A bankruptcy judge recently denied a debtor’s request to convert his case from Chapter 11 to Chapter 7, finding that he had not acted in accordance with his fiduciary duties throughout the case. Most individual debtors do not find Chapter 11 to be helpful. It is much more common for business bankruptcies and individuals with very large estates. In this case, the debtor is a professional hockey player. In re Johnson, No. 2:14-bk-57104, petition (S.D. Oh., Oct. 7, 2014). When he moved for conversion to Chapter 7, the court reviewed the course of the case and issued a 150-page order denying the motion and criticizing the debtor’s conduct. Johnson, op. and order (Feb. 26, 2016). The judge’s reasoning offers an idea of the concerns that courts address in Chapter 7 cases.
A key difference between the Johnson case and a Chapter 7 or Chapter 13 case is that the bankruptcy estate had no independent trustee. The debtor was acting as trustee when he moved for conversion to Chapter 7. In Chapter 11 cases, a trustee is only appointed if requested by a party in interest or the U.S. Trustee’s Office. 11 U.S.C. § 1104. If no trustee is appointed, the debtor serves in the capacity of trustee, with all the same fiduciary duties towards creditors and others. Under Chapters 7 and 13, the Bankruptcy Code states unconditionally that a trustee “shall” be appointed. 11 U.S.C. §§ 701, 1302.
Debtors are typically allowed to convert their case from one chapter to another if they meet various criteria established in the Bankruptcy Code. A Chapter 11 debtor can convert their case to Chapter 7, with several exceptions. A bankruptcy court may not convert a case to Chapter 7 if it finds that appointment of a Chapter 11 trustee would be in the estate’s and the creditors’ best interest, or if it “identifies unusual circumstances” indicating that conversion would not be in their best interest. 11 U.S.C. § 1112(b). A Chapter 7 debtor can convert their case to Chapter 11 or Chapter 13 with the court’s permission, after establishing cause. 11 U.S.C. § 707. A Chapter 13 debtor is far less constrained in converting a case to Chapter 7. 11 U.S.C. § 1307.
The debtor in Johnson filed a voluntary Chapter 11 petition in late 2014. According to the court, the debtor “went astray” from his fiduciary duty—as trustee for the estate—to “use his income to provide creditors with a meaningful recovery.” Johnson, op. & order at 1. A group of creditors with claims totaling about $14 million objected to Chapter 7 conversion on several grounds, including bad faith conduct by the debtor.
The court found that the debtor’s motivation in seeking conversion appeared to be to shield “all of his post-bankruptcy earnings…including those he earned before conversion” from the bankruptcy estate, thereby keeping a substantial amount of assets away from creditors. Id. It also found that the debtor failed to take numerous steps available to him under Chapter 11 to raise objections to the creditors’ claims, and that he “neglected to take other steps that are necessary to reorganize his financial affairs.” Id. at 2. The court therefore denied his motion for conversion.
Since 1997, bankruptcy attorney Devin Sawdayi has assisted individuals and families who are experiencing financial distress in the Los Angeles area. We help our clients understand their rights and obligations in bankruptcy, and guide them through the process of obtaining relief in Chapter 7 and Chapter 13 cases. Please contact us online, at (800) 474-6050, or at (310) 475-9399 today to schedule a free and confidential consultation with an experienced and compassionate financial advocate.
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