Bankruptcy Code Section 348(f) states when a Chapter 13 Bankruptcy is converted to a Chapter 7 Bankruptcy, the Bankruptcy Estate does not include property acquired by the Debtor after the original Chapter 13 Bankruptcy was filed.
This is an interesting element of Bankruptcy Law because in a Chapter 13 Bankruptcy the Bankruptcy Estate can include property or assets that are held by the Debtor both before the filing of the Bankruptcy and after the filing of the Bankruptcy, during the entire term of the Chapter 13 Bankruptcy, which generally is a period of 36 to 60 months. However, with some exceptions, in a Chapter 7 Bankruptcy, the Bankruptcy Estate only includes assets or property held by the Debtor before the filing of the Chapter 7 Bankruptcy.
If the intent of Congress was to fashion the Bankruptcy Laws with a recognition of the rights of Creditors, such a rule appears contrary to such intent, because such rule may disfavor the filing of Chapter 13 Bankruptcies, which tend to offer some distribution to the Unsecured Creditors, whereas Chapter 7 Bankruptcy generally offers no payment to such creditors.
In the instance in which a Debtor files Chapter 13 Bankruptcy, and more than six months after the filing of the Bankruptcy, inherits a property, the Chapter 13 Trustee will typically demand that either the property be sold and some or all of the proceeds be distributed to the Chapter 13 Bankruptcy Plan, or the Debtor pay an additional amount to the unsecured creditors, that is equivalent to the value of the inheritance received by the Debtor.
If the same Debtor filed a Chapter 7 Bankruptcy and received such inheritance subsequent to the six months after the filing of the Chapter 7 Bankruptcy, then such inheritance would not be included in the Bankruptcy Estate, and not subject to liquidation by the Chapter 7 Trustee.
Although the above scenarios appear to create unfair results for the filer of the Chapter 13 Bankruptcy, such is the result created by the constructors of the Bankruptcy Code.
One strategy that may employed by such Debtor in a Chapter 13 Bankruptcy would be to convert the Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy. Bankruptcy Code Section 348(f) provides when a Debtor converts a Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy, the property of the Bankruptcy Estate does not include property acquired by the Debtor after the original Chapter 13 Bankruptcy was filed.
In the above example, the Debtor could convert the Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy, and the inheritance received would not be considered property of the Bankruptcy Estate.
However, if the Bankruptcy Court determines that such conversion was in bad faith, then the Court may determine that such property or inheritance may be included in the Bankruptcy Estate, and subject to administration or liquidation by the Bankruptcy Trustee.
Generally, the finding of bad faith is a difficult standard to establish, as the Debtor is generally given the right to convert a Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy without restraint. The Bankruptcy Courts will typically not enter a finding of bad faith because the Debtor is unable to complete the Chapter 13 Bankruptcy because of financial constraints, even in situations where the Debtor has inherited a property or asset of significant value. Bad faith generally necessitates actions by the Debtor to conceal assets or property from the Bankruptcy Court. Bad faith is found when the Debtor has acted in a dishonest manner.
If the Debtor simply uses the Bankruptcy Code to achieve a more advantageous result, such as the Debtor in this example converting the Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy in order to escape the ramification of the inheritance, is this considered an example of bad faith? The Bankruptcy Court have generally answered, “No”.
A Middle District of Florida decision in 2014 in the case of In re Stillwagon found that bad faith was not present when the Debtor converted the Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy for the purpose of protecting an inheritance that was received after the filing of the Chapter 13 Bankruptcy. A similar finding was made in the Minnesota case of In re Wiczek-Spaulding, in reference to severance monies that were received post-petition in the Chapter 13 Bankruptcy.
One case that goes contrary to such findings was In re Lien [527 BR 1], in which the Bankruptcy Court found that bad faith did exist when such conversion was made in order to protect an inheritance received after the filing of the Chapter 13 Bankruptcy.
In such determinations of whether bad faith exists, the proper analysis would be to look at the surrounding circumstances present in the Debtor’s Bankruptcy. Simply using the Bankruptcy Laws as they exist to one’s advantage is not sufficient for a finding of bad faith. However, the Court should property look at the surrounding facts including whether it appears the Debtor appeared committed to the completion of the Chapter 13 Bankruptcy, whether there are elements of concealment of assets, how long the Debtor remained in the Chapter 13 Bankruptcy before conversion, and whether the Debtor made a good faith attempt to liquidate such asset, or negotiate with the Chapter 13 Trustee, a reasonable accommodation.
In the same example, then how are the assets treated that were held or owned by the Debtor at the time of the filing of the Chapter 13 Bankruptcy? The Debtor in the Chapter 13 Bankruptcy may have filed Chapter 13 in order to protect certain non-exempt assets, which would be subject to possible liquidation or sale in a Chapter 7 Bankruptcy.
A number of cases have addressed this issue, finding that the value of such property should be determined at the time of the conversion of the Chapter 13 Bankruptcy to Chapter 7 Bankruptcy, and not at the time of the filing of the Chapter 13 Bankruptcy.
The Western District of New York case of In re Lang [437 BR 70] found that the value of the property is to be determined at the date of the conversion of the Chapter 13 Bankruptcy to Chapter 7 Bankruptcy. In such an instance even though the asset may have declined in value, one should still determine the value at the time of conversion.
The Ninth Circuit case of Warfield v Salazar [465 BR 875] in 2012 found that a tax refund which the Debtor was entitled at the filing of the Chapter 13 Bankruptcy was no longer property of the Bankruptcy Estate after conversion as such tax refund was spent by the Debtor.
Such findings portend well for the Debtor who filed Chapter 13 Bankruptcy in order to protect an asset which is considered not exempt. If the Debtor converts the Chapter 13 Bankruptcy to a Chapter 7 Bankruptcy after a significant number of years participation in the Chapter 13 Bankruptcy, then certain assets, such as automobiles, are certain to have depreciative value. If such value is determined at the time of the conversion of the Bankruptcy, then such determination of value leans toward the benefit of the Debtor.
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