Opinion
BKY Case No. 11–60636
03-16-2015
In re: Bruce J. Lien and Sherie N. Lien, Debtors.
Gene Doeling, Kaler Doeling PLLP, Michael L. Gust, Anderson & Bottrell, Fargo, ND, for Trustee. Logan M. Moore, Velde Moore Ltd., Alexandria, MN, for Debtors.
Gene Doeling, Kaler Doeling PLLP, Michael L. Gust, Anderson & Bottrell, Fargo, ND, for Trustee.
Logan M. Moore, Velde Moore Ltd., Alexandria, MN, for Debtors.
MEMORANDUM OPINION AND ORDER
Michael E. Ridgway, United States Bankruptcy Judge
This matter came on for evidentiary hearing before the Court on December 16, 2014, upon the chapter 7 Trustee's (“Trustee”) motion for a determination that conversion from chapter 13 to chapter 7 was done in bad faith under 11 U.S.C. § 348(f)(2), and for a determination that the “inheritance” received by the Debtors during the chapter 13 bankruptcy filing is property of the chapter 7 bankruptcy estate (the “Bad Faith Conversion Motion”), and the Debtors' response thereto, as well as the Trustee's motion for turnover appearing at ECF No. 58 (the “Turnover Motion”), and the Debtors' response thereto. Appearances were as noted on the record. After some discussion, the Court allowed the parties, in their discretion, to submit supplemental briefing on the Turnover Motion. Both parties did so and the Court took the matters under advisement. The matters are now ready for disposition.
So stated by the Debtors on Schedule B of their conversion documents. Ex. 13. Both parties have referred to Bruce Lien's interest as a beneficiary of the Loretta A. Lien Irrevocable Trust dated November 2, 1999, as an “inheritance.” The technical jargon may more accurately describe Bruce's “interest” in his mother's trust vis-a-vis his status as a trust beneficiary, e.g., his entitlement to distributions from trust assets. For ease of reading, however, the Court may also utilize the parties' nomenclature in referring to the interest as an “inheritance.”
At the hearing, the Court also certified familiarly with the record under Fed. R. Bankr.P. 9028. Stalnaker v. Allison (In re Tri–State Financial, LLC ), 519 B.R. 759, 766 n.4 (8th Cir. BAP 2014) (Fed.R.Civ.P. 63 applies in bankruptcy cases by virtue of Fed. R. Bankr.P. 9028 ).
This is a core proceeding under 28 U.S.C. § 157(b)(2)(A), (B), (E), and (O) ; this Court has jurisdiction under 28 U.S.C. §§ 157(a) and 1334. The motions arise under 11 U.S.C. §§ 521 and 542. The motions were filed under Fed. R. Bankr.P. 9014 and Local Rule 6072–1. For the reasons set forth below, the Court will grant the Trustee's motions.
On December 9, 2014, the Trustee and the Debtors filed a stipulation of undisputed facts. ECF No. 66. The facts identified in the parties' stipulation are incorporated in the Court's own findings of fact. On December 16, 2014, the parties also submitted an amended stipulation regarding admissibility of exhibits. ECF No. 69.
The Debtors, Bruce and Sherie Lien, originally filed a chapter 13 bankruptcy case on June 21, 2011. The Debtors' first amended chapter 13 plan was submitted to the Court on August 17, 2011; under it, the Debtors proposed to pay $550.00 each month for sixty months for a total of $33,000.00 to be paid under the plan. Ex. I. This plan was confirmed on October 25, 2011. The Debtors' second amended chapter 13 plan was submitted to the Court on April 2, 2012 and was approved by the Court on May 22, 2012. Ex. J. The Debtors' second amended chapter 13 plan provided that the Debtors would make the same payments of $550.00 per month for 60 months for a total of $33,000.00, but added an IRS debt to be paid as a priority claim in the second amended plan. On July 30, 2014, the debtors filed a verified conversion form, converting their chapter 13 case to a case under chapter 7. Ex. 13.
While the Debtors were in chapter 13, they added a new creditor to their bankruptcy case on each of the following dates: April 16, 2012; February 1, 2013; and March 25, 2013. ECF No. 66.
The chapter 13 trustee's final report and account was filed on August 18, 2014; it reflects that the Debtors paid a total of $19,250.00 during the chapter 13 plan, $4,308.24 of which went to costs of administration, and the remainder to creditors. The chapter 13 trustee's final report shows total allowed claims of $345,241.97.
Bruce Lien was appointed the trustee of the Loretta A. Lien Irrevocable Trust dated November 2, 1999. Ex. 9; Ex. B. Loretta A. Lien was Bruce Lien's mother. Mr. Lien testified that, at the time, he understood that he was also a beneficiary under the trust and he knew that his mother owned farmland. Bruce and his siblings are each beneficiaries under the trust. The trust provided that upon the death of the debtor's mother, Bruce, along with his eleven siblings, would each be entitled to one equal share of the assets of the trust, i.e., each was entitled to a one-twelfth share, unless alternative provisions of distribution were invoked.
