Bankr. E.D.N.C.: In re McKenzie- Involuntary Conversion to Chapter 7 following Undisclosed Bequest

Summary:

The bankruptcy court granted a motion to convert the debtors' Chapter 13 case to Chapter 7 after they failed to disclose a $350,000 gift received post-petition. The Bankruptcy Administrator (BA) sought the conversion, citing the debtors' lack of good faith due to their failure to notify the Chapter 13 trustee of this substantial financial change, as required by court orders.

The court noted that the debtors did not contest the conversion in writing and did not appear to testify at the hearing. The BA argued that if this financial information had been disclosed earlier, it would have likely led to objections to the Chapter 13 plan. The court found the nondisclosure showed a lack of good faith, constituting "cause" under 11 U.S.C. § 1307(c) for conversion to Chapter 7. The court determined conversion was in the best interest of creditors and the estate, allowing a Chapter 7 trustee to retain control over the funds and investigate their disposition.

Commentary:

It is worth noting that Mr.  McKenzie received this gift (or,  using the term from  §541(a)(5)(A),  a bequest)   only 81 days after the filing of this bankruptcy case.  Accordingly,  even without a finding of bad faith conversion under §348(f)(2),  that bequest received within 180-days of filing becomes an asset of the Chapter 7 estate.  (It was an asset under §1306 and  Carroll v. Logan.) 

This might not actually be the result if here,  however,  if the bequest had been made more than 180-days after the filing of the case: §348(f)(2) provides that:

If the debtor converts a case under chapter 13 of this title to a case under another chapter under this title in bad faith, the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.  (Emphasis added.)

Here,  however,  it was not the debtors who converted to Chapter 7,  but the Bankruptcy Administrator who moved for that conversion.  Congress could have provided for the more expansive result with a passive tense "is converted" but,  likely in preserving the right of debtors to voluntarily dismiss their Chapter 13 cases (which springs from the 13th Amendment prohibition on debt slavery),  instead limited the broadening of the Chapter 7 estate to only apply when the debtor actively converts.

Further, as noted by others,  while there is a  statutory good faith requirement for filing Chapter 13 and confirmation of a plan,  there is no explicit  good faith requirement for remaining in a Chapter 13. Following Law v. Siegel,  the court is not given unfettered authority to craft remedies for the misdeeds of parties,  including failure to comply with orders of the court.  And while the court seemed troubled that dismissal instead of conversion of this case would have been to the detriment of creditors,  those creditors would still have the non-bankruptcy collection options (including commencing an involuntary bankruptcy against the debtor.)

Lastly,  this is also an example of where,  had the debtor or his very generous father first consulted with an attorney before making this bequest,  the debtor would not necessarily have had to pay little or any of these funds to his creditors.  This could have been accomplished either by the father creating a spendthrift trust  or by first approaching the Chapter 13 trustee to negotiate how much   would need to be paid to general unsecured creditors  for this contingent gift to be made.  

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