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The Fight Against An Alarming Trend: Section 706(b) Motions – Part 3


III. Dealing With A Motion To Convert Pursuant To Section 706(b)

This post assumes familiarity with my last two posts (Part 1 and Part 2) of this multi-part series. Thus, while you can certainly read this post without reading those previous ones, you’ll get more out of it if you read those posts first.

A. Oppose Any Motion To Extend The Time To Enter A Discharge

If the Court has already granted a nonconsumer debtor a Chapter 7 discharge, the judge will probably not entertain a motion to convert the Chapter 7 case to one under Chapter 11, pursuant to § 706(b). Therefore, oppose any motion to extend the time for the Court to enter the discharge. Here’s the argument:

The Federal Rules of Bankruptcy Procedure provide (with emphasis added):

In a chapter 7 case, on expiration of the times fixed for objecting to discharge and for filing a motion to dismiss the case under Rule 1017(e), the court shall forthwith grant the discharge, except that the court shall not grant the discharge if:

(A) the debtor is not an individual;
(B) a complaint, or a motion under §727(a)(8) or (a)(9), objecting to the discharge has been filed and not decided in the debtor’s favor;
(C) the debtor has filed a waiver under §727(a)(10);
(D) a motion to dismiss the case under §707 is pending;
(E) a motion to extend the time for filing a complaint objecting to the discharge is pending;
(F) a motion to extend the time for filing a motion to dismiss the case under Rule 1017(e)(1) is pending;
(G) the debtor has not paid in full the filing fee prescribed by 28 U.S.C. §1930 (a) and any other fee prescribed by the Judicial Conference of the United States under 28 U.S.C. §1930(b) that is payable to the clerk upon the commencement of a case under the Code, unless the court has waived the fees under 28 U.S.C. §1930(f);
(H) the debtor has not filed with the court a statement of completion of a course concerning personal financial management if required by Rule 1007(b)(7);
(I) a motion to delay or postpone discharge under §727(a)(12) is pending;
(J) a motion to enlarge the time to file a reaffirmation agreement under Rule 4008(a) is pending;
(K) a presumption is in effect under §524(m) that a reaffirmation agreement is an undue hardship, and the court has not concluded a hearing on the presumption; or
(L) a motion is pending to delay discharge, because the debtor has not filed with the court all tax documents required to be filed under §521(f).

Fed. R. Bankr. Proc. 4004(c)(1).

If the sixty-day bar dates of Rules 4004(a) and 1017(e) have passed, and no one has asked the Court to extend either of those deadlines prior to their expiration, then unless one of the exceptions in Rule 4004(c)(1) applies, the Court must forthwith enter the discharge.

If the motion to extend the deadline asks the Court to extend it long enough for the Court to rule on the § 706(b) motion to convert, resist it: “A pending motion to convert is not an enumerated exception under Bankruptcy Rule 4004(c)(1). See generally Fed. R. Bankr. P. 4004(c)(1)(A)-(L).” In re Johnson, 564 B.R. 653, 657 (E.D. Cal. 2017).

Since the rule uses the imperative, “shall,” the Court must apply Rule 4004(c)(1) and grant the debtor a Chapter 7 discharge forthwith. See, e.g., Assoc. of Civilian Technicians v. FLRA, 22 F. 3d 1150, 1153 (D.C. Cir. 1994) (“The word ‘shall’ generally indicates a command that admits of no discretion on the part of the person instructed to carry out the directive.”)

B. Oppose A § 707(b)(2) Type Of Analysis In A § 706(b) Motion

In a § 706(b) motion to convert you will probably see a discussion of income and expenses following the sort of analysis found in the means test that is the embodiment of 11 U.S.C. § 707(b)(2). Since the movant cannot get a nonconsumer debtor’s case dismissed directly under section 707(b), it is, in effect, attempting to get the case dismissed indirectly using 11 U.S.C. § 706(b). However, 11 U.S.C. § 706(b) was not designed to be used as an end-run around section 707(b).

While section 707(b)(2) requires a detailed analysis of the debtor’s income and expenses to determine whether dismissal is appropriate, section 706(b) does not. This leads ineluctably to the conclusion that an income and expense analysis has no place in section 706(b) jurisprudence.

