Opinion
Case No. 98-15832-SSM
January 4, 2000
Thomas P. Gorman, Esquire, Tyler, Bartl, Burke Albert, PLC, Alexandria, VA, of Counsel for the debtors in possession
Joel Steinberg, Esquire, Joel Steinberg Associates, Alexandria, VA, of Counsel for David B. and Kelli A. Cecil
MEMORANDUM OPINION
The question before the court is whether the order converting this case from chapter 7 to chapter 11 should be vacated, or the case reconverted, on the ground that the debtors have already been granted a discharge while the case was in chapter 7. A hearing was held in open court on December 14, 1999, at which the objecting creditors, David and Kelli Cecil (themselves chapter 7 debtors) were present by counsel, as were the debtors. The United States Trustee was not present and took no position.
Background
This present controversy has its genesis in a long-standing dispute between Thomas and Judith Hutchins, the debtors in this case, and their next door neighbors, David and Kelli Cecil, over a joint driveway. Matters eventually reached the point where Mr. and Mrs. Cecil had Thomas Hutchins arrested. He responded by filing suit for malicious prosecution and obtained a jury verdict in state court against Mr. and Mrs. Cecil for $19,000. Mr. and Mrs. Cecil thereafter filed a voluntary chapter 7 petition in this court on July 2, 1998. They have not yet been granted a discharge.
Inre David B. Cecil and Kelli A. Cecil, No. 98-15023.
There is a pending complaint by Mr. and Mrs. Hutchins objecting to their discharge. On August 13, 1999, after the chapter 7 trustee's objection to their exemption of an individual retirement account (IRA) was sustained, Mr. and Mrs. Cecil converted their case to chapter 13. The case was reconverted to chapter 7 on November 16, 1999, on motion of Mr. and Mrs. Hutchins.
On August 6, 1998, Mr. and Mrs. Hutchins also filed a voluntary chapter 7 petition in this court. They were granted a discharge on April 23, 1999. On their schedules, they listed $98,437 in unsecured debts, most of it credit-card related, but $5,000 of which consisted of a disputed, unliquidated claim of David Cecil. Among their assets, they listed their judgment against Mr. and Mrs. Cecil, as well as a pending state court suit (which they valued at $40,000) against Mr. and Mrs. Cecil seeking injunctive and monetary relief for an alleged continuing trespass. Their house located at 4307 General Kearny Court, Chantilly, Virginia, is shown on their schedules as having a market value of $160,000 and as being subject to a first-lien deed of trust with a balance of $137,255. Additionally, their schedules reflect $4,240 in net monthly income and $4,172 in monthly expenses.
Subsequent to the filing of their petition, Mr. and Mrs. Hutchins, with the consent of the then — chapter 7 trustee, filed a complaint in Mr. and Mrs. Cecil's chapter 7 case objecting to their discharge and seeking a determination that the $19,000 judgment was nondischargeable. That adversary proceeding is still pending. Mr. Cecil then offered to purchase the judgment from the trustee for $9,500. Mr. and Mrs. Hutchins's trustee initially accepted the offer and gave notice of his intent to compromise the judgment. However, the trustee withdrew the motion to compromise when questions were raised as to whether the $9,500 was property of the bankruptcy estate. Subsequently, Mrs. Cecil's mother, Carol Ladzian, offered to purchase both the $19,000 judgment and the equity in the debtors' house for a total of $30,000. As before, the trustee initially accepted the offer and noticed a motion to sell. Again, however, the motion was withdrawn after questions were raised as to the source of the funds.
The original trustee in the case was Robert G. Mayer, who was subsequently appointed as a judge of this court. Ann E. Schmitt has been appointed successor trustee.
On November 12, 1999, Mr. and Mrs. Hutchins filed a motion to convert their case to chapter 11. An order was entered by the clerk under the authority of the Local Bankruptcy Rules on November 15, 1999, converting the case to chapter 11. Mr. and Mrs. Cecil, who had been served with the motion to convert, filed an objection to the conversion on November 22, 1999.
