Charles Riecke Published in American Bankruptcy Institute Update
"Supreme Court Recognizes 'Bad Faith' Exception to the § 706 (a) Conversion Right, and the Breadth of Bankruptcy Courts § 105 (a) and Inherent Powers"

"Supreme Court Recognizes 'Bad Faith' Exception to the § 706 (a) Conversion Right, and the Breadth of Bankruptcy Courts § 105 (a) and Inherent Powers" by Charles in the February 27, 2007 issue of American Bankruptcy Institute Update states: "In its recently-announced 5-4 decision, Marrama v. Citizens Bank of Massachusetts, __S. Ct. __, 2007 WL 517340 (Feb. 21, 2007), the Supreme Court issued a blow to dishonest debtors while at the same time adding an arrow to the quivers of not only chapter 7 trustees but bankruptcy courts everywhere, by recognizing a “bad faith” exception to a chapter 7 debtor’s once-thought “absolute right” to convert his or her case to chapter 13 (or 11 or 12). The right stems from §706 of the Bankruptcy Code, which provides that “[t]he 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 §1112, 1208 or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.” 11 U.S.C. §706(a). However, the right is limited by the following: “Notwithstanding any other provision of [§706], 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. Previously, many courts held a debtor’s right under §706(a) to be inviolate, with sometimes ridiculous and burdensome results. While [the debtor’s] actions do not justify an equitable override of his ‘one-time absolute right’ to convert the case under §706(a), they do justify the bankruptcy court’s sua sponte consideration of whether immediate reconversion…is appropriate.”

The Supreme Court recognized that it was faced with just such a prospect in Marrama when it (1) noted that “some courts have suggested that even a bad-faith debtor has an absolute right to convert to at least one chapter 7 proceeding into a chapter 13 case, even though the case will thereafter be dismissed or immediately returned to chapter 7,” and (2) phrased the issue before it as “whether the Code mandates that procedural anomaly.” Under the case facts, the debtor scheduled his residence, which was his primary asset, as having no value, and “denied that he had transferred any property other than in the ordinary course of business during the year preceding the filing of his petition,” with “[n]either statement [being] true.” On further appeal, the Supreme Court “conclude[d] that the courts in this case correctly held that Marrama forfeited his right to proceed under chapter 13.” The decision marks a victory for chapter 7 trustees and the bankruptcy estates they represent because it prevents the waste to an estate, and the administrative waste in courts, that was attendant to those chapter 7 cases in which conversions only resulted in reconversion back to chapter 7—a process that both terminated the service of “any trustee…serving in the case before such conversