In a recent decision, Marrama v. Citizens Bank of Massachusetts1, the United States Supreme Court considered whether a debtor has an absolute right under Section 706(a) of the Bankruptcy Code to convert a case to Chapter 13, clarifying a growing split among circuits as to whether the debtor’s bad faith conduct prior to his proposed conversion results in the forfeiture of the debtor’s right to convert. The Supreme Court, voting 5 to 4, ultimately decided that, unlike the right to convert a case to Chapter 7, no comparable absolute right to convert to Chapter 13 exists, and, by acting in bad faith, the debtor forfeited his right to so convert.

Background

Both Chapter 7 and Chapter 13 of the Bankruptcy Code provide for the discharge of debts. Chapter 7 authorizes a discharge of prepetition debts following the liquidation of the debtor’s assets by a bankruptcy trustee for distribution to creditors, whereas Chapter 13 authorizes an individual with regular income to be discharged after the successful completion of a bankruptcy court-approved payment plan. Under Chapter 7, the debtor’s nonexempt assets are controlled by the bankruptcy trustee, while under Chapter 13 the debtor retains possession of his property.

As a general matter, a case that is commenced under Chapter 7 may be converted to a case under Chapter 13 and vice versa.2 Section 706 provides, in relevant part: (a) The debtor may convert a case under this chapter to a case under Chapter 11, 12, or 13 of this title at any time, if the case has not been converted under Section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable. * * * (d) Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter. 11 U.S.C. §§ 706(a), (d).

However, Section 1307(c) of the Bankruptcy Code provides that a Chapter 13 case may be dismissed or converted to Chapter 7 “for cause,” and sets forth a non-exclusive list of ten grounds that would support dismissal or conversion.3 Although not specifically set forth in Section 1307, it is well-established that bad-faith conduct by the debtor constitutes cause for dismissal or conversion of a Chapter 13 case.

Facts

In Marrama, petitioner Robert Marrama made a number of misleading or inaccurate statements in the schedules attached to his voluntary Chapter 7 bankruptcy petition, including valuing a house in Maine at zero and denying that he made nonordinary course transfers of property in the year prior to his petition.4 Marrama later admitted that these misstatements were intended to protect certain assets from his creditors.

After the trustee announced that he intended to recover the Maine property, Marrama filed a “Verified Notice of Conversion to Chapter 13.” The trustee and Marrama’s principal creditor, Citizen Bank of In a recent decision, Marrama v. Citizens Bank of Massachusetts1, the United States Supreme Court considered whether a debtor has an absolute right under Section 706(a) of the Bankruptcy Code to convert a case to Chapter 13, clarifying a growing split among circuits as to whether the debtor’s bad faith conduct prior to his proposed conversion results in the forfeiture of the debtor’s right to convert. The Supreme Court, voting 5 to 4, ultimately decided that, unlike the right to convert a case to Chapter 7, no comparable absolute right to convert to Chapter 13 exists, and, by acting in bad faith, the debtor forfeited his right to so convert.

Background

Both Chapter 7 and Chapter 13 of the Bankruptcy Code provide for the discharge of debts. Chapter 7 authorizes a discharge of prepetition debts following the liquidation of the debtor’s assets by a bankruptcy trustee for distribution to creditors, whereas Chapter 13 authorizes an individual with regular income to be discharged after the successful completion of a bankruptcy court-approved payment plan. Under Chapter 7, the debtor’s nonexempt assets are controlled by the bankruptcy trustee, while under Chapter 13 the debtor retains possession of his property.

As a general matter, a case that is commenced under Chapter 7 may be converted to a case under Chapter 13 and vice versa.2 Section 706 provides, in relevant part: (a) The debtor may convert a case under this chapter to a case under Chapter 11, 12, or 13 of this title at any time, if the case has not been converted under Section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable. * * * (d) Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter. 11 U.S.C. §§ 706(a), (d).

However, Section 1307(c) of the Bankruptcy Code provides that a Chapter 13 case may be dismissed or converted to Chapter 7 “for cause,” and sets forth a non-exclusive list of ten grounds that would support dismissal or conversion.3 Although not specifically set forth in Section 1307, it is well-established that bad-faith conduct by the debtor constitutes cause for dismissal or conversion of a Chapter 13 case.

Facts

In Marrama, petitioner Robert Marrama made a number of misleading or inaccurate statements in the schedules attached to his voluntary Chapter 7 bankruptcy petition, including valuing a house in Maine at zero and denying that he made nonordinary course transfers of property in the year prior to his petition.4 Marrama later admitted that these misstatements were intended to protect certain assets from his creditors.