At an earlier hearing where the subject of the intended conversion had come up, the court had given counsel for Mr. and Mrs. Hutchins ten days in which to file a written opposition to the conversion. The order by the clerk converting the case was therefore premature. Since the opposition was filed within ten days of the order converting the case, for procedural purposes the court treats the opposition as a timely motion under F.R.Bankr.P. 9023 and Fed.R.Civ.P. 59(e) to alter or amend the conversion order.
Conclusions of Law and Discussion I.
As a threshold issue, the debtors question whether Mr. and Mrs. Cecil have standing to object to the conversion. Although Mr. Cecil has filed a proof of claim in the debtors' case for $5,000 for "contribution for maintenance of shared driveway," that claim was not listed as an asset on Mr. and Mrs. Cecil's original schedules, or even their first amended set of schedules. However, it has now been listed as an asset on amended schedules that were filed on August 2, 1999. An objection to that claim has been filed by Mr. and Mrs. Hutchins but has not yet been ruled upon. Mr. and Mrs. Hutchins additionally argue that the claim, even if valid, would be fully offset by the $19,000 judgment.
Claim No. 12 filed on February 12, 1999. Mr. and Mrs. Hutchins have filed an objection to the claim, and a hearing on the objection is scheduled for February 9, 2000.
Under well-settled principles, a debtor's prepetition causes of action belong to the bankruptcy estate, and, unless exempted or abandoned, may be asserted only by the chapter 7 trustee. Field v. Transcontinental Ins. Co., 219 B.R. 115 (E.D. Va. 1998). At the hearing on the objection to conversion, Mr. and Mrs. Cecil acknowledged that they might not have standing based solely on the $5,000 claim — which in any event, was filed only by Mr. Cecil and not by Mrs. Cecil — but represented that they had recently purchased a small ($150) claim held by an attorney who had formerly represented Mr. Hutchins. Counsel for Mr. and Mrs. Hutchins responded that the claim was not valid and represented that the attorney was in the process of refunding the purchase price to Mr. and Mrs. Hutchins. In any event, no notice of the claim assignment has been filed with the clerk.
On the present record, the standing of Mr. and Mrs. Cecil as creditors is at least doubtful. However, it is wholly possible that their chapter 7 trustee may abandon the $5,000 claim. Additionally, whether or not the $19,000 judgment would be a complete offset has not yet been finally determined, since the judgment is under appeal. Since the argument that is being made by Mr. And Mrs. Cecil goes to the very heart of the debtors' eligibility to proceed in chapter 11 — and, indeed, is one that the court might have raised sua sponte — the court believes it appropriate to reach the merits of the issue and to defer the question of standing until after the objection to claim is decided.
Mr. and Mrs. Cecil filed a timely appeal from the judgment, but the appeal was stayed when they filed their chapter 7 petition. This court recently modified the automatic stay to permit the appeal to go forward.
II.
Although Mr. and Mrs. Cecil acknowledge that § 706(a), Bankruptcy Code, permits a chapter 7 debtor to convert his or her case to chapter 11 "at any time" so long as the case was not previously converted to chapter 7 from some other chapter, they argue that the right to convert is nevertheless not absolute, and that, in particular, conversion should not be permitted following issuance of a chapter 7 discharge. Since there is no language in the Bankruptcy Code expressly barring a conversion from chapter 7 to chapter 11 following the granting of a discharge or expressly requiring, as a condition of such conversion, that the chapter 7 discharge be vacated, the issue is whether the existence of a chapter 7 discharge in the same case is nevertheless somehow fundamentally inconsistent with proceeding under chapter 11.
Section 706(a), Bankruptcy Code, provides as follows:
The debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.
A.
