Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.
By Diane Davis
Oct. 30 — A debtor's Chapter 13 case was correctly converted by the bankruptcy court to a case under Chapter 7 after the debtor failed to accurately disclose the full amount of his inheritance and intentionally spent it rather than pay his creditors, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit held Oct. 26.
In an unpublished opinion, Judge Margaret M. Mann concluded that it was in the best interests of creditors and the estate to convert the debtor's case from one under Chapter 13 which allows a debtor receiving regular income to obtain debt relief while retaining his property to one under Chapter 7 in which the debtor's nonexempt assets are liquidated and the proceeds are distributed to creditors.
The BAP also found sufficient evidence to support a finding of bad faith. Debtor Jason Scott Brown's failure to provide an accounting of the inheritance funds was bad faith, the panel said. The BAP also noted the inconsistencies in the debtor's disclosures in which a fair inference could be drawn that the debtor wanted to withhold any non-exempt amount of the inheritance from his unsecured creditors.
Bankruptcy Code Section 1307(c) provides for the conversion of a Chapter 13 case to Chapter 7, or the dismissal of a case, whichever is in the best interests of creditors and the estate, for cause, on the request of a party in interest and after notice and a hearing. Section 1307(c), the panel said, also sets forth a non-exclusive list of factors that constitute “cause” for conversion or dismissal, including “unreasonable delay by the debtor that is prejudicial to creditors,” “failure to commence making timely payments under Section 1326,” and “denial of confirmation of a plan under Section 1325 and denial of a request made for additional time for filing another plan or modification of a plan.”
The debtor's father died intestate and the debtor was the personal representative of his father's probate estate. The debtor filed documents in the probate proceeding indicating that his three brothers each assigned and abandoned to him their beneficial interests in the father's estate. The debtor also arranged to sell his father's home, which generated net proceeds of $65,812.
Three days before the closing, the debtor filed a bare bones Chapter 13 petition. Later, he filed his bankruptcy schedules and Chapter 13 plan, which proposed $250 monthly payments over 36 months. The plan paid three secured creditors in full and proposed a zero percent dividend for unsecured creditors.
The debtor listed his anticipated inheritance on his schedules of $2,500, which he claimed as fully exempt. At the time of filing, the debtor was unemployed and collecting Social Security.
At the Section 341(a) meeting of creditors, debtor's counsel and trustee Thomas H. Billingslea signed a pre-confirmation modification (PCM) to the Chapter 13 plan, which resolved the trustee's objection to the length of the plan by requiring the debtor to turn over $3,224 in probate proceeds within 45 days of receipt because the plan needed to pay a car creditor more funds.
After the probate estate closed, the debtor distributed to himself $55,487 as the sole beneficiary of his father's estate. He didn't amend his bankruptcy schedules to include the increased inheritance or claim any further exemption.
The trustee objected to the debtor's plan and moved to dismiss the case. The trustee also argued that a confirmation order should be contingent on the debtor forwarding a check to the trustee's lockbox account for $37,569 and a PCM increasing the pro-rata payment to the general unsecured creditors to $34,563.
The debtor asserted that his equitable share of his father's estate was $12,372 and fully exempt. According to the debtor, his plan didn't need to be modified because he and his three brothers were entitled to 25 percent of the inheritance.
The trustee filed an amended objection to the debtor's plan and asked the court to convert the case to Chapter 7 because the debtor failed to disclose his inheritance, which was an abuse of the bankruptcy system.
At a bankruptcy court hearing on the conversion, the debtor told the court that his share of the inheritance went into his business and the balance was paid in cash to two brothers and by check to a third brother. The bankruptcy court found that the only apparent source of assets to pay creditors had been dissipated, and that the debtor's pursuit of the Chapter 13 plan couldn't be in good faith.
The bankruptcy court also found that cause existed for conversion because a Chapter 7 trustee would be better suited to investigate the debtor's transfers to his brothers and bring any fraudulent transfer claims. Thus, the bankruptcy court ordered conversion of the case to Chapter 7 and concluded that there was an abuse of the bankruptcy process.
The debtor appealed, arguing that since most of the inheritance was transferred pre-conversion, the inheritance was no longer part of the estate under Section 348(f)(1)(A), which addresses the effect of conversion.
The BAP agreed with the bankruptcy court that there was sufficient evidence to find “cause” for conversion under Section 1307(c)(1).
According to the BAP, the debtor never affirmatively filed a modified plan and the debtor provided no evidence that his modified plan was feasible when his income wouldn't support a 100 percent plan and the inheritance, which was the only source of 100 percent payment, was gone.
The BAP also found sufficient evidence to support a finding of bad faith. According to the BAP, the evidence showed that the debtor had the proceeds from the sale of his father's house at the time he filed his schedules, and yet he disclosed that he anticipated receiving only $2,500 from the probate estate. The debtor also claimed that his brothers were entitled to 75 percent of the inheritance, but his brothers filed waivers of their beneficial interests with the probate court, the BAP said.
Finally, the BAP rejected the debtor's argument that he has an absolute right to dismiss his case under Section 1307(b). The debtor's right of voluntary dismissal under Section 1307(b) is not absolute, but is qualified by the authority of the bankruptcy court to deny dismissal on grounds of bad faith conduct or “to prevent an abuse of process,” the BAP said, citing Rosson v. Fitzgerald (In re Rossen), 545 F.3d 764 (9th Cir. 2008).
Michael G. Doan of Doan Law Firm, Carlsbad, Calif., represented the appellant Jason Scott Brown; Todd Headden represented the appellee/Chapter 13 Trustee.
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