Indeed, courts have held that it is improper to use section 706(b) to convert a case based on ability to repay debts, simply because section 707(b) does not apply. “To permit a § 707(b) type inquiry under the rubric of a § 706(b) conversion request ‘would countenance easy circumvention of the limitations upon dismissals for substantial abuse incorporated into § 707(b).’” In re Ryan, 267 B.R. 635, 638 (Bankr. N.D. Iowa 2001) ().

That is precisely what the typical § 706(b) motion attempts to do: Circumvent the nonconsumer debt limitation of section 707(b) by analyzing the debtor’s income and expenses to try to show that he can afford to repay some of his debts in a Chapter 11 case. In sum, by attempting to force the debtor into a doomed involuntary repayment plan in contravention of the thirteenth amendment to the U.S. Constitution, the movant ultimately seeks to dismiss the debtor’s case through a motion under section 706(b) because it cannot use section 707(b). This is a bad faith end-run around the Bankruptcy Code’s limitations. I’ll discuss the thirteenth amendment problem in great detail in my next post.

While Ryan is a pre-BAPCPA case, holdings denying conversion under section 706(b) on these same grounds continued after the passage of BAPCPA in 2005.

For example, in rejecting the U.S. Trustee’s effort to force debtors earning $560,000 per year (i.e., $46,666 per month – nice work if you can get it) into a Chapter 11 repayment plan, the Court in In re Quinn, 490 B.R. 607, 621-22 (Bankr. D. N.M. 2012) held:

It is clear to the Court that the United States Trustee’s objective is to force the Debtors to repay their creditors, whether through dismissal and the re-filing of a Chapter 11 case or through conversion to Chapter 11 under 11 U.S.C. § 706(b). Under these circumstances, it is not appropriate to compel the same end result through conversion to Chapter 11 when it is not appropriate to dismiss the Chapter 7 case to compel a re-filing under Chapter 11 by necessity.

Likewise, the Court in In re Snyder, 509 B.R. 945 (Bankr. D. N.M. 2014) refused to convert the case of a debtor who earned $290,000 per year (i.e., $24,166 per month), holding that because there was no basis under section 707 for dismissing the debtor’s case, it would not be appropriate to convert the case to one under Chapter 11 pursuant to section 706(b).

In sum, using a § 707(b)(2) type of analysis in a § 706(b) motion is contrary to the statutory provisions specifically excluding nonconsumer individual debtors from the “abuse” and “ability to repay” analysis set forth in section 707.

Finally, the current § 707(b)(1) states (with emphasis added): “… with the debtor’s consent, convert such a case to a case under chapter 11 or 13 of this title …”  Therefore, if a § 707(b) analysis should be used, then that subsection’s voluntary conversion provision should come along for the ride, in direct conflict with § 706(b)’s involuntary conversion language.

C. 11 U.S.C. § 706(b) Should Not Apply To An Individual Case

Section 706 of the Bankruptcy Code governs conversion of Chapter 7 cases, and section 707(b) governs dismissal of Chapter 7 cases where the debtor’s debts are primarily consumer debts.

Section 706(a) allows the debtor to request conversion to another chapter, unless the case has previously been converted. Section 706(b) allows a party in interest to convert a Chapter 7 case to Chapter 11, regardless of a prior conversion.
Section 706(b) has been a rarely used provision, that until relatively recently was not used to force an individual debtor who was eligible for Chapter 7 relief into a Chapter 11 case.

In fact, until the 2012 case, In re Gordon, 465 B.R. 683 (Bankr. N.D. Ga. 2012), cases uniformly held that section 706(b) could not be used to force an individual Chapter 7 debtor into an involuntary Chapter 11 payment plan. Instead, the statute was used in unusual cases such as In re Seychelles, 30 B.R. 72 (Bankr. N.D. Tex. 1983), where the general partners of a partnership debtor could not agree to convert the case from Chapter 7 to Chapter 11.

