Wednesday, February 21, 2007

Supreme Court Holds Chapter 7 Debtors Have NO Absolute Right to Convert to Chapter 13

In a 5-4 decision, the United States Supreme Court today decided that a chapter 7 debtor does not have an absolute right to convert to chapter 13. The case is Marrama v. Citizens Bank of Massachusetts, and you can view the opinion here.

In a 5-4 decision (Stevens writing for the majority, Alito writing for the dissent, and Kennedy being the swing vote), the Supreme Court held that 11 U.S.C. Section 706(a) and (d) read together, prevents a debtor, who could not be a debtor under a chapter 13, from converting a chapter 7 case to chapter 13.

The Court reasoned that: (1) in this case, the debtor cannot qualify as a debtor under chapter 13 because of debt limitations set forth in 11 U.S.C. section 109(e); (2) the debtor filed the petition in "bad faith," which is a cause to dismiss chapter 13 cases pursuant to case law under 11 U.S.C. section 1307(c); and (3) bankruptcy court has power under 11 U.S.C. section 105(a) to immediately deny a conversion motion under section 706 in response to fraudulent conduct of a debtor who has demonstrated he is not entitled to relief.

As the Supreme Court noted in its footnote 2, the Ninth Circuit was one of the circuits that had allowed even bad-faith debtors an absolute right to convert at least one chapter 7 case to chapter 13. This opinion will substantially change the law in the Ninth Circuit. Moreover, part of the Supreme Court's rationale relies on "bad faith" debtors could be dismissed under 11 U.S.C. Section 1307(c), even though that is not a specified cause. This will prevent any "bad faith" debtors from escaping chapter 7 into chapter 13.

The dissent pointed out that Congress crafted the Bankruptcy Code to deal with "bad faith" debtors already (requiring good faith proposal of chapter 13 plan, reconversion to chapter 7, etc.). In addition, the dissent reasoned that the majority should focus solely on section 109 instead of incorporating section 1307 because 109 sets forth requirement to become a debtor under various chapters.