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Debtors Barred from Chapter 7 Liquidation by Court, but Given Option to Convert to Chapter 13

Nicholas Eckhart [CC BY 2.0 (https://creativecommons.org/licenses/by/2.0/)], via FlickrChapter 7 bankruptcy enables qualifying debtors to pay down their debts by liquidating their non-exempt assets, followed by a discharge of many remaining debts. In order to qualify for a Chapter 7 discharge, debtors must demonstrate that they meet the criteria set out in the “means test,” 11 U.S.C. § 707(b). A trustee or creditor may ask the court to convert a Chapter 7 “liquidation” case to a Chapter 11 “reorganization” case for good cause, such as if they believe that the debtor does not qualify under the means test. Individual debtors rarely use Chapter 11, but a court cannot convert a Chapter 7 case to Chapter 13 without the debtor’s agreement. 11 U.S.C. § 706(c). A bankruptcy court recently ruled that a married couple could not file under Chapter 7 and essentially encouraged them to use Chapter 13 instead. In re Decker, No. A14-00065, memorandum (D. Alaska, Mar. 31, 2015).

The debtors in Decker have a complicated history of financial problems, as described by the bankruptcy court. Their adult daughter has required their ongoing support for medical problems and addiction recovery since 2009. The debtors began having serious issues with the Internal Revenue Service (IRS) in 2007, when it assessed deficiencies for the previous two tax years. Those debts have reportedly continued to accrue.

When the debtors filed their Chapter 7 petition in March 2014, they identified almost $426,000 in debts. Debts owed to the IRS included over $102,000 in priority debt and $81,000 in non-priority debt. The IRS filed a proof of claim for more than $204,000 in taxes, interest, and penalties. They also identified tax debts owed to the states of California and Alaska. The $35,000 in personal property identified in their schedules is all exempt or subject to liens.

The court-appointed trustee challenged the debtors’ accounting of monthly income and expenses, which initially showed a negative monthly cash flow of about $130. The wife admitted that they had overstated certain monthly expenses, but the trustee claimed that the overstatements were even more extensive. The trustee moved to convert the case to Chapter 11 under 11 U.S.C. § 706(b).

A court has discretion to convert a case under § 706(b) if it finds that it would benefit both the debtors and the creditors. The court found that conversion would benefit the creditors because the debtors apparently had a greater ability to pay their debts than what they stated in their schedules. It noted that the debtors were opposed to conversion, but that this did not preclude the court from finding that conversion would be to their benefit.

Since the debtors had primarily tax debts rather than consumer debts, the court found that Chapter 11 would be more beneficial to the debtors than Chapter 7. It noted that Chapter 13 might be an even better option for them, but it was prevented from converting the case to Chapter 13 by § 706(c). It ordered a conversion to Chapter 11, but it deferred the order for two weeks to give the debtors a chance to elect Chapter 13 instead.

If you are in financial distress, without sufficient income to continue paying your debts, an experienced and knowledgeable bankruptcy attorney can help you understand your rights and options. Devin Sawdayi has represented individuals and families in Chapter 7 and Chapter 13 personal bankruptcy cases in Los Angeles since 1997. To schedule a free and confidential consultation to see how we can help you, contact us today online or at (310) 475-939.

More Blog Posts:

Debtor’s “Tortious Conduct” May Prevent Discharge of Debt in Chapter 7 Bankruptcy, Los Angeles Bankruptcy Lawyer Blawg, May 5, 2015

Bankruptcy Court Grants Trustee’s Motion to Deny Discharge in Chapter 7 Case, Los Angeles Bankruptcy Lawyer Blawg, April 8, 2015

Transfer of Real Estate by Debtor More than One Year Before Filing Chapter 7 Bankruptcy Petition Does Not Bar Discharge of Debt, According to California Appellate Court, Los Angeles Bankruptcy Lawyer Blawg, January 9, 2015

Photo credit: Nicholas Eckhart [CC BY 2.0], via Flickr.