Opinion
Case No. 08-30020 Adv. No. 11-3402
04-24-2018
In re: ARNOLD SMITH MARY J. SMITH, Debtors ARNOLD SMITH MARY J. SMITH, Plaintiffs v. JOHN PAUL RIESER, Defendant
Copies to: James M. Hill (Counsel for the Plaintiffs) Dianne F. Marx (Counsel for Defendant) John Paul Rieser (Counsel for the Defendant)
Chapter 7 Decision Granting the Chapter 7 Trustee Summary Judgment on Counterclaim Against the Defendants, Arnold Smith and Mary J. Smith
Background
This litigation concerns a dispute about certain rents from real property leases and whether such funds belong to the debtors or the bankruptcy estate. This case began with a Chapter 11 petition filed by the debtors, Arnold and Mary Smith, in January 2008. The Smiths owned 185 parcels of rental property, some of which were vacant, or in foreclosure, but the majority of which had paying tenants. (See Trustee Exhibit 3, doc. 88). On May 23, 2008 the United States Trustee (the "UST") moved to convert the case to Chapter 7 or, alternatively, appoint a Chapter 11 Trustee (estate doc. 1082). That motion alleged that the Smiths failed to, among other things, file accurate and complete schedules and statements, failed to properly amend those documents, and failed to file monthly operating reports. The motion stated that the most important allegation was the failure to account for post-petition rental income. After a hearing on July 2, 2008 the court entered an order requiring the Smiths to provide complete amended schedules, a statement of financial affairs and clarification and supplementation of operating reports (estate doc. 1001). The order stated if such information was not provided in a satisfactory manner to the UST, the UST could request an emergency hearing which could lead to sanctions or conversion of the case. The parties agreed to a short extension, but the Debtors failed to fully comply with the order and the case was converted to Chapter 7 by an order entered on August 22, 2008 (estate doc. 1145). John Paul Rieser was appointed the Chapter 7 Trustee (the "Trustee").
On February 12, 2009 the Trustee moved to compel the Smiths to turnover all payments collected post-petition and provide an accounting (estate doc. 1463). See 11 U.S.C. § 542(a) (requiring, with exceptions not relevant here, the debtor to turnover and account for estate property). See also 11 U.S.C. § 521 (enumerating the duties of the debtor). The Smiths filed a response, and the parties attempted to reach a settlement. However, a settlement did not occur and on November 29, 2011 the Smiths filed an adversary proceeding against the Trustee, asserting the Smiths were owed $76,464.57 from the Trustee (doc. 1). This figure was alleged to represent rent payments collected by the Trustee after certain properties were abandoned. The Trustee moved to dismiss the complaint, or alternatively, consolidate it with the pending dispute in the estate case. On September 19, 2012 the parties entered into an agreed order denying the dismissal order, but preserved the right of the Trustee to file a counterclaim to seek the relief pending in the estate case (doc. 11). The Trustee filed a counterclaim seeking turnover of the un-accounted for rents during the Chapter 11 (doc. 13). Following the completion of the pleadings, this adversary proceeding was set for trial on November 13, 2013 (doc. 20), but the trial was rescheduled on a number of occasions to provide an opportunity for settlement. Upon the retirement of the prior Judge adjudicating this adversary proceeding, the court set a trial date of July 19, 2018 and a summary judgment deadline of March 12, 2018 (doc. 86).
On March 12, 2018 the Trustee moved for summary judgment on his counterclaim, and requests judgment in the amount of $381,015.85 (doc. 88). The Smiths did not file a response.
Jurisdiction
This court has jurisdiction pursuant to 28 U.S.C. § 1334(b). This is a core proceeding pursuant to 28 U.S.C. § 157(b)(2)(A) and (E) and the court has constitutional authority to enter final judgment.
Summary Judgment Standard
The appropriate standard to be used by the court to address this motion for summary judgment is contained in Federal Rule of Civil Procedure 56(a) and incorporated in adversary proceedings by reference in Federal Rule of Bankruptcy Procedure 7056. Rule 56(a) states in part that "[t]he court shall grant summary judgment if the movant shows that there is no genuine dispute as to any material fact and the movant is entitled to judgment as a matter of law." Fed. R. Civ. P. 56(a). In order to prevail, the movant, if bearing the burden of persuasion at trial, must establish all elements of its claim. Celotex Corp. v. Catrett, 477 U.S. 317, 331 (1986). Thereafter, "the nonmoving party must come forward with 'specific facts showing that there is a genuine issue for trial.' " Matsushita Elec. Indus. Co. v. Zenith Radio Corp., 475 U.S. 574, 587 (1986) (citations omitted).