After the trustee announced that he intended to recover the Maine property, Marrama filed a “Verified Notice of Conversion to Chapter 13.” The trustee and Marrama’s principal creditor, Citizen Bank of Massachusetts, objected to the conversion on the grounds that Marrama’s effort to convert was made in bad faith and sought to abuse the bankruptcy process. The bankruptcy court agreed, denying Marrama’s request for conversion.5 

The Lower Court Rulings

Marrama appealed the bankruptcy court’s ruling to the bankruptcy appellate panel, arguing that the plain language of Section 706(a) of the Bankruptcy Code afforded him the absolute, nondiscretionary, right to convert the case to Chapter 7.6 The bankruptcy appellate panel rejected this argument, instead holding that such “absolute” right was available only “in the absence of extreme circumstances,” and concluded that Marrama’s actions constituted such circumstances.7 The court of appeals also affirmed, noting that the “bankruptcy court has unquestioned authority to dismiss a Chapter 13 petition” and concluding that the court could “discern neither a theoretical nor a practical reason why Congress would have chosen to treat a first-time motion to convert a Chapter 7 case to Chapter 13 differently from the filing of a Chapter 13 petition in the first instance.”8 The Supreme Court Decision

On appeal to the Supreme Court, Marrama argued that the plain language of subsection 706(a) grants an absolute right to convert and pointed to House and Senate Committee Reports which also described the right as “absolute.”9 Justice Stevens, writing for the majority, rejected this argument, pointing out that the “absolute” right described by the debtor is conditioned on the debtor’s never having converted the Chapter 7 case from Chapters 11 or 13—rendering the right to convert more conditional than “absolute”. The Supreme Court also pointed out that Section 706(d) further qualifies this “absolute” right, because a case may not be converted if one other condition applies: if the debtor may not be a debtor under the chapter to which the case is being converted.10

The Supreme Court concluded that, because Marrama’s bad faith conduct provided the Bankruptcy Court with a basis to dismiss his case “for cause” under Section 1307(c) of the Bankruptcy Code, it was also a basis for the denial of his conversion motion under Section 706(c). In dicta, the Supreme Court continued to recognize the class of people intended to benefit from the “absolute” right to convert to Chapter 13: those “honest but unfortunate debtors” for whom Congress “sought to give…the chance to repay their debts should they acquire the means to do so.”11 Finally, the Supreme Court noted that denial of the motion to convert might be proper even in the absence of Section 105(a)—which allows a bankruptcy court to take any action that is necessary or appropriate to prevent an abuse of process—as falling within the bankruptcy court’s general powers to “sanction ‘abusive litigation practices.’” Denying the motion to convert avoided the delayed ruling on Marrama’s unmeritorious attempt to qualify as a debtor under Chapter 13 that would have resulted if the bankruptcy court had to await a motion to reconvert following automatic conversion under Section 706 before it could address Marrama’s bad faith.12

Dissent

Justice Alito, joined by Chief Justice Roberts, Justice Scalia and Justice Thomas, disagreed with the majority’s position, asserting in the dissent that the majority’s reading of the requirement that a debtor’s right to convert is conditioned upon a finding of “good faith” is inconsistent with the Bankruptcy Code. Rather, the dissent agreed with Marrama that Section 706(a) gives the debtor the right to convert, regardless of the debtor’s good or bad faith. In reaching this result, the dissent compared the debtor’s independent right to convert under Section 706(a) with the court’s express discretion over a debtor’s right to convert a case to Chapter 11 pursuant to Section 706(b), which provides:

(b) On request of a party in interest and after notice and a hearing, the court may convert a case under this chapter to a case under Chapter 11 of this title at any time.

11 U.S.C. § 706(b) (emphasis added).13 After considering several other sections referencing a bankruptcy court’s right to police conversion, the dissent concluded that Congress chose to remove the bankruptcy court’s oversight of conversion under Section 706(a) and rejected the majority’s reading of Section 706(a) as deliberately reading in a role for the bankruptcy court that Congress deliberately left out. Instead, argued the dissent, Congress provided several other means for a court to exercise oversight over the debtor aside from oversight of the debtor’s conversion rights, including the bankruptcy court’s right to convert or reconvert a Chapter 11 or Chapter 13 restructuring to a Chapter 7 liquidation case for “cause,” the obligation of a Chapter 13 debtor to propose a good faith repayment plan subject to court approval, and the fact that the debtor’s statements and schedules are filed under penalty of perjury. With these and other means available for a bankruptcy court to remedy a debtor’s bad faith, the dissent argued that denial of a conversion motion was not one of them.14

Conclusion

The Supreme Court’s ruling resolves a split among lower courts as to whether the debtor’s bad faith conduct prior to its proposed conversion results in the forfeiture of the debtor’s right to convert. Further, in its decision, the Supreme Court upheld one of the basic equitable principles underlying bankruptcy law in emphasizing that the principal purpose of the Bankruptcy Code is to grant a “fresh start” to the “honest but unfortunate debtor.”