Bankruptcy Chapter Conversion
A debtor who decides to file bankruptcy must also decide under what chapter to file. If the debtor decides that he wants to liquidate, then Chapter 7 is applicable. If the debtor wants to repay his debts over time to keep valuable assets, then Chapters 11, 12, or 13 would be applicable. However, sometimes a debtor, after filing under a particular chapter, realizes that another chapter would be more appropriate or changed circumstances, such as unemployment or serious medical problems, makes it impossible to continue a payment plan under the rehabilitative bankruptcies—Chapters 11, 12, or 13. Except for some special restrictions, a bankruptcy case can be converted to another chapter at any time.
In each of these cases, the debtor has a choice to convert to another chapter of bankruptcy after filing under another. However, each chapter has its own eligibility requirements, so the debtor must be eligible not only for the initially filed chapter, but also for any chapter that the debtor wishes to convert to. Each chapter of the Title 11 Code has its own rules for converting from or to other chapters, specifically, sections 706, 1112, 1208, and 1307 for Chapters 7, 11, 12, and 13 respectively.
For instance, Chapter 12 is for family farmers and fisherman and it has debt limits as does Chapter 13. Furthermore, Chapter 13 is for individual debtors only, not business entities. Creditors may also force a conversion, but their only choices are between Chapters 7 and 11, since these are the only chapters that allow involuntary bankruptcies. For instance, if a Chapter 13 petitioner is unable to make payments, creditors may move to convert the case to Chapter 7, arguing that Chapter 13 is an abuse.
The means test may also prevent a debtor from converting between Chapter 7 and 13, because if the debtor's income is too high, a Chapter 7 filing or conversion will be deemed abusive unless the debtor can show good cause for the conversion; likewise if income is too low and the debtor is trying to convert to Chapter 13.
Conversion is possible whether the bankruptcy petition was voluntary or involuntary. Either the debtor or parties in interest, such as creditors or the trustee, can move for a conversion, but the debtor is given the most latitude for conversion. If a non-petitioner moves for an involuntary conversion, then the court can only order a conversion based on good cause and must provide a notice and a hearing so that the debtor or any other interested party can challenge the conversion. However, a debtor's right to convert is not absolute; it can be denied if the conversion is requested because of bad faith or is considered an abuse of the Bankruptcy Code.
Since Chapter 12 and 13 are only for individuals, not businesses, and do not allow involuntary petitions, only the debtor can convert to those chapters. Involuntary conversion by creditors or other parties in interest are not allowed.
When a case is converted, some bankruptcy rules depend on the original filing date, while other rules depend on the conversion date.
The debtor has an absolute right to convert from Chapter 7 to Chapter 11, 12, or 13 if he is eligible under those chapters and if the Chapter 7 was an initial filing and not a converted case. The debtor cannot waive the right to convert.
If the case is converted, then any subsequent conversion or dismissal rights will be based on the rules for conversion or dismissal under the converted chapter.
However, bad faith may limit the debtor's right to convert. An example of bad faith is when the debtor doesn't list valuable assets on his petition for Chapter 7 that the trustee finds out about during the case. Naturally, the trustee will want to sell the property for the benefit of the unsecured creditors, but also for her own benefit, since she gets a percentage of the sale of assets. To prevent the sale, the debtor seeks conversion to Chapter 13. However, courts consider this to be bad faith and will prevent the conversion. Although §706(a) gives an absolute right for the Chapter 7 petitioner to convert to Chapter 13, the Supreme Court has held that the bankruptcy court's general power [§105(a)] to prevent an abuse of the system trumps the plain statutory language.
A Chapter 11 petitioner can convert to Chapter 7 if the Chapter 11 case was voluntary and the debtor is a debtor in possession. Otherwise, the case can be converted for cause if the Chapter 11 was an involuntary case, either as an initial filing or as a conversion, or if the debtor was not serving as a debtor in possession.
Some additional chapter conversion specifics:
- A Chapter 12 or 13 debtor has an absolute right, which cannot be waived, to convert to Chapter 7. If a party in interest moves to have the case dismissed, the debtor may move to convert to Chapter 7 to prevent dismissal.
- Because Chapter 12 applies specifically to family farmers and fishermen, and is, therefore, considered the best chapter for those debtors, there is no provision for converting out of Chapter 12. Some courts have allowed a good faith petitioner to convert to other chapters, but most courts have not allowed it.
- Conversion from Chapter 11 to 12 must be equitable.
- A Chapter 13 debtor must move to convert to Chapter 11 or 12 as a party in interest before the Chapter 13 plan confirmation.
If the debtor is forced into bankruptcy by an involuntary petition, then the debtor's right to convert to another chapter of bankruptcy is limited; otherwise, the involuntary petition would have limited usefulness. The right to move for conversion extends to any party in interest, such as creditors or their committee, the trustee, the U.S. Trustee, or equity holders of a business debtor.
Involuntary conversion is more limited than voluntary conversions. There is no absolute right to an involuntary conversion. The movant must show cause for forcing the debtor into a different chapter of bankruptcy. The debtor may also defeat the conversion by moving for dismissal of the bankruptcy case.
