Although his decision favored the debtor, an opinion by Bankruptcy Judge Brian C. Walsh of St. Louis shows how citizens with low incomes are poorly served by the Bankruptcy Code and meager state exemptions.

The debtor filed a chapter 7 petition in January. In his September 4 opinion, Judge Walsh said that the debtor owned a “modest” home in which she appeared to have “some equity.” In her schedules, the debtor showed monthly net income that was negative by about $350. Her only income was from retirement benefits.

The debtor scheduled her home as being worth $43,000, subject to a mortgage of slightly over $15,000. The debtor claimed a $15,000 state homestead exemption.

After the debtor received her chapter 7 discharge, the trustee decided there was equity in the home. So, the trustee retained counsel and a real estate broker. After the trustee asked the debtor for assistance in marketing the home, the debtor filed a motion asking Judge Walsh to convert the case to chapter 13.

The chapter 7 trustee opposed conversion, arguing that conversion was impossible after the debtor had been discharged. The trustee also contended that conversion would be futile because the debtor lacked sufficient income to confirm a plan.

Discharge Isn’t a Bar to Conversion

Judge Walsh began his analysis of the merits by reciting Section 706(a), which says that 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 had not previously been converted from chapters 11, 12 or 13. [Emphasis added.]

Although the statutory right to convert has been held to be “absolute,” Judge Walsh found three nonstatutory exceptions: if (1) the debtor has already received a discharge; (2) the debtor was “destined to fail” in chapter 13; or (3) it would be an “abuse of the bankruptcy process.”

Judge Walsh cited cases precluding conversion after discharge. Some courts, he said, believe that “conversion is not possible after discharge because a debtor’s personal liability for any debts has been extinguished.” “Still other courts,” he said, “resolve the complex issues in a post-discharge conversion case by setting aside the discharge under Federal Rule of Civil Procedure 60(b).”

“Nothing in Section 706,” Judge Walsh said, “expressly prevents a debtor from converting a case after receiving a discharge.” Furthermore, Section 109(e) provides that an individual with “regular” income may be a chapter 13 debtor as long as the amount of debt is less than the statutory cap.

Judge Walsh observed that eligibility under Section 109(e) does not turn on “whether that debtor has already received a discharge.” Similarly, he noted that chapters 12 and 13 have limitations on conversion after discharge, but no such restriction is present in chapter 7. He therefore decided that receipt of a discharge did not preclude conversion to chapter 13.

Futility

The chapter 7 trustee argued that conversion was futile because the debtor had insufficient income to satisfy the best-interests test in chapter 13. However, the debtor had amended her schedules by lowering her expenses. In addition, the debtor could propose a five-year plan, rather than a three-year plan.

Judge Walsh was not sure that the debtor could confirm a plan, that the plan would be feasible or that the debtor could make the required payments. “But that is not the test,” he said. “Because I do not believe that conversion of this case to Chapter 13 is ‘an exercise in futility,’” he concluded “that it is appropriate for the Debtor to have an opportunity to pursue confirmation and a Chapter 13 discharge.”

Further complicating the debtor’s problems, Judge Walsh was obliged to permit the trustee’s counsel and the real estate broker to file applications for allowances of compensation, which, if allowed, would be paid through the debtor’s chapter 13 plan. He admitted that the administrative claims “may create an additional burden on the Debtor as she attempts to craft and fund a Chapter 13 plan.”

Judge Walsh therefore held “that a Chapter 7 debtor who has received a discharge may convert to Chapter 13, but the discharge should be set aside under Rule 60(b)(5) upon conversion.”

Observation

For some of our citizens, bankruptcy is an illusion. States should consider raising their exemptions to prevent elderly folks from having their homes sold out from underneath them in bankruptcy. For debtors living on retirement income and possessing few assets, Congress should consider barring the sale of a home when the distribution to creditors would be minimal.