Bankruptcy Judge Tony M. Davis of Austin, Texas, praised a bankrupt couple for attempting to repay their business debts over seven years and rebuffed an effort by a U.S. Trustee at converting their chapter 7 case involuntarily to chapter 11.
The attempted conversion was not instigated by the creditor whose lawsuit prompted the chapter 7 filing. Rather, the U.S. Trustee wanted the case converted to chapter 11 so the couple would be forced to put their disposable income toward the payment of creditors’ claims.
Interpreting Fifth Circuit authority, Judge Davis denied conversion on Jan. 21 and in the process established a standard for involuntary conversion to chapter 11: a requirement that there be benefit to all parties including the debtors, not just the creditors or the estate.
The husband was a teacher, and the wife was a veterinarian. Her attempt to establish her own practice was a failure, resulting in large business debts. Over the ensuing years, the couple paid off all of the business debts aside from some $220,000 owing to a bank. Payments on their home mortgage and auto liens were current. They owed no taxes, but had credit card debt.
A lawsuit by the bank precipitated the chapter 7 filing. After paying living expenses plus auto and home payments, the couple was left with some $2,700 in monthly disposable income. The couple intended to reaffirm their home and auto loans.
Although the U.S. Trustee wanted their disposable income disbursed to creditors under a chapter 11 plan, the Bankruptcy Code provided little room to maneuver.
Dismissal for abuse under Section 707(b) was unavailable because the couple’s liabilities were not primarily consumer debts, and the U.S. Trustee could not move for conversion to chapter 13, because Section 706(c) requires the debtors’ consent. Instead, the U.S. Trustee’s motion was based on Section 706(a), which contains no statutory standard for conversion.
Based on a 1998 Fifth Circuit opinion called Pickens, Judge Davis rejected lower court authorities from other circuits categorically barring conversion of individuals’ cases to chapter 11 absent consent. He said that a blanket rule would preclude conversion even when debtors have primarily business debts.
Judge Davis interpreted Pickens to mean that a decision on conversion must be based on “what will most inure to the benefit of all parties in interest,” including the debtors.
Since there was no evidence of benefit to the debtors, Judge Davis denied the conversion motion. Converting to chapter 11, he said, would be a “zero-sum game” accomplishing nothing aside from transferring some of the couple’s future income to creditors.