Involuntary conversions are limited by the same rules that limit involuntary petitions. For instance, no involuntary conversion is possible to Chapter 13 or 12, since only the debtor can choose these chapters.
Some additional chapter specifics:
- A farmer or non-profit corporation cannot be converted from Chapter 11 to Chapter 7 unless the debtor moves for the conversion. Similarly, a Chapter 13 farmer cannot be involuntarily converted to any other chapter.
- A Chapter 12 debtor can be converted to Chapter 7 if the debtor committed fraud. Although the Chapter 12 debtor may move to dismiss, a judge may deny the motion based on the court's power to prevent an abuse of bankruptcy. §105(a)
- Whether a petition under Chapter 7 can be converted to another chapter involuntarily is up to the discretion of the court.
- Cause must be shown for an involuntary conversion from Chapter 11 to Chapter 7. Section 1112(b)(4) lists 16 nonexclusive causes for conversion, most of which are based on the presumptive unlikely success that the debtor will be able to successful complete the payment plan in Chapter 11. The judge may, based on the best interests of the bankruptcy estate and the creditors, either convert the case to Chapter 7 or dismiss the case entirely.
- A Chapter 13 case may be converted to Chapter 11 or 12 at the discretion of the judge, but must be before the confirmation of the Chapter 13 payment plan.
A conversion is not the commencement of a new case, but rather a continuation of the old. However, because the different chapters have different requirements and obligations, some rules depend on the bankruptcy filing date and some depend on the conversion date.
If a different trustee is appointed for the converted case, then the pre-conversion trustee or the debtor in possession must turn over all property and records along with an accounting of the pre-converted case to the new trustee.
Conversion creates new time periods for creditors to file proof of claims or to file an objection to the dischargeability of a debt or to the discharge itself. However, whether the trustee or creditors have additional time to file an objection against a debtor's claimed exemptions depends on jurisdiction.
A notice of conversion is sent to creditors, who may have to file a proof of claim for the converted case or who may want to challenge the conversion. For instance, in Chapter 11, creditors with unliquidated, undisputed, noncontingent claims don't have to file a proof of claim if they are listed in the Chapter 11 petition, but will have to file in a Chapter 7 conversion.
Bankruptcy Rule 1019(2) extends the time for filing a motion for dismissal because of abuse as defined by the means test in a conversion to Chapter 7, but this rule only applies to individual debtors with mostly consumer debts. There is no extension of time for a Chapter 7 conversion that began as a Chapter 7 case but was converted to another chapter.
Postpetition, Pre-Conversion Property and Debts
Normally, in a Chapter 7 case, only prepetition debts are payable from the estate and are subsequently discharged. Postpetition debts are not discharged, nor are they paid out from the bankruptcy estate. However, when the Chapter 7 is a conversion from another chapter, then debts incurred postpetition but pre-conversion become part of the debts that are paid out of the estate and are subsequently discharged.
Subsequent to a 1994 amendment, if the Chapter 13 debtor converts to Chapter 7, then only the debtor's property as of the filing date becomes property of the bankruptcy estate—property acquired postpetition but pre-conversion are excluded if the debtor converted in good faith; otherwise the postpetition property is included. However, the Code does not address Chapter 12 postpetition property—some courts have held that postpetition property is excluded from the estate, while others have included it; likewise for Chapter 11 postpetition property.
Secured Debt in a Chapter 13-to-Chapter 7 Conversion
The Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA) amended rules preventing a Chapter 13 debtor from reducing secured liens to the value of the collateral, then converting to Chapter 7 so that the debtor could pay off the secured claim at the lower value of the collateral compared to the original debt. The BAPCPA prevents the Chapter 13 write-down from passing to a converted Chapter 7, with §348(f)(1)(B) nullifying any reduced valuations made under Chapter 13 to a converted Chapter 7. Also, any payments made under Chapter 13 do not reduce the creditor's secured lien in a converted Chapter 7.
For example, consider the debtor with a auto loan of $20,000 secured by a car worth only $13,000 who initially files Chapter 13 and pays $2,000 on the loan while in Chapter 13. Before BAPCPA, the debtor could file Chapter 13, reduce the auto loan to the value of the collateral—$13,000—which is further reduced by the $2,000 paid to $11,000. Then the debtor could convert to Chapter 7 and redeem the car for $11,000—free of any liens. BAPCPA prevents this. After converting to Chapter 7, the lender's security interest would not be reduced at all. The debtor would be liable for the full amount of the remaining debt minus the $2,000 paid. The debtor would only have the options that an original Chapter 7 petitioner would have: surrender the car, redeem it by paying the full amount of the debt, or keep it by signing a Reaffirmation Agreement, requiring the debtor to continue making payments on the car.
However, a Chapter 13 valuation based on the reduced value of the collateral may pass in a conversion to Chapter 11 or 12, since these chapters are much like Chapter 13, in that the debtor pays off his debts according to a payment plan. However, there is a contradiction in §348(f)(1), where subsection (B) states that the valuations made in Chapter 13 are applicable to a converted Chapter 11 or 12, while subsection (C) states that "with respect to cases converted from chapter 13" that reduced valuations made in Chapter 13 and any payments that have reduced the creditors lien will not apply.