Analysis
All the rents the Trustee seeks to recover in his counterclaim are post-petition, pre-conversion funds from rental property when the Smiths acted as Chapter 11 debtors-in-possession. A split exists in the case law as to whether post-petition, pre-conversion earnings are property of the Chapter 7 estate. There is no debate that post-petition earnings in an individual Chapter 11 are property of the Chapter 11 estate. See 11 U.S.C. § 1115(a)(2) (post-petition, pre-conversion earnings of an individual Chapter 11 debtor are property of the estate). The debate begins because § 348(f)(1) provides, in a conversion from Chapter 13 to another Chapter, property of the estate is limited to property of the estate as of the petition date "that remains in the possession of or is under the control of the debtor on the date of conversion[.]" 11 U.S.C. § 348(f)(1)(A). Only in the instance of a bad faith conversion is all the property as of date of conversion from Chapter 13 included in the estate. 11 U.S.C. § 348(f)(2). But, in a conversion of an individual Chapter 11 to another Chapter, § 348(f) does not apply. Therefore, the majority of courts have concluded that such earnings are property of the estate at conversion and remain as property of the Chapter 7 estate following conversion. In re Gorniak, 549 B.R. 721 (Bankr. W.D. Wisc. 2016); In re Meier, 528 B.R. 162 (Bankr. N.D. Ill. 2015), aff'd 550 B.R. 384 (N.D. Ill. 2016); In re Lincoln, 2017 WL 535259 (Bankr. E.D. La. Feb. 8, 2017); In re Colon, 2016 WL 5819783 (Bankr. D.P.R. Oct. 5, 2016); Pergament v. Pogano (In re Tolkin), 2011 WL 1302191 (Bankr. E.D.N.Y. Apr. 5, 2011), aff'd 2011 WL 1828854 (E.D.N.Y. May 16, 2012). Other courts disagree on various grounds. In re Evans, 464 B.R. 429 (Bankr. D. Colo. 2011) (considering legislative history and the purpose of § 348(f), finding "no policy reason" to treat property held by an individual Chapter 11 debtor upon conversion to Chapter 7 different from a conversion from Chapter 13) and Wu v. Markosian (In re Markosian), 506 B.R. 273 (B.A.P. 9th Cir. 2014) (despite the omission of Chapter 11 from § 348(f), the decision relied upon 11 U.S.C. §§ 348(a) and 541(a)(6) for the conclusion that post-petition, pre-conversion property is not part of the bankruptcy estate in a conversion of an individual case from Chapter 11 to Chapter 7).
Arguably, the Smiths acted in bad faith, but the court need not address this issue to reach its conclusion. (See Trustee Exhibits 1 and 2) (correspondence with the Smiths by the Trustee). --------
The Trustee argues in his summary judgment motion for the majority position; however, this court need not take a position on whether Chapter 11 post-petition, pre-conversion earnings are estate property. In this instance, rents, as opposed to earnings, are considered property of the estate under § 541(a)(6) under either analysis. See 11 U.S.C. § 541(a)(6) ("Proceeds, product, offspring, rents, or profits, of or from property of the estate, except that such as are earnings for services performed by an individual debtor after the commencement of the case.") (emphasis added). Had the Smiths made some argument or provided any evidence that the net rents should be fairly characterized as "earnings", this court would decide if such post-petition, pre-conversion earnings are property of the Chapter 7 estate. See In re Hoyle, 2013 WL 3294273 (Bankr. D. Idaho June 28, 2013) (determining post-petition earnings in a Chapter 11 are property of the Chapter 7 estate upon conversion, and further determining that such funds were not proven to be "earnings" under Idaho exemption law). As the record stands, the net rents are property of the estate under § 541(a)(6) and there is nothing in the record to re-characterize such rents as earnings. Such rents are property of the estate even if estate property is based upon the petition date, rather than the date of conversion.
Therefore, the only issue left to determine in the Trustee's motion is the calculation of any post-petition, pre-conversion rental income the Smiths failed to turnover to the bankruptcy estate. The Trustee has summarized the income from the various rental properties from January 2008 to August 2008, when the Chapter 11 case was converted. (Trustee Exhibit B). During that time, the Smiths had $699,305.01 in income. The Smiths' actual expenses for repairs, maintenance, utilities, real estate taxes, and other operating expenses were $318,289.16. This figure does not include depreciation or other expenses relevant for accounting or tax purposes. The Smiths' income, net of actual expenses, is the $381,015.85 figure that the Trustee seeks judgment.
These income figures, for January, July, and August 2008 come from an exhibit provided to the UST by the Smiths, the Owners Rent History 2008, because the operating reports fail to list rental income. (Trustee Exhibit 3). The income for the other months and all the expense information comes from the Smiths' operating reports. (See estate docs. 938, 939, 940, 941, and 1142). In both instances, the figures that form the basis for the Trustee's summary judgment motion came from the Smiths. The court independently reviewed the exhibits, the filed operating reports, and the summary of the Smiths' income and expenses. (See doc. 88 at 11-16) (summarizing the un-accounted for net rents for the post-petition, pre- conversion period). The record shows that the net rental income during the post-petition, pre-conversion period was never paid to the estate and is unaccounted for by the Smiths. The Smiths have chosen not to respond to explain these discrepancies.
Conclusion
The court grants summary judgment on the Trustee's counterclaim in the amount of $381,015.85, plus post-judgment interest pursuant to 28 U.S.C. § 1961. The trial on July 19, 2018 will be limited to the issue raised in the Smiths' complaint -- whether the Trustee owes any funds to the Smiths on rents collected by the Trustee after estate property was surrendered. If the Smiths succeed on that claim, any judgment obtained by the Smiths may result in a setoff against the Trustee's judgment, all of which is subject to subsequent determination. A separate order will issue.
This document has been electronically entered in the records of the United States Bankruptcy Court for the Southern District of Ohio.
IT IS SO ORDERED.
/s/ _________
Guy R. Humphrey
United States Bankruptcy Judge Dated: April 24, 2018 Copies to: James M. Hill (Counsel for the Plaintiffs)
Dianne F. Marx (Counsel for Defendant)
John Paul Rieser (Counsel for the Defendant)