In a decidedly split decision, the U.S. Supreme Court has held that a debtor who filed an initial chapter 7 petition in bad faith forfeited the right to seek conversion to another chapter of the Bankruptcy Code. In so holding, the divided Court implied a requirement of good faith in the otherwise silent language of chapter 7. See Marrama v. Citizens Bank of Massachusetts, 127 S.Ct. 1105 (2007).
In Marrama, the debtor filed a chapter 7 bankruptcy petition and, as required, filed the appropriate Schedules of Assets and Liabilities. On the Schedules, the debtor reported that he was the beneficiary of a trust that held certain real estate. The debtor estimated the value of the property at $0. At the debtor’s Section 341 Meeting of Creditors, the chapter 7 trustee elicited that, in fact, the property was very valuable, previously was owned by the debtor outright, and only was transferred to the trust to avoid the debtor’s creditors.
The trustee advised of his intent to pursue an adversary proceeding to recover the property transferred to the trust. The debtor sought to convert his case to a chapter 13 case to prevent this cause of action.
The trustee and the debtor’s largest creditor opposed the debtor’s attempted conversion, noting that the concealment of his assets from the trustee constituted bad faith and should preclude conversion. The bankruptcy court agreed with the objectors and, denied conversion. The debtor appealed asserting that he had an absolute right to convert his case to a chapter 13 case under the plain language of section 706 of the Bankruptcy Code. The debtor’s appeal was rejected by both the Bankruptcy Appellate Panel and the U.S. Court of Appeals for the First Circuit.
The Supreme Court attempted to reconcile the apparent plain language of section 706 and the debtor’s fraudulent intent. By a margin of 5-4, the Court determined that, notwithstanding the seemingly plain language of section 706, the court nonetheless must determine if the debtor would be eligible to proceed under chapter 13 before allowing a conversion. Assessing the present debtor’s ability to proceed under chapter 13, the court determined that the debtor’s chapter 13 case, if filed as an initial chapter 13 petition, would be subject to dismissal for cause (i.e., the debtor’s pre-petition bad faith).
Therefore, the court concluded that an implied obligation of good faith was required to convert existing cases to chapter 13 to avoid the waste of judicial resources that would result from converting and ultimately dismissing a case. The court further held that the implied good faith furthers a fundamental policy of the Bankruptcy Code to provide a "fresh start to honest but unfortunate debtors."
In dissent, the "Conservative Four" - Chief Justice Roberts and Justices Alito, Scalia and Thomas – relied on the plain language of section 706 of the Bankruptcy Code. The dissenters base their entire argument on the "unambiguous" and "broad" right to convert the case and noted that section 706 places only two conditions on conversion: (i) no prior conversion and (ii) eligibility to proceed as a debtor under that chapter. Because "good faith" is not an express condition under section 706, no such condition should be implied, they argued.
The thin majority upon which this decision is based indicates the issue is by no means settled. While the majority’s decision seems to strike a balance in light of the policies of the Bankruptcy Code, it contradicts the Court’s recent trend to adhere to the plain language of the Bankruptcy Code. Hence, the decision is likely to hamper the predictability of future Supreme Court bankruptcy jurisprudence
This article is presented for informational purposes only and is not intended to constitute legal advice.