Alternative provisions of distribution have not been invoked.
Bruce Lien testified that he began his duties as trustee of the trust in January 2012, when his mother was admitted to the nursing home; prior to that, his mother was in an assisted living facility since autumn of the preceding year, and prior to that, had lived alone, having been “feisty.” Bruce Lien's mother died on April 7, 2012, at which time he became entitled to receive property from his mother's trust. Ex. C. At that time, Bruce was also advised by the attorney for his mother's estate that Bruce was the sole trustee.
Bruce also testified that his brother was—for a period of time—an “acting trustee” or a “secondary trustee.”
Sherie Lien testified that she was aware that Bruce was a beneficiary of the trust after his mother's death.
Sherie Lien testified that Bruce and his brother decided to liquidate their mother's trust estate sometime in 2013. There were two parcels of real estate in the trust, which are legally described in the trust document. Ex. 9; Ex. B.
In the Bad Faith Conversion Motion, the Trustee refers to the property described as “Parcel B” in the trust document as “Parcel 1,” and he refers to the property described as “Parcel A” in the trust document as “Parcel 2.” Compare ECF No. 50 with Ex. 9; Ex. B. For ease of reference, and for context in relation to which property sold first, the Court will utilize the Trustee's naming convention.
Parcel 1 was sold and the debtor received his share from the sale of that property in August, 2013, in the amount of $34,191.00. The Debtors did not report the income from this inheritance/land sale to the chapter 13 trustee. These funds were deposited into the Debtors' Mid Central Federal Savings Bank account, and the statement for that account reflects an ending balance of $19,925.32 as of June 30, 2014. Ex. 17. Sherie Lien testified that the difference was spent on medical bills and business debt. Sherie and Bruce further testified that additional amounts of the sale proceeds have since been spent, leaving a current balance of approximately $17,000.00.
Prior to trial, and per the parties' stipulation of undisputed facts, Parcel 2 had been listed for sale with a listing price of $159,000.00, which would have yielded a potential gross recovery from the sale of that land, before costs of sale, of $13,250.00 ($159,000.00 /12 children = $13,250.00). ECF No. 66.
In addition, Bruce Lien has a claim to a one-twelfth interest in $40,000.00 currently being held in escrow for taxes and trust expenses by the attorney for the trust.
As noted, Bruce Lien received the funds from the sale of Parcel 1 of the real estate in approximately August 2013 and did not notify the chapter 13 trustee. Both Debtors testified, rather unconvincingly, that they had no idea that they had an obligation to report additional disposable income or property to which they became entitled during the pendency of their chapter 13 case, i.e., after the filing of their chapter 13 case. This testimony was belied by the fact that Bruce Lien testified that he knew he had an obligation, among other things, to submit copies of the Debtors' state and federal income tax returns to the chapter 13 trustee. And, the Debtors' second amended chapter 13 plan, provided, at ¶ 13, that the “debtors will submit copies of their state and federal income tax returns to the Trustee annually while this case is pending and shall be entitled to retain the first $2.000 ($1,200 if single) plus any earned income credit and Minnesota Working Family Credit. Any remaining amounts shall be turnover to the Chapter 13 trustee as additional plan payments.” Ex. J. More specifically, both Debtors unconvincingly testified that they were under the belief that they had no obligation to report the inheritance that Bruce Lien received after the passing of his mother, a substantial amount when viewed in comparison to what the Debtors were paying their unsecured creditors under their chapter 13 plan. In actuality, the amount the Debtors received from the trust proceeds from the sale of Parcel 1 alone, $34,191.00, was more than the entire amount the Debtors were to pay under their chapter 13 plan, which was $33,000.00.
Bruce Lien testified that he had not advised the chapter 13 trustee because he “didn't [know he] had to.”
See the Debtors' second amended chapter 13 plan, at ¶ 13, which stated that the “debtors shall contribute all disposable income into this plan for the length of time set forth in paragraph 1 [of the plan].” Ex. J.
Not long after receiving a copy of the Debtors' 2013 federal tax return, on May 29, 2014, the chapter 13 trustee's office sent the Debtors a letter inquiring about the Loretta Lien Irrevocable Trust referred to in Schedule E of the Debtors' 2013 tax return, as well as requesting other income information, and documentation and turnover of a portion of the 2013 tax refund. Exs. 6 & 21. Bruce Lien testified that he was very “upset” about this letter, primarily because of the chapter 13 trustee's request for information regarding the trustee's assertion that the tax return reflected greater income than that reflected in the Debtors' schedules.
The letter stated, among other things, that according to the Debtors' 2013 tax return, the Debtors' “wage income” was “$15,589.59/month,” which Bruce Lien testified was inaccurate. It is unclear how the chapter 13 trustee arrived at this figure. Ex. 21.
On June 19, 2014, the Debtors' attorney requested information from the chapter 13 trustee as to a “payoff” amount for the chapter 13 case. Ex. 16. The chapter 13 trustee's office provided counsel for the Debtors the amount required to pay all claims in full, $293,432.80. The Debtors never discussed the inheritance with the chapter 13 trustee, e.g., the proceeds from the sale of Parcel 1, or that they had a right to a share of the sale proceeds from Parcel 2. The Debtors made no effort to resolve the inheritance issue with the chapter 13 trustee, as Mr. Gieseke testified chapter 13 debtors sometimes do, e.g., when they become entitled to an inheritance or receive other, unexpected disposable income—post-confirmation. Instead, the Debtors converted their chapter 13 case to a case under chapter 7.
A staff attorney for the chapter 13 trustee, Michael Gieseke, testified that, because this was a 60–month plan, and because the Debtors were above-median income, the Debtors were not allowed to pay off only the remaining payments due under the plan; rather, the Debtors needed to pay all unsecured claims in full, i.e., in a “payoff” scenario.
Mr. Gieseke testified that, since 2014, the chapter 13 trustee typically inquires of debtors at the § 341 meeting of creditors if the debtors are beneficiaries under a trust or if the debtor is a trustee under a trust; no such information was disclosed on the Debtors' initial filings, either. Ex. 1. Mr. Gieseke could not say whether such questions had been asked of the Debtors' at their initial meeting of creditors in 2011. Mr. Gieseke further testified that if a chapter 13 debtor receives an inheritance, often a modified plan is required, since this post-petition property is property of the estate. See 11 U.S.C. § 1306(a)(1). Mr. Gieseke also testified that, in some cases, voluntary dismissal of the case may be the remedy. He further testified that the chapter 13 trustee also considers an inheritance “disposable income.”
One option might be a post-confirmation plan modification under 11 U.S.C. § 1329, in which case a proposed post-confirmation modified plan would be vetted by the debtor's creditors.
Sherie Lien testified that the reason for the conversion had not been because the Debtors were financially unable to make their chapter 13 plan payments; rather, it was because the Debtors understood that they could “pay off” their chapter 13 plan. When asked by the Trustee at trial whether the inheritance had anything to do with the conversion, Sherie Lien—rather forcefully—responded, “absolutely not!” Initially, Bruce Lien testified at trial that the reason the Debtors converted their case to chapter 7 was to “move on” with life. However, upon further inquiry from the Trustee at trial, Bruce Lien later admitted that “part of” of the reason for the conversion was indeed the inheritance.
He also testified that he wanted to clear the record because of the views of the industry in which he makes his living, and the resultant stigma associated with being in bankruptcy.
On Schedule B of the conversion documents, the Debtors identified an “inheritance over 180 days from filing date” in the amount of $34,191.00, which was Bruce Lien's interest in the proceeds from a sale of one parcel of farmland previously owned by his mother. Ex. 13. None of the conversion documents, however, disclosed Bruce Lien's one-twelfth interest in the second parcel of real property, also previously owned by his mother, and which, according to Mr. Lien's testimony, sold on December 12, 2014 for $140,000.00; he also testified that he was entitled to one-twelfth of the net proceeds of the $140,000.00. The Debtors also failed to disclose a Toyota automobile, which was purchased for Sherie Lien, pre-conversion, for $2,500.00. Finally, the Debtors did not disclose Conservation Reserve Program (“CRP”) annual payments, which Bruce Lien testified totaled approximately $2,500.00 to $3,000.00 per year, and which Mr. Lien testified the Debtors had been receiving since 2001 or 2002.
To be clear, this was in addition to the $34,191.00 received from the sale of Parcel 1.
Bruce Lien testified that this vehicle was purchased after their chapter 13 case had been filed, but before the conversion to chapter 7.
The CRP is a cost-share and rental payment program under the United States Department of Agriculture (“USDA”); the program is administered by the USDA Farm Service Agency. 16 U.S.C. §§ 3801, 3831 –35.
The Debtors testified that they could have continued making payments under the chapter 13 plan without incurring a financial hardship, as their income had increased during their chapter 13 bankruptcy. Indeed, Sherie Lien testified that the Debtors could have continued making payments under their chapter 13 plan; she also testified that no negative financial event occurred that would have prevented the Debtors from making their plan payments.
Mr. Gieseke testified that, aside from one early payment and two late payments, the Debtors had been generally current on their chapter 13 plan payments, but that the two late payments had been quickly cured.
In point of fact, the Debtors' income had actually increased each year since their chapter 13 bankruptcy was filed. Indeed, Bruce Lien testified that he expected that the Debtors' income for 2014 will have increased by 5% from the previous year. The Debtors are still employed. Sherie Lien is employed part-time, performing bookkeeping work for the Debtors' insurance agency, Wadena Agency Incorporated, and also works as a manufacturer's “rep” for Midwest Energy Systems. Bruce Lien is an insurance agent for Farm Bureau, through his agency, Wadena Agency Incorporated. Bruce is a 100% owner of both Wadena Agency Incorporated and Midwest Energy Systems; Bruce sets his own salary as well as Sherie's.
The Debtors' adjusted gross income from line 37 of their 2011 federal tax return showed negative income of $60,820. Line 37 of the Debtors' 2012 federal tax return showed adjusted gross income of $56,378. Line 37 of the Debtors' 2013 federal tax return showed adjusted gross income of $86,126. ECF No. 66; Exs. D, E, & F.
Mr. Lien's brief, contrary testimony, during examination by his attorney at trial, that it would now be difficult for the Debtors to make chapter 13 plan payments, was simply not credible.
Discussion
Bad Faith Conversion
Section 348(f)(2) of the Bankruptcy Code provides: “If the debtor converts a case under chapter 13 of this title to a case under another chapter under this title in bad faith, the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.” 11 U.S.C. § 348(f)(2). Because “bad faith” is not a defined phrase, the Court must look to the case law to discern its meaning:
Bad faith is not defined in the Bankruptcy Code nor has the term as used in § 348(f)(2) been interpreted by any court in this jurisdiction. In In re Siegfried, 219 B.R. [581, 585 (Bankr.D.Colo.1998) ], and Warren v. Peterson, 298 B.R. 322, 327 (N.D.Ill.2003), the courts defined bad faith by referring to the term “good faith” in 11 U.S.C. § 1325(a)(3). The Fifth Circuit long-ago
adopted a “totality of the circumstances” test for deciding whether a Chapter 13 plan has been filed in good faith and satisfies § 1325(a)(3).
In re Mullican, 417 B.R. 389, 401 (Bankr.E.D.Tex.2008), aff'd, 417 B.R. 408 (E.D.Tex.2009). See also In re Love, 957 F.2d 1350, 1357 (7th Cir.1992) (“[T]he focus of the good faith inquiry under both Sections 1307 and 1325 is often whether the filing is fundamentally fair to creditors and, more generally, is the filing fundamentally fair in a manner that complies with the spirit of the Bankruptcy Code's provisions.”). And, as the Eighth Circuit Bankruptcy Appellate Panel recently stated:
The term “good faith” is not defined in the Bankruptcy Code or its legislative history. [In re LeMaire, 898 F.2d 1346, 1348 (8th Cir.1990) ]. Prior to the enactment of a new section 1325(b) as part of the Bankruptcy Amendments and Federal Judgeship Act of 1984, Pub.L. No. 98–353 (1984), the Eighth Circuit provided a non-exclusive list of several factors to consider when determining whether the totality of the circumstances showed that good faith existed. U.S. v. Estus (In re Estus ), 695 F.2d 311, 316 (8th Cir.1982). In Educ. Assistance Corp. v. Zellner, 827 F.2d 1222 (8th Cir.1987), the Eighth Circuit considered the effect of the new section 1325(b)'s ability to pay test on the factors set forth in Estus . According to the Eighth Circuit, the criteria required by new section 1325(b) “subsumes most of the Estus factors.” It explained that the court's “inquiry into whether the plan ‘constitutes an abuse of the provisions, purpose or spirit of Chapter 13’ has a more narrow focus. The bankruptcy court must look at factors such as whether the debtor has stated his debts and expenses accurately; whether he has made any fraudulent misrepresentation to mislead the bankruptcy court; or whether he has unfairly manipulated the Bankruptcy Code.” Zellner, 827 F.2d at 1226–27 (quoting Estus, 695 F.2d at 316 ). In LeMaire, the Eighth Circuit explained that “Zellner preserved the traditional ‘totality of circumstances' approach with respect to Estus factors not addressed by the [1984] legislative amendments.” LeMaire, 898 F.2d at 1349.
Fink v. Thompson (In re Thompson ), 439 B.R. 140, 143 (8th Cir. BAP 2010) ; Tina Livestock Sales, Inc. v. Schachtele (In re Schachtele ), 343 B.R. 661, 668 (8th Cir. BAP 2006) (“the Eighth Circuit preserved parts of the Estus ‘totality of circumstances' approach and, thus, factors such as the type of debt sought to be discharged and whether the debt is nondischargeable in Chapter 7, and the debtor's motivation and sincerity in seeking Chapter 13 relief, are particularly relevant”).
In a case largely on “all fours” with the case at bar, the court in Mullican utilized the “totality of circumstances” approach and found the following circumstances should be considered in making the “bad faith” determination under § 348(f)(2) :
In determining whether a Chapter 13 case has been converted in bad faith, the Court considers whether the conversion was motivated by an inability to make required payments to the Chapter 13 trustee. The Court also considers whether the debtors have been forthcoming regarding the existence of any post-petition change in circumstances that might affect their ability to make payments to their creditors and whether the conversion would create a windfall for the debtors (other than a decrease in liabilities) to which they would not have
been entitled but for the existence of their pending Chapter 13 case.
Mullican, 417 B.R. at 401. Utilizing this rubric, the Mullican court found that the debtors had converted their case in bad faith because the debtors had been current on their chapter 13 plan payments; the inheritance would have paid unsecured creditors in full; the debtors paid family member debts and not other unsecured creditors; the debtors had spent some of the inheritance; and the debtors had made false representations about the use of some the inheritance proceeds. Id. at 402–03. See also In re Castillo, 508 B.R. 1 (Bankr.W.D.Tex.2014) (utilizing the Mullican test in addressing the “bad faith” issue under § 348(f)(2) ; trustee failed to satisfy burden of showing that conversion of debtors' chapter 13 case to one under chapter 7 was in bad faith, so that chapter 7 estate did not included these inherited interests).
Further, the another court described the fact-intensiveness of the inquiry under § 348(f)(2) :
The Court disagrees with the Debtors' assertion that only bad faith in the conversion of the case is relevant. Rather, the Court must look at the Debtors' conduct throughout the case ... The cases cited by the [sic] both the Trustee and the Debtors concur that section 348(f)(2) requires a finding of bad faith. This is more than a lack of diligence, however. It requires a determination that the Debtors unfairly manipulated the bankruptcy process to the disadvantage of creditors ... This is a fact-intensive inquiry.
In re Perez, 345 B.R. 137, 141 (Bankr.D.Del.2006) (citing In re Bejarano, 302 B.R. 559, 562 (Bankr.N.D.Ohio 2003) and In re Siegfried, 219 B.R. 581 (Bankr.D.Colo.1998) ). See also In re Malone, 2011 WL 1541289, at *4 (Bankr.D.Neb. Apr. 21, 2011) (“For purposes of § 348(f)(2), it generally is found in situations where the weight of the evidence indicates the debtor is dishonest, deceptive, or unfairly manipulating the bankruptcy system.”).
In Perez, the court concluded:
The Trustee has presented evidence that the Debtors were dilatory in filing their Schedules, responding to motions, and making payments to the chapter 13 trustee. Unfortunately, this is not unusual for persons in financial distress. The Debtors' explanation for their actions is plausible and not contested by the Trustee: they were trying to save a rental property. As a result of Mr. Perez's unemployment which lasted several months, however, the Debtors were unable to make the chapter 13 plan payments and lost their rental property and vehicle to foreclosure. Once that occurred, the Debtors found there was no reason to remain in chapter 13.
The Court concludes that the actions of the Debtors in their chapter 13 case do not rise to the level of bad faith. Nor does there appear to be a manipulation of the bankruptcy process by the Debtors or any unfair advantage gained over creditors. Therefore, the Court concludes that the Trustee has failed to meet the standard for application of section 348(f)(2).
Perez, 345 B.R. at 141–42.
Additional factors for consideration include “the timing of the conversion, the chapter 13 pay history, the debtor's participation in the chapter 13 process, the amount of post-petition debt, ... the debtor's previous bankruptcy filings, and the value of assets in question.” In re Smith, 2012 WL 43647, at 3 (Bankr.N.D.Ohio January 9, 2012) (citing In re Bejarano, 302 B.R. 559, 562 (Bankr.N.D.Ohio 2003) ). “The undisputed conduct of concealment of assets and the non-reporting of income is sufficient to find bad faith.” In re Standifered, 2009 WL 7831848, at *3 (D.N.M. Aug. 17, 2009) (citing Siegfried, 219 B.R. at 585–86 (Bankr.D.Colo.1998) ).
“Similarly, the court must look at conduct throughout the entire case, both pre- and post-conversion, ... as a debtor's actions post-conversion are relevant to ‘help a court ascertain the credibility of a debtor's statements regarding the motivation for conversion[.]’ ” In re Wiggins, 2012 WL 3889099, at **4–7 (Bankr.E.D.Tenn.2012) (quoting Smith, 2012 WL 43647, at *3 and adopting the above analysis; “the court finds that the Debtors converted their Chapter 13 case in bad faith. The inherited property consisting of the remaining funds in the amount of $10,000.00 and the [real property] are property of their converted Chapter 7 bankruptcy case and subject to administration by the Trustee”).
The Court finds the analyses of these courts instructive, and not inconsistent with the Eighth Circuit's corollary authority.
Moreover, the facts of this case are remarkably similar to the facts in Wiggins, where one of the debtors inherited money from his mother and the debtors converted their chapter 13 case to chapter 7. The chapter 7 trustee in that case brought a motion asking the court to enter an order directing the debtors to turn over the funds under § 348(f)(2). The court, after having gone through the analysis of many of the cases cited here, determined that the debtors had converted their chapter 13 case in bad faith and the remaining property from the inheritance was property of the chapter 7 estate. In re Wiggins, 2012 WL 3889099 (Bankr.E.D.Tenn.2012).
In this case, the evidence shows that the Debtors could have continued making payments under their chapter 13 plan without incurring a financial hardship, as their income has increased during the chapter 13 bankruptcy, and since, for that matter. This is troubling to the Court. Indeed, the Debtors testified that they could have continued making payments under their chapter 13 plan. They also testified that no negative financial event occurred that would have prevented the Debtors from making their plan payments. And, significantly, the Debtors are still employed.
Also troubling is that both of the Debtors testified, rather unconvincingly, that they had no idea that they had an obligation to report additional disposable income or property to which they became entitled during the pendency of their chapter 13 case, including, most importantly, the inheritance-related property, i.e., after the filing of their chapter 13 case. See the Debtors' second amended chapter 13 plan, at ¶ 13. Ex. J. As noted, this testimony was belied by the fact that Bruce Lien testified that he knew he had an obligation, among other things, to submit copies of the Debtors' state and federal income tax returns, as well as, at least potentially, excess tax refunds, to the chapter 13 trustee. Id.
Additionally, the Court finds the Debtors' testimony regarding the true reason(s) for the conversion less than entirely forthcoming. As noted, Sherie Lien testified that the reason for the conversion was not because the Debtors were financially unable to make their chapter 13 plan payments, but rather because the Debtors understood that they could “pay off” their chapter 13 plan. And when asked by the Trustee at trial whether the inheritance had anything to do with the conversion, Sherie Lien rather forcefully responded, “absolutely not!” This testimony is rather convenient for the Debtors, especially when viewed in the light of the fact that Bruce Lien later admitted at trial that at least “part of” of the reason for the conversion was, in fact, the inheritance. Equally unconvincing is the Debtors' testimony that they did not think the inheritance would have any effect on their obligations under their chapter 13 plan, i.e., their pledge of their disposable income to their unsecured creditors. Id . Indeed, Bruce Lien testified that he was aware that the Debtors were under an obligation to provide the chapter 13 trustee with any excess post-petition tax refunds the Debtors received. Id .
Further, on Schedule B of the conversion documents, while the Debtors identified an “inheritance over 180 days from filing date” in the amount of $34,191.00, the Debtors did not disclose Bruce Lien's one-twelfth interest in a second parcel of real property, also previously owned by his mother—a parcel that, according to Bruce Lien's testimony, sold on December 12, 2014, for $140,000.00. Mr. Lien also testified at trial that he was entitled to one-twelfth of the net proceeds of the $140,000.00. The Debtors also failed to disclose a Toyota automobile purchased, pre-conversion, for $2,500.00, for Sherie Lien. Finally, the Debtors did not disclose CRP annual payments, which Bruce Lien testified totaled approximately $2,500.00 to $3,000.00 per year, and which Mr. Lien testified the Debtors had been receiving since 2001 or 2002.
Taken in isolation, one of the above omissions might be understandable—an innocent mistake, or oversight, if you will. But, taken collectively, as the Court must do under the totality-of-the-circumstances analysis required under § 348(f)(2), these omissions evidence a manipulation of the Bankruptcy Code in an effort to obtain a windfall, at the expense of the Debtors' creditors.
As noted, the amount the Debtors received from the inheritance proceeds from the sale of Parcel 1 alone, $34,191.00, was more than the entire amount the Debtors were to pay under their chapter 13 plan, which was $33,000.00. But this is just part of the windfall—witness the proceeds generated from the sale of Parcel 2, as well as the other inheritance-related property.
If the inheritance-related property is not brought into the chapter 7 bankruptcy estate, the Debtors will receive a windfall by virtue of their conversion to chapter 7. The Court finds that the main reason for the Debtors' conversion from chapter 13 to chapter 7 was to avoid paying to the chapter 13 trustee the non-exempt inheritance received by Bruce Lien during the chapter 13 bankruptcy. Accordingly, the Court concludes that the Debtors' conversion from chapter 13 to chapter 7 was one done in bad faith under § 348(f)(2).
11 U.S.C. § 1306(a)(1) (“Property of the estate includes, in addition to the property specified in section 541 of this title—(1) all property of the kind specified in such section that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first[.]”).
Property of the Estate and the Turnover Motion
Section 348(f)(1) of the Bankruptcy Code provides, among other things, that property of the estate in a converted case is the property the debtor had when the debtor filed the original chapter 13 petition, that is still in the possession of or under the control of the debtor. 11 U.S.C. § 348(f)(1). See also, In re Alexander, 236 F.3d 431, 433 (8th Cir.2001) (“The legislative history to section 348(f)(1) indicates that Congress intended this language to overrule the holding of cases ... holding that the property of the estate in a converted case is the property the debtor had when he filed his original Chapter 13 petition.” ) (citing 140 Cong. Rec. H10770 (Oct. 4, 1994)).
Section 348(f) was later amended by the 2005 Act. See The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the “BAPCPA”), Pub.L. No. 109–8, 119 Stat. 23 (2005).
Section 348(f)(2), however, trumps the general rule of § 348(f)(1) ; § 348(f)(2) provides that, if a chapter 13 debtor converts the case to another chapter in bad faith, the property of the estate in the converted case consists of the property of the estate as of the date of conversion. 11 U.S.C. § 348(f)(2) (“If the debtor converts a case under chapter 13 of this title to a case under another chapter under this title in bad faith, the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.”). See, e.g., Standiferd v. U.S. Trustee, 641 F.3d 1209 (10th Cir.2011) (§ 348(f)(2) provides that, if a chapter 13 debtor converts a case to a case under another chapter in bad faith, the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion); In re Bell, 225 F.3d 203 (2d Cir.2000) (under § 348(f)(2), upon conversion of a chapter 13 case, after-acquired property does not form part of the converted estate unless the case was converted in bad faith). See also In re Michael, 699 F.3d 305 (3d Cir.2012) (absent a showing of bad faith, undistributed plan payments that are held by a chapter 13 trustee when the chapter 13 case is converted must be returned to debtor); In re Rosenberg, 303 B.R. 172, 176 (8th Cir. BAP 2004) (“Absent bad faith, when a case is converted from Chapter 13 to Chapter 7, property of the estate in the Chapter 7 case consists of the property of the estate as of the original Chapter 13 petition date which remains in the debtor's control at the time of conversion.”); Farmer v. Taco Bell Corp., 242 B.R. 435, 439 (W.D.Tenn.1999) (debtors' failure to schedule personal injury claim that arose after debtors' chapter 13 plan was confirmed but prior to debtors' conversion of their case to chapter 7 did not preclude debtors from pursuing claim when claim did not become property of bankruptcy estate under § 348(f)(1)(A), “after-acquired property belongs to the debtor pursuant to § 348(f)(1)(A) unless the conversion was made in bad faith, triggering application of the bad faith exception under § 348(f)(2) ”).
In a bad faith conversion case, property of the estate includes after-acquired property, i.e., property of the chapter 13 debtor acquired post-petition. See, e.g ., In re Harris, 757 F.3d 468, 478 (5th Cir.2014) (“If the debtor is found to have converted in bad faith, all of the property he has acquired after filing will be included in the Chapter 7 estate and therefore be liquidated.”); In re Reeves, 509 B.R. 35 (Bankr.S.D.Tex.2014) (debtors, who converted their case from chapter 13 to chapter 7 in bad faith after confirmation of a chapter 13 plan, were required to file amended schedules reflecting their financial condition on the conversion date, i.e., a schedule of property, not listed in the final report, acquired between the petition date and the conversion date). “Of course, it is possible that upon conversion, the debtor may no longer have in his possession any property acquired after filing the Chapter 13 petition; in that specific scenario, undistributed wages held by the trustee would constitute all of the debtor's remaining post-petition property.” Harris, 757 F.3d at 478 n. 9.
On November 24, 2014, the Trustee filed the Turnover Motion, seeking turnover of the following “nonexempt” property of the Debtors:
A. Prince poster ebay—$200.00;
B. Two prints—$1,000.00;
C. Firearms—two 12 gauges, one 410, two .22s, one 25.06 and one ML—$1,100.00;
D. 2005 GMC Sierra—$11,600.00 equity;
E. 2004 Crestliner boat with '04 4–stroke 115 Yamaha motor—$7,000.00;
F. Duck boat—$50.00;
G. '99 Polaris 550cc snowmobile—$1,000.00; and
H. 2004 Sportsman 600cc ATV—$3,000.00.
Initially, the Debtors responded and proposed that they obtain third-party valuations for the following property: 2005 GMC Sierra; 2004 Crestliner boat, 99 Polaris 550 cc snowmobile, and the 2004 Sportsman 600 cc ATV. ECF No. 68. In that response, the Debtors also requested that “the Court determine whether any assets should be turned over to the chapter 7 trustee for liquidation based on the amended schedules and chapter 13 distribution to creditors.” Id .
This asset is the subject of a separate motion by the Trustee objecting to Sherie's claim of exemption in the vehicle—see ECF No. 78; the motion is currently set for evidentiary hearing on May 27, 2015.
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As noted earlier, at the hearing on the Trustee's motion for turnover held on December 16, 2014, and after some discussion, the Court allowed the parties to submit supplemental briefing on the Turnover Motion. The Trustee filed his supplemental brief at ECF No. 72, and the Debtors filed their supplemental brief at ECF No. 73, along with amended Schedules B and C, at ECF No. 74 (via this document, and as relevant here, the valuations of the “nonexempt” assets in the Trustee's Turnover Motion remain unchanged).
In his supplemental brief, the Trustee states, among other things, and rather pragmatically: “The trustee is merely seeking turnover of assets which were either not exempted or were partially nonexempt ... The estate is not seeking the difference between what the assets were worth at the time of the Chapter 13 filing, and their value at conversion. There is no need to revalue assets as of the time of conversion, and the trustee requests that the Court order turnover of the assets as requested in the turnover motion.” ECF No. 68. In their response, however, the Debtors stated that “the parties agree that an updated valuation is not necessary and the [ ] assets [listed in the Turnover Motion], with their chapter 13 values, are correct,” but then jumped to the conclusion that, in this case, “liquidation would create a disincentive for debtors to file chapter 13 if their actual payments to creditors were not recognized by the Court.” Such an argument is fundamentally flawed, however, since a finding of “bad faith” under § 348(f)(2) trumps the “default” rule of § 348(f)(1). And the Court has already determined that this is not a “§ 348(f)(1) ” case; it is a “bad faith” case under § 348(f)(2).
“Section 348(f)(1) provides that property of the estate in a converted chapter 13 case shall consist of the property of the estate as of the date of the petition and that remains in the debtor's possession or control at conversion. Notably, subsection (f)(2) provides that valuations of property in chapter 13 do not survive conversion to chapter 7.” In re Auernheimer, 437 B.R. 405, 409 (Bankr.D.Kan.2010). “Section 348(f)(2) provides that any appreciation in the value of [the debtors'] home becomes property of the converted Chapter 7 estate.” In re Standiferd, 2008 WL 5273690 (Bankr.D.N.M.2008) (citing In re Perez, 345 B.R. 137, 141 (Bankr.D.Del.2006) (acknowledging that under § 348(f)(2), post-petition, pre-conversion earnings and appreciation of property become property in the converted chapter 7 case upon a finding that debtors converted their case in bad faith)).
Both parties argue that no re-valuation of the property listed in the Turnover Motion is required; that may or may not be true. But, the Trustee is not bound by an earlier valuation, i.e., with respect to the § 348(f)(2) context, including valuation of after-acquired property. Here, however, neither the Debtors nor the Trustee seek re-valuation. And as § 348(f)(2) makes clear: “If the debtor converts a case under chapter 13 of this title to a case under another chapter under this title in bad faith, the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.” 11 U.S.C. § 348(f)(2). Because the following property is not claimed exempt by the Debtors, and because it is property of the estate virtue of § 348(f)(2), the Trustee is entitled to its turnover:
A. Prince poster ebay—$200.00;
B. Two prints—$1,000.00;
C. Firearms—two 12 gauges, one 410, two .22s, one 25.06 and one ML—$1,100.00;
D. 2004 Crestliner boat with '04 4–stroke 115 Yamaha motor—$7,000.00;
E. Duck boat—$50.00;
F. '99 Polaris 550cc snowmobile—$1,000.00; and
G. 2004 Sportsman 600cc ATV—$3,000.00.
Because the 2005 GMC Sierra is the subject of a separate motion by the Trustee objecting to Sherie's claim of exemption in the vehicle, see ECF No. 78, and because the motion is currently set for evidentiary hearing on May 27, 2015, the Court reserves ruling on its turnover pending the outcome of the evidentiary hearing.
Conclusion
The Court concludes that the Debtors' conversion in this case was done in bad faith. Because the conversion was in bad faith under § 348(f)(2), the property of the Debtors as of the date of conversion is property of the chapter 7 bankruptcy estate, and the non-exempt property thereof must be turned over to the Trustee.
Accordingly,
IT IS ORDERED:
1. The Trustee's Bad Faith Conversion Motion is granted:
A. The Debtors shall turn over the funds from sale of the inherited real estate already received, $34,191.00, to the Trustee, or the remaining proceeds from that sale, and any other property or funds received from his mother's trust estate, including the net proceeds from the sale of Parcel 2;
B. Any net recovery to be paid to Bruce Lien from the $40,000.00 currently being held by the trust for trust expenses, shall be turned over to the Trustee; and
C. In the event the Debtors are unable to turn over the full amount of $34,191.00 to the Trustee, the debtors shall turn over any assets purchased with the inherited funds, within ten days of the date of this order.
2. The Trustee's Turnover Motion is granted in part and the Debtors shall deliver to the Trustee the following property within ten days of the date of this order:
A. Prince poster ebay—$200.00;
B. Two prints—$1,000.00;
C. Firearms—two 12 gauges, one 410, two .22s, one 25.06 and one ML—$1,100.00;
D. 2004 Crestliner boat with '04 4–stroke 115 Yamaha motor—$7,000.00;
E. Duck boat—$50.00;
F. '99 Polaris 550cc snowmobile—$1,000.00; and
G. 2004 Sportsman 600cc ATV—$3,000.00.
3. The Court reserves ruling on that portion of the Trustee's Turnover motion requesting turnover of the $11,600.00 in “equity” regarding the 2005 GMC Sierra pending the outcome of the May 27, 2015 evidentiary hearing regarding the Trustee's exemption objection with respect to the vehicle.
4. The Trustee's request for $300.00 in attorney's fees for bringing the Turnover Motion is denied.