‘Unfair Manipulation’ of Process Boomerangs on Debtor

Understand the complexities and nuances of the Bankruptcy Code to better advise clients and prepare for court.

By Diane Davis

Debtors who abused the bankruptcy process can’t convert their Chapter 7 case to Chapter 13, the U.S. Bankruptcy Court for the Central District of California held Jan. 10 ( In re Santos , 2017 BL 8706, Bankr. C.D. Cal., No. 6:13-bk-13557-MH, 1/10/17 ).

Michael & Maricar Santos asked for conversion after the court ordered them to turn over their house in Chino Hills, Calif. The couple had already received a “standard discharge” of debts in their Chapter 7 case, but their estate property hadn’t yet been liquidated, Judge Mark D. Houle’s opinion said.

Because “the Chapter 7 case is not fully administered,” there “is no benefit to the estate in exchange for the Debtors’ discharge,” the court said.

The Santos’ "attempt to retain the benefits of the bankruptcy process, without fulfilling their corresponding duties, constitutes an unfair manipulation of the Bankruptcy Code,” the court said.

Before 2007, some courts interpreted Bankruptcy Code Section 706(a) as giving debtors an absolute, one-time right to conversion, but “after a discharge has been obtained,” historically “the majority of courts have not,” Houle’s opinion said.

Following Marrama v. Citizens Bank of Mass., 549 U.S. 365 (2007), the court determined that it has the authority to deny conversion “for cause,” and abuse of the process is “cause.” “Cause” doesn’t require fraudulent intent or any bad conduct by the debtors, the court said.

For a detailed discussion of Marrama, see Bloomberg Law: Bankruptcy Treatise, pt. VII, ch. 226 (D. Michael Lynn et al. eds., 2016).In Chapter 7 bankruptcy, a debtor’s nonexempt assets are liquidated by a trustee, and the proceeds are distributed to creditors. Chapter 13 bankruptcy allows individuals receiving regular income to obtain debt relief while retaining their property, but to do so, the debtor must propose a plan that uses future income to repay all or a portion of his debts over a three to five year period.

Jeffrey B. Smith, Long Beach, Calif., represented the Santos’. Law Offices of Wesley H. Avery, APC, Pasadena, Calif., represented Trustee Larry D. Simons, Riverside, Calif.

To contact the reporter on this story: Diane Davis in Washington, D.C. at DDavis@bna.com

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

Copyright © 2017 The Bureau of National Affairs, Inc. All Rights Reserved.

Try Bankruptcy on Bloomberg Law