Over a dissent, the majority on a Ninth Circuit panel affirmed the Bankruptcy Appellate Panel by holding that a debtor retains an “absolute right” to dismiss a chapter 13 case under Section 1307(b) even when an objecting creditor contends that the debtor filed the chapter 13 petition in bad faith and was never eligible for chapter 13.

A former employer sued the debtor before bankruptcy for breach of a noncompetition and nondisclosure agreement, together with misappropriation of trade secrets. The former employer won a judgment for about $215,000 and recorded the judgment to obtain a lien on the debtor’s real property.

The debtor filed a chapter 13 petition, listing about $87,000 in unsecured debt plus $950,000 in secured debt, including $364,000 owing to the former employer. At the time, the debt limit in Section 109(e) was about $1.25 million for secured debts and about $420,000 for noncontingent, liquidated, unsecured debts.

Alleging that the debt resulted from a willful and malicious injury to property or a fraud while acting in a fiduciary capacity, the employer filed an adversary proceeding in bankruptcy court to declare that the judgment was nondischargeable. In addition, the employer alleged that the debtor had concealed assets. The employer also objected to the debtor’s homestead exemption.

Rather than fight on all fronts, the debtor filed a motion to dismiss the chapter 13 case under Section 1307(b), which provides, “On request of the debtor at any time, . . . the court shall dismiss a case under this chapter.” [Emphasis added.]

Arguing that dismissal would further the debtor’s wrongdoing and that the debtor had too much unsecured debt for chapter 13, the former employer opposed dismissal and moved for conversion to chapter 7. The former employer contended that the bankruptcy judge could not dismiss the case without first holding a hearing and deciding whether the debtor was eligible for chapter 13.

Bankruptcy Judge Natalie M. Cox of Las Vegas overruled the objection and permitted dismissal. The former employer appealed, losing a second time in an opinion for the BAP by Bankruptcy Judge Robert J. Faris. Tico Construction Co. v. Van Meter (In re Powell), 644 B.R 181 (B.A.P. 9th Cir. Oct. 21, 2022). To read ABI’s report, click here.

Interpreting Section 1307(b), the BAP cited the Second, Sixth and Ninth Circuits for giving a chapter 13 debtor a seemingly absolute right to dismiss a chapter 13 case that has not been previously converted from chapters 7, 11 or 12. The Ninth Circuit opinion is Nichols v. Marana Stockyard & Livestock Market Inc. (In re Nichols), 10 F.4th 956 (9th Cir. Sept. 1, 2021). To read ABI’s report on Nichols, click here. However, the BAP cited the Fifth and Eighth Circuits for holding that dismissal under Section 1307(b) may be conditioned on the debtor’s good faith.

Nichols Controls

In the circuit, the former employer conceded that Nichols gave the debtor an “absolute right to dismiss,” even if the filing were in bad faith. However, the debtor argued that the word “debtor” in Section 1107(b) must be interpreted to mean a debtor who is eligible for chapter 13.

[Note: To this writer, it appears that the former employer was asking the Ninth Circuit panel to overrule Nichols, without asking the circuit to sit en banc.]

In her majority opinion on October 1, Circuit Judge Jennifer Sung declined to decide whether “debtor” means someone eligible for chapter 13. Even if the former employer was correct, she held that “the debtor is presumptively a debtor under Chapter 13 — and the petition filing is enough to commence a Chapter 13 case under § 301(a).”

“And once a Chapter 13 case has been commenced under § 301(a),” Judge Sung held that “the debtor has an absolute right to voluntarily dismiss that case under § 1307(b), and the bankruptcy court is not required to conclusively resolve any disputes about the debtor’s Chapter 13 eligibility before granting a dismissal request.”

Judge Sung based her conclusion on the notion “that a case is commenced [under Section 301(a)] by the filing of a petition — not an eligibility determination by the bankruptcy court.” She said that the former employer did “not identify any statutory text that requires or even suggests that the court must verify the debtor’s eligibility before a dismissal can be granted under § 1307(b).”

Even if the debtor had filed under chapter 13 in bad faith, Judge Sung cited Nichols in holding that the filing of the petition “caused a case to be commenced under chapter 13,” requiring the bankruptcy court “to dismiss [the debtor’s] Chapter 13 case without further inquiry.” She affirmed the BAP.

The Dissent

Circuit Judge Daniel P. Collins “respectfully” dissented. To him, it was “implicit in the language of § 103(j) and § 1307(b) that the various rights and procedures specified in Chapter 13, including the absolute right of voluntary dismissal under § 1307(b), apply only in a case that is properly ‘under such chapter.’” [Emphasis in original.]

To Judge Collins, it made “no sense” to say that “the Code nonetheless allows the various rights contained within a given chapter to be invoked by an entity that is ineligible to proceed under that chapter.” It “cannot be correct,” he said, that a debtor could “brazenly falsify his schedules” and “later invoke Chapter 13’s absolute right of dismissal when a creditor calls out his false statements and seeks to convert the proceedings to another chapter.”

Judge Collins would have reversed.

Note: Circuit Judge Daniel P. Collins is not to be confused with Bankruptcy Judge Daniel P. Collins, who sits in Phoenix.

Observations

Allowing dismissal despite possible bad faith, the BAP alluded to the statement in Nichols that the bankruptcy court has “other tools” to deal with abuse. An example, the BAP said, would be imposing a bar to refiling or other conditions under Section 105(a). Another tool might be sanctions under Bankruptcy Rule 9011(c)(1)(A).

In Caldwell v. Unified Capital Corp. (In re Rainbow Magazine, Inc.), 77 F.3d 278, 284 (9th Cir. 1996), the Ninth Circuit said there was “little doubt” that a bankruptcy court has “inherent power” under Section 105(a) to issue sanctions for abuse of process and vexatious conduct.

In the case on appeal, dismissal of the chapter 13 case wasn’t necessarily the end of the story. After dismissal, the bankruptcy court could have retained the power to impose sanctions if the debtor had misbehaved.