Many courts have strongly challenged the notion that the right to convert from chapter 7 to one of the reorganization chapters is "absolute." See, e.g., In re Jones, 111 B.R. 674, 680 (Bankr. E.D. Term. 1990) ("[T]he provisions of § 706(a) allowing a Chapter 7 debtor to convert to Chapter 13 `at any time' must be limited to those situations where the debtor's Chapter 7 discharge has not been granted or has been revoked upon motion of the debtor[.]"); In re Jeffrey, 176 B.R. 4, 6 (Bankr. D. Mass. 1994) ("Where the debtors have already received a discharge, it is clear that their purpose in converting . . . is not to repay their creditors. Rather, their purpose is to evade their obligations under Chapter 7."); In re Starkey, 179 B.R. 687, 692 (Bankr. N.D. Okla. 1995) ("The words `at any time' refer literally to any stage in the progress of a case, not to any conditions which may develop during that progress, especially in an abnormal and abusive case."); and In re Lesniak, 208 B.R. 902, 906 (Bankr. N.D. Ill. 1997) (articulating a "bright-line rule that would prohibit conversions from Chapter 7 to Chapter 13 if the request is made post-discharge"). The reported opinions at the court of appeals level, however, have held that only the most egregious circumstances could justify denial of what is otherwise a clear statutory right. Thus, conversion has been allowed both after the debtor received a chapter 7 discharge, Matter of Martin, 880 F.2d 857 (5th Cir. 1989), and, perhaps more surprisingly, after the debtor had been denied a chapter 7 discharge based on fraudulent post-petition transfers of property. Finney v. Smith (In re Finney), 992 F.2d 43, 44 (4th Cir. 1993) ("[C]ongress intended § 706(a) to confer `the one-time absolute right' to convert from liquidation to reorganization, because `the debtor should always be given the opportunity to repay his debts.'"). See also, 6 Lawrence P. King, Collier on Bankruptcy ¶ 706.02 at 706-4 (15th ed. rev. 1999) ("Indeed, a debtor may request conversion even after a chapter 7 discharge has been entered. Since the Code makes no provision for revocation of the discharge in that event, the discharge remains operative and the converted case may proceed on that basis.").
Although in Finney the Fourth Circuit held that the debtor's fraudulent conduct was not sufficiently "egregious" to bar conversion from chapter 7 to chapter 11 on equitable grounds, the Court did rule that the debtor had no right to remain in chapter 11 if the conversion was motivated by bad faith and reorganization was objectively futile. Since the debtor in Finney had not been afforded a hearing on the latter issue, the Court remanded for further proceedings. Because the debtor in Finney had not been granted a discharge, the Fourth Circuit was not required to address the effect such a discharge might have on the debtor's right to proceed under chapter +11. Nevertheless, given the broad reading in Finney of the statutory language "at any time," this court concludes that the Fourth Circuit would not — any more than the Fifth Circuit did in Martin — find the prior granting of a chapter 7 discharge in the same case to be an absolute bar to conversion.
This does not mean that the timing of, and circumstances surrounding, the conversion would not weigh as a factors to be considered in determining whether the case should be reconverted. In In re Sieg, 120 B.R. 533 (Bankr. D. N.D. 1990), for example, the court, although acknowledging that the debtors had absolute right to convert to chapter 13 even after a chapter 7 discharge was granted and the case was closed, nevertheless found that the debtors' plan was not proposed in good faith and observed, "Most courts regard a post-discharge conversion into Chapter 13 to be lacking in sincerity." Id. at 536. In some circumstances, it will be clear that the motive for the conversion is not a desire to repay creditors but rather to derail an aggressive chapter 7 trustee. If that type of bad faith is coupled with an objective futility of reorganization, or if the debtor, despite a reasonable opportunity to do so, does not propose a confirmable plan, then the case is a candidate for reconversion to chapter 7.
B.
One of the most frequent arguments made against allowing a post-discharge conversion from chapter 7 into a reorganization case (chapters 11, 12 or 13) is that the issuance of the chapter 7 discharge effectively leaves the debtors with no debts to pay. In re Jones, 111 B.R. 674, 680 (Bankr. E.D. Term. 1990) ("Once the Chapter 7 discharge has been granted the debtor's personal liability is extinguished, thus rendering conversion to Chapter 13 meaningless except as to those creditors holding nondischargeable claims."); Sieg, 120 B.R. at 535 (chapter 7 discharge granted earlier in case left only nondischargeable student loan debts to be paid after conversion to chapter 13); Lesniak, 208 B.R. at 902 ("In order to have debts to repay, debts must exist. If a discharge order is entered, and the automatic stay is vacated as to secured creditors, a logical assumption is that debts no longer exist for the debtor to repay.").
