” The debtors also cited their disagreement with the legal fees and their fear that the trustee was “administratively wasting assets of the estate.” The debtors failed to meet their evidentiary burden to show that they could be a “debtor” under Chapter 13, the court said.

Qualify as a ‘Debtor.'

Bankruptcy Code Section 706(a) provides that a “debtor may convert a case under [Chapter 7] to a case under chapter 11, 12, of 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title,” the court said. While this appears to give a debtor an absolute right to convert his or her Chapter 7 case to one under Chapter 13, this section can't be read without looking at Section 706(d), the court said, which states that a “case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.” Thus, the debtor's right to convert depends on his or her ability to qualify as a “debtor” under Chapter 13, the court said.

To be a Chapter 13 debtor, one must be an “individual with regular income” and meet certain limits on the amount of indebtedness, and there must be sufficient cause for a court to convert the debtor's Chapter 13 case to Chapter 7 or dismiss it, the court said, citing Section 109(e).

Section 1307(c) provides that a Chapter 13 proceeding may be either dismissed or converted to a Chapter 7 proceeding “for cause” and lists a nonexclusive list of causes justifying that relief, the court said. Although bad faith isn't expressly listed as a cause, the U.S. Supreme Court in Marrama v. Citizens Bank of Massachusetts, , 549 U.S. 365, 127 S. Ct. 1105 (2007), held that “prepetition bad faith conduct is tantamount to a ruling that the individual does not qualify as a debtor under Chapter 13,” the court said.

Fire-Damaged Property for Sale

Debtors Mark A. Culp and Patricia J. Chamberlain filed a conversion motion consisting of five sentences in length about 14 months after the bankruptcy court entered an order to sell the debtors' property. Chapter 7 trustee Charles A. Stanziale, Jr., wanted to sell the debtor's property, which had been damaged by fire, for $143,423.

The parties disagreed as to the value of the fire-damaged property and the trustee's decision to sell the property. Green Tree asserted a secured claim against the property for $280,000, and was holding $74,000 of insurance proceeds as an escrow account. Accord Restoration, Inc. asserted a mechanic's lien against the property for $39,630, plus unpaid interest. Accord filed a proof of claim in the debtors' Chapter 7 bankruptcy for $131,210.

Subsequently, Accord agreed to purchase the property “as is” for $290,000.

Last Minute Maneuvers

The bankruptcy court approved the bidding and sale procedures and estimated the value of the property to be $175,000. Prior to the final hearing on the sale motion, the debtors filed a motion to convert the case to one under Chapter 13 to remove the trustee's power to sell the property.

The trustee and Accord opposed the conversion motion, arguing that the debtors were ineligible to be debtors under Chapter 13. Accord contended that neither of the debtors were employed and had no income to propose a feasible Chapter 13 plan.

On the eve of the conversion motion hearing, the debtors amended their bankruptcy schedules to show Mark Culp as employed.

The bankruptcy court held a hearing to consider the conversion motion, sales motion, and fee application, but later urged the parties to discuss settlement. At a subsequent hearing, the parties informed the court that no settlement could be reached with the debtors, and the bankruptcy court entered the sales order. The bankruptcy court also denied the conversion motion.

No Absolute Right to Convert

The debtors then appealed to the district court, arguing that they had an absolute right to convert to Chapter 13.

The trustee contended that there is no absolute right to convert because a debtor's right to seek conversion is limited by the express language of Section 706(d). The trustee also argued that the debtors' conversion motion wasn't filed in good faith and for a proper purpose.

Sale in Good Faith

Ultimately, the district court found that the trustee established a sound business purpose justifying the sale of the debtors' property. The court also found the debtors' appeal of the sale order moot under Section 363(m). Accord was a good faith buyer and “entitled to all of the protections afforded thereby,” the court said. The sale was undertaken by Accord in good faith, the court said.

Peter K. Schaeffer, Jr., Avenue Law, Dover, Del., represented appellants Mark A. Culp, Patricia J. Chamberlain; Katharine L. Mayer, McCarter & English, LLP, Wilmington, Del., represented appellee/Chapter 7 Trustee Charles A. Stanziale, Jr.

To contact the reporter on this story: Diane Davis in Washington at ddavis@bna.com

To contact the editor responsible for this story: Jay Horowitz at jhorowitz@bna.com


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