The Court in In re Graham, 21 B.R. 235, 238-39 (Bankr. N.D. Iowa 1982) cited the legislative intent behind the creation of Section 706(b):

Congress considers it “unwise to force a debtor into a repayment plan.” … In the view of Congress, it is more important to encourage a debtor to retain his or her employment, instead of running the risk of a debtor’s walking away from his or her job in order to avoid working to fund a repayment plan that primarily benefits someone else. … In the view of Congress, it is also better to avoid the possible administrative difficulties involved in attempting to get a debtor to comply with a repayment plan, and to avoid the prospect of a bankruptcy court’s presiding over a repayment plan that is preordained to fail, instead of attempting to enforce compliance with a mandatory repayment plan. Thus, the expressed legislative intent is that individual debtors should not be forced into a repayment plan against their will. … Because the forced submission of the debtor to such a plan is the sole purpose of the Movant’s motion to convert these proceedings from Chapter 7 to Chapter 11 and because the effect of such an 11 U.S.C. § 706(b) conversion would be such a forced submission, the Court is forced to deny the Movant’s motion.

A line of cases followed Graham, including In re Brophy, 49 B.R. 483, 484 (Bankr. D. Haw. 1985): “The Court agrees with In re Graham and finds that Section 706(b) was not intended to be a vehicle by which individual debtors would be forced to submit to a plan of repayment against their wills.”

D. The Balancing Of Interests Test

I recently faced a § 706(b) motion that incorrectly asserted that “Section 706(b) does not require the bankruptcy court to balance the interests of the parties in interest.” The actual test is:

[I]n considering a decision to convert from chapter 7 to chapter 11, over the debtor’s objection, the bankruptcy court should exercise its discretion “based on [a] determination of what will most inure to the benefit of all parties in interest.” The … directive to examine the “benefit to all parties in interest” suggests not an inquiry solely into the best interests of the creditors, or even the best interests of the estate, but rather a broader inquiry into what will collectively benefit the debtor, the creditors, and any other parties with a stake in the case. Thus, the decision should not be made based on the interests of any one party or class of parties.

In re Karlinger-Smith, 544 B.R. 126, 131 (Bankr. W.D. Tex. 2016).

The Lobera decision cited by Snyder, supra, expanded on this test by specifically addressing the interests of the debtor:

[C]onversion to Chapter 11 would not further the interests of the Debtor or those that depend on him for support. The obviously apparent reasons for the existence of a bankruptcy law available to individuals is to discharge debt and provide a fresh start. If the Court were to order conversion of this case to Chapter 11, the Debtor would be unable to automatically reconvert it to Chapter 7. See Section 1112(a)(3) . . . Instead, he would be trapped in a Chapter 11 proceeding that he does not need and does not want. There is no business to reorganize. This is not the fresh start than Congress envisioned. Balancing this consideration against the increased estate, the Court finds that the case should not be converted to Chapter 11.

In re Lobera, 454 B.R. 824, 854-55 (Bankr. D. N.M. 2011).

Thus, the debtor’s interests must be taken into account in the analysis.

E. Most Of The Few Recent Cases Granting Conversion § 706(b) Motions Involved Extremely High Income Debtors

Finally, almost all of the few recent cases in which bankruptcy courts granted motions to convert under section 706(b), involved wealthy debtors with extremely high incomes. If you don’t inhabit the stratospheric realm of these debtors, perhaps you can distinguish your case from their cases.

The debtor in In re Gordon, 465 B.R. 683 (Bankr. N.D. Ga. 2012), the first case in which a Court granted a § 706(b) conversion motion, had an average monthly income of $24,152.50. The debtors in In re Decker, 535 B.R. 828 (Bankr. D. Alaska 2015) had gross monthly income of $23,855.77. The debtors in In re Baker, 503 B.R. 751 (Bankr. M.D. Fla. 2013) had net income of approximately $19,000 per month. The debtor in In re Parvin, 538 B.R. 96 (Bankr. W.D. Wash. 2015), aff’d, 549 B.R. 268 (W.D. Wash. 2016) had monthly gross income of $62,499. The debtors in In re Schlehuber, 489 B.R. 570 (B.A.P. 8th Cir. 2013) had gross monthly income of $24,353.55.

In my next post I will discuss the thirteenth amendment implications of a § 706(b) motion.

 

(Note: James Selth and I made a presentation at a local bar association.  These are the notes we used.  Although I wrote the notes, some of the content came from a brief Jim filed in one of his cases.)

 

Based on Flicker Image  (Licensed) by Cepican

The post The Fight Against An Alarming Trend: Section 706(b) Motions – Part 3 appeared first on Southern California Bankruptcy Law Blog.

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About the Author

Mr. Nicholas Gebelt represents debtors—individuals, couples, and Businesses—and helps them succeed in an area fraught with traps for the uninitiated.

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