Through the Bankruptcy Code, Congress established two main types of consumer bankruptcy: Chapter 7 and Chapter 13. Chapter 7 is what most people think of when they hear the word “bankruptcy.” It is a type of liquidation. In Chapter 7, the debtor turns over most non-exempt assets to a trustee — the Chapter 7 trustee — who then liquidates such assets and distributes the proceeds for the benefit of creditors. Typically, after a fairly short time, the debtor receives a discharge of most of the debtor’s debts and moves on.
Chapter 13 is a type of reorganization. Chapter 13 “affords individuals receiving regular income an opportunity to obtain some relief from their debts while retaining their property.” Bullard v. Blue Hills Bank, 575 U.S. 496, 498 (2015). The quid pro quo is the Chapter 13 plan. A debtor must propose and obtain Court approval of a “plan under which [the debtor] pay[s] creditors out of . . . future income.” Hamilton v. Lanning, 560 U.S. 505, 508 (2010). If the debtor makes “all payments under the plan,” the debtor earns the right to a discharge and a “fresh start” free from most prior financial burdens. The Chapter 13 bargain is tough. Most Chapter 13 cases do not make it all the way to completion and discharge.
In a recent bankruptcy case, the Debtors filed for protection under Chapter 7. The first stages of the case went well. The Debtors obtained their Chapter 7 discharge. However, many months into the bankruptcy case, the Chapter 7 trustee, Simon E. Rodriguez (the “Chapter 7 Trustee”) determined that he might be able to sell their home (for an amount in excess of the Debtors’ mortgage, closing costs, and the Debtors’ exemption) resulting in a potential return for creditors. The Debtors did not want to lose their home. So, they filed a “Motion to Convert” requesting authorization to switch from Chapter 7 liquidation to Chapter 13 reorganization and thereby retain their home. They relied on Section 706(a) which generally allows a debtor to “convert” a case from Chapter 7 to Chapter 13 “at any time.”
This case presents a dispute over the Debtors’ ability to convert from Chapter 7 to Chapter 13. At first blush, Section 706(a) might seem to allow a bankruptcy debtor an “absolute right” to convert from Chapter 7 to Chapter 13. However, a key Supreme Court decision, Marrama v. Citizens Bank of Mass., 549 U.S. 365 (2007), says otherwise. Under Marrama, the Debtors must show that they are eligible (per Section 109(e)) to obtain relief under Chapter 13. The Chapter 7 Trustee disputes the Debtors’ eligibility. And, he goes further. Relying on Marrama, the Chapter 7 Trustee also
contends that the Debtors’ attempted switch to Chapter 13 constitutes “bad faith” which justifies denial of conversion.
Ultimately, the Court must decide whether the Debtors may convert from Chapter 7 to Chapter 13. After analyzing the facts and law, the Court concludes that the Debtors are eligible to obtain relief under Chapter 13 and that their effort to convert does not constitute “bad faith.” As a result, the Debtors may convert to Chapter 13. Of course, that does not end the story because the Debtors still have a long way to go. They must propose and confirm a Chapter 13 plan to pay their creditors. And, then they will need to complete their Chapter 13 plan.
This is not an “extraordinary case” justifying denial of conversion from Chapter 7 to Chapter 13 under the Marrama framework. See Lane, 2011 WL 3205782 (debtors permitted to convert from Chapter 7 to Chapter 13 to attempt to save real property). There is no evidence of “fraudulent conduct by the atypical litigant.” Marrama, 549 U.S. at 374. Instead, the Debtors appear to be “honest but unfortunate.” And, the circumstances of this case are quite typical. The Debtors are merely trying to save their home by converting to Chapter 13 and engaging in the hard bargain of paying
their creditors over three to five years through a Chapter 13 plan. They have every right to try to obtain such relief in Chapter 13 although, ultimately, they will need to meet all the confirmation requirements under Section 1325(a). Maybe the Debtors will succeed. Or, maybe not. But the Debtors have the right to try Chapter 13. Their efforts are not
an abuse of the provisions, purpose, or spirit of Chapter 7, Chapter 13, or the Bankruptcy Code. Rather, the Debtors are endeavoring to avail themselves of the benefits of Chapter 13 which Congress afforded to honest but unfortunate debtors.
Their conduct is not bad faith.
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