The debtors in this case dispute that analysis and argue that creditors retain their claims against the bankruptcy estate even after the personal liability of the debtors has been discharged, with the result that even dischargeable claims may properly be paid under a plan. While this argument does not appear to have been expressly embraced by any reported case, the court is constrained to agree with the debtors. A discharge operates as an injunction against any act to collect a discharged debt "as a personal liability of the debtor." § 524(a), Bankruptcy Code. Nothing in the Code, however, suggests that it eliminates the creditor's claim against the bankruptcy estate. See Board of Comm'rs of Shawnee Co., Kansas v. Hurley, 169 F. 92, 94 (8th Cir. 1909) (filing of bankruptcy petition vests in creditors an equitable interest in the estate of the bankrupt) (decided under former Bankruptcy Act of 1898). The bankruptcy estate comes into existence upon "the commencement of the case." § 541(a), Bankruptcy Code. Claims against the estate are determined "as of the date of the filing of the [bankruptcy] petition." § 502(b), Bankruptcy Code. Even in an unconverted chapter 7 case, the sequence of events is such that the debtor generally receives his or her discharge prior to the trustee making distributions to creditors. No one has ever seriously argued, however, that creditors whose debts are discharged in the course of a chapter 7 case thereby lose the right to receive their pro rata share of distributions. The fact that a case is converted does not change the analysis. Conversion of a case does not change the date of the commencement of the case or of the filing of the petition. § 348(a), Bankruptcy Code. As noted above, claims are determined as of the date of the filing of the petition. Thus, the court concludes that creditors with valid claims against the bankruptcy estate on the date the bankruptcy petition is filed do not lose them simply because the debtor is granted a discharge or the case is converted to another chapter.
Because the existence of a chapter 7 discharge does not, as a matter of law, leave the debtors without claims to pay, the court is not required to reach the thorny issue of whether, and under what circumstances, a debtor may have a chapter 7 discharge vacated or revoked in order to qualify for conversion to a reorganization proceeding. Compare In re Leiter, 109 B.R. 922 (Bankr. N.D. Ind. 1990) (holding that a chapter 7 discharge, once entered, can be set aside only by the trustee, a creditor, or the United States Trustee under § 121(d) or (e) and not on motion of the debtor), with In re Jones, 111 B.R. 674, 680 (Bankr. E.D. Term. 1990) (holding that discharge may be vacated on debtor's motion under F.R.Bankr.P. 9024 in appropriate circumstances). The debtors, in any event, have not requested that their discharge be vacated, and, for the reasons discussed, the court does not find that there is any requirement they do so.
C.
No grounds have been urged in opposition to the conversion other than the fact that the debtors have already received a discharge. In particular, no specific evidence has been put forth suggesting that bad motives underlie the conversion or that the debtors will be unable to propose a confirmable plan. See Carotin Corp. v. Miller, 886 F.2d 693 (4th Cir. 1989) (to dismiss chapter 11 case at outset for want of good faith in filing, there must be a showing of both subjective bad faith and objective futility of any possible reorganization). Nevertheless, the timing of the conversion — coming as it does some 15 months after the commencement of the chapter 7 case and closely following an attempt by the trustee to sell the debtors' house — does gives rise to an inference that the true motive of the conversion was not a desire to repay creditors but rather to escape an aggressive trustee. Additionally, the income and expense schedules filed by the debtors reflect only $68 per month in disposable income that could be devoted to a plan.
Given the circumstances surrounding the conversion, the court concludes that, although the present record does not support immediate reconversion to chapter 7, this case should not be permitted to linger in chapter 11. If the debtors intend to, and can, reorganize, there is no reason why they cannot do so promptly. After all, they have already had 15 months to ponder their options. Accordingly, the court, on its own motion, will require that the debtors file a plan and disclosure statement within 120 days of the entry of the order of conversion. A status hearing will be set for a date following that deadline, and, if an apparently confirmable plan has not been filed, the court will consider at that hearing whether to reconvert the case to chapter 7.
A separate order will be entered consistent with this opinion.