A Primer on a Motion to Convert to Chapter 11 or 13; the James vs. West case, part five

As a bankruptcy attorney in Mount Vernon, IL for over 20 years, I read through and analyze court rulings throughout the country. I was lucky to find this wonderful case from the Western District of Missouri (whence lay Kansas City, Independence, Branson, etc.). James v. West, 16-40358.

 

What a wonderful case this is: an excellently written opinion dealing with fraud, the means test and other topics important in bankruptcy.

This isn’t an opinion, this is a text book. It should be on the curriculum of anyone teaching bankruptcy law. It is that good!

Click on the links to read Part One, Two, Three and Four.

 

  1. Count 2: Motion to Convert to Chapter 11

Count II of the Jameses’ Amended Motion seeks, in the alternative to dismissal, conversion to Chapter 11 under § 706(b). For the reasons stated below, the Court denies Count II of the Jameses’ Amended Motion.

Section 706(b) provides that, “[o]n request of a party in interest and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 11 of this title at any time.” Section 706(b) does not state under what circumstances a court should consider conversion; courts therefore retain discretion to order conversion under § 706(b). In re Schlehuber, 489 B.R. 570, 573 (B.A.P. 8th Cir. 2013), aff’d, 558 Fed. App’x 715 (8th Cir. 2014).

The movant generally bears the burden to show grounds for conversion to Chapter 11 under §706(b). In re Ryan, 267 B.R. 635, 637–38 (Bankr. N.D. Iowa 2001). This burden includes showing a debtor’s ability to reorganize through a Chapter 11 plan. Id.

In the Eighth Circuit, the decision whether to convert is “based on what will most inure to the benefit of all parties in interest.” Schlehuber, 489 B.R. at 573; In re Willis, 345 B.R. 647, 654 (B.A.P. 8th Cir. 2006). Because § 706(b) does not contain conversion factors, a court “should consider anything relevant that would further the goals of the Bankruptcy Code.” Schlehuber, 489 B.R. at 573. In Schlehuber, the court noted that the most important factor under § 706(b) is the ability to fund a Chapter 11 plan. Id. Because the debtors in Schlehuber could fund a Chapter 11 plan, the bankruptcy court’s order converting their Chapter 7 case to Chapter 11 was affirmed by both the B.A.P. and the Eighth Circuit on appeal.

Here, the relevant considerations are:

  • Based on this Court’s experience, Chapter 11 individual bankruptcy cases are both complicated and expensive; typical attorney fees and expenses for individual Chapter 11s average $20,000 or more; typically, experienced Chapter 11 lawyers charge higher hourly rates than Chapter 7 consumer lawyers, reflecting the higher level of skill, knowledge, risk, and expertise required for Chapter 11s.
  • Attorney fees, as administrative expenses of the estate, must be paid in full as of the effective date, unless the holder of the claim agrees to different treatment. See §1129(a)(9).
  • Likewise, expenses in a Chapter 11 are higher, as reflected both in the much higher filing fee plus the copy and mailing expense required to mail plans, disclosure statements, ballots and other required mailings to all creditors under Rule 2002; in addition, Chapter 11 debtors pay a quarterly fee based on disbursements to the United States Trustee under 28 U.S.C. § 1930.
  • Confirming an individual Chapter 11 plan of reorganization is not necessarily a “slam-dunk” process. Generally speaking, in Chapter 11, a debtor has the burden to prove that all the provisions of § 1129(a) are established, including the feasibility requirement of § 1129(a)(11).
  • Other § 1129(a) requirements include that the plan must classify classes of creditors, and “impaired classes” must vote to accept the plan if it is to be confirmed. See §§1124; 1129(a)(8), (a)(10). If impaired creditor classes do not vote to accept the plan, the plan may still be confirmed, but only if the plan meets the cramdown provisions of § 1129(b). The “absolute priority rule,” as it is known, means effectively that the creditors must be paid in full for the plan to be confirmed; otherwise, all of a debtor’s assets, including exempt ones such as cars and household goods, must be liquidated. E.g., In re Woodward, 537 B.R. 894 (B.A.P. 8th Cir. 2015) (absolute priority rule applies to individual Chapter 11 cases).
  • All unsecured creditors must be classified in the same class, but if classified separately, treatment cannot be discriminatory between classes. See §§ 1122, 1123(a)(4); 1129(a)(1); 1129(b).
  • The Jameses, as the largest unsecured creditors with the largest vote, would effectively control the class of unsecured creditors. This means, effectively, that unless the Jameses voted in favor of the plan, the plan could not be confirmed and the Chapter 11 case would have to be dismissed or converted. See §§ 1126(c), 1112(b)(4)(J).
  • Even if the Jameses voted in favor of a potential plan, based on the number of other creditors, there would have to be a number of other creditors who voted in favor or the plan could not be confirmed. See § 1126(c).
  • Unlike in a Chapter 7 or Chapter 13, if a debtor has scheduled undisputed creditors, they are considered to have an allowed unsecured claim in a Chapter 11 and thus are entitled to a vote. Rule 3018(a).
  • The Jameses presented no evidence about whether they would support any Chapter 11 plan; in the absence of that evidence, the Court must presume – given the vehemence with which they are pursuing the Debtor – that they would not vote to support a Chapter 11 plan unless it paid them 100% of their claim. Since any plan could not discriminate in treatment against the other unsecured creditors, the plan would have to propose to pay the Debtor’s approximately $163,000 in unsecured claims ($145,000 for the Jameses’ claim plus the $18,000 of other unsecured claims) in full.
  • Realistically, if the Debtor were to propose a Chapter 11 plan, she would be required to pay $190,000 to $200,000 to her creditors, after considering the $163,000 in unsecured claims, plus administrative fees and expenses. Assuming the Debtor continues to have $500 to $600 in projected disposable income, it would nonetheless take her more than 30 years to pay her debts and administrative expenses in full under a Chapter 11 plan (e.g., $190,000 divided by $500/mo. = 380/mos.; 380 mos. Divided by twelve = 31.6 years).
  • The Debtor has no other assets except exempt assets to fund a Chapter 11 plan and although she has a good job, as a woman in her 60s, she cannot be expected to work another thirty years.
  • In the alternative, it is not even clear that what the Jameses suggested in their Amended Motion – a Chapter 11 plan devoting all disposable income for five years – could be confirmable under these circumstances; the Debtor will likely need another car within the next five years and may face other increased living expenses. Unlike in a Chapter 13, in an individual Chapter 11 case, the debtor must complete all payments and demonstrate she devoted all disposable income during the Chapter 11 before receiving a discharge; there may be disputes about whether all disposable income was paid. § 1141(d)(5)(A).
  • Conversely, the Chapter 7 Trustee in this case has opened an asset case; there was no evidence about how much money she has collected (although there was some argument of counsel); but the Court can take judicial notice of the fact that the Chapter 7 Trustee requested issuance of a bar date, meaning that she intends to collect or has collected assets. Also, the Court may take judicial notice of the Chapter 7 Trustee’s “strong arm powers” to collect assets, such as the payments the Jameses received under their garnishment within the preference period of § 547(b), for the benefit of all creditors.
  • In a Chapter 11, the Debtor would be considered the trustee with strong arm powers and the power to sue the Jameses to the extent they received preferential or other avoidable transfers under § 547(b) [see § 1107]; it is not clear that it would be in the best interests of the estate for the Debtor acting as her own trustee to sue the Jameses, however, given the litigious relationship exhibited thus far.

Conclusion as to § 706(b) Conversion to Chapter 11

The Court believes that this case is not at all similar to Schlehuber. Rather, there is no evidence here that converting this case to a Chapter 11 would be in the best interests of the estate and other parties in interest, or that the Debtor could even propound a confirmable Chapter 11 plan. In sum, the Court concludes that the Jameses failed to meet their burden of proof under §706(b) to convert the case to a Chapter 11; likewise, the Court declines to exercise the discretion granted it under § 706(b) and the Schlehuber case to convert this case to a Chapter 11. Count II of the Amended Motion is therefore denied.

III. Count 3: Motion to Convert to Chapter 13

Count III of the Jameses’ Motion requests, in the alternative, that the Court convert the Debtor’s case to a Chapter 13. The Court denies the request, for the following reasons.

It is undisputed that at the time the Debtor filed bankruptcy, she was not eligible for a Chapter 13 given that her debts exceeded the debt limits of § 109(e). The Jameses added Count III after the state court reduced the judgment to $145,000. They argue that since a portion of their original judgment is void, that portion of the judgment never existed, such that the Debtor should be deemed eligible for conversion to Chapter 13 as of the date she filed bankruptcy. For the reasons set forth below, the Court disagrees.

Section 109(e) provides in relevant part that “[o]nly an individual with regular income that owes, on the date of the filing of the petition, noncontingent, liquidated, unsecured debts of less than $383,175 . . . may be a debtor under chapter 13 of this title.” (emphasis added).

Numerous events may occur postpetition to affect a debtor’s total secured or unsecured debt. Collateral may be liquidated, converting a secured claim to an unsecured deficiency claim.

Contingent personal guaranties may be liquidated after the creditor pursues a co-debtor, surety, or principal. A creditor may file a postpetition claim treated under the Code as prepetition, such as a lease rejection claim under § 365(g) or a § 1305 claim. Or, as was the case here, a judgment might be modified or vacated by the trial court that issued the judgment or later on appeal.

The majority of courts that have considered the effect of a postpetition event on eligibility to file (or be converted) to Chapter 13 have concluded that postpetition events should not be considered in determining eligibility. To hold otherwise would mean that a debtor could float in and out of Chapter 13 eligibility during the course of a case, depending on what happens, which of course makes no legal or practical sense.

The Court thus agrees with the majority of courts that the plain language of § 109(e) requires consideration of the debts as they exist as of the petition date, irrespective of postpetition events. (The other issue that arises when considering the Chapter 13 debt limits under § 109(e) is whether a court is limited to considering the debts as listed on the schedules or whether a court may look at other evidence besides the schedules. That is the not the issue in this case, and the Court expresses no opinion about the split of authority on that issue.) E.g., In re Wiencko, 275 B.R. 772 (Bankr. W.D. Va. 2002); In re Slac 187 F.3d 1070 (9th Cir. 1999); In re Snell, 227 B.R. 127 (Bankr. S.D. Ohio 1998); In re Harwood, 519 B.R. 535, 539–40 (Bankr. N.D. Cal. 2014); In re Pearson, 773 F.2d 751, 758 (6th Cir. 1985) (“[T]he fact that some later resolution of the conflict might render more certain the precise nature of the debt itself . . . is relatively immaterial in determining the debtors’ financial condition and Chapter 13 eligibility on the date the petition is filed. . .. We do not believe that the statute requires any more” than a realistic look at “the state of the debtors’ affairs” on the petition date). The fact that Missouri law might treat a voided judgment differently is simply not relevant to the meaning of § 109(e).

For the reason that the Debtor was not eligible to file a Chapter 13 on the date of filing of her petition, the Court concludes that Count III should be denied.

The Jameses’ Amended Motion to Dismiss or Convert is thus denied in toto and a separate written judgment will issue.

 

About the blogger:

Michael Curry of Curry Law Office in Mount Vernon, Illinois (http://michaelcurrylawoffice.com/) has helped thousands of individuals, family and small businesses in southern Illinois find protection under the Bankruptcy Code for almost twenty-five years. He is also available to help individuals and families with their estate planning (wills, power-of-attorney) and real estate and other sales transactions.

He is also the author of books on finance and bankruptcy available on Kindle through Amazon!

Whether you live in Mount Vernon, Dahlgren, Albion, Flora, and throughout Southern Illinois call Curry Law Office today at (618) 246-0993 and Finally Be Financially Free!

 

 

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5 thoughts on “A Primer on a Motion to Convert to Chapter 11 or 13; the James vs. West case, part five

  1. Pingback: A Review of Fraudulent Intent: the factual scenario from James vs. West | Curry Law Office

  2. Pingback: What is Fraud? And how does it affect bankruptcy? The James vs. West case | Curry Law Office

  3. Pingback: A primer on the elements of fraud | Curry Law Office

  4. Pingback: The James vs. West case, part nine: More analysis on the Elements of Fraud | Curry Law Office

  5. Pingback: A primer on Willfull and Malicious: the final review of the James vs. West case | Curry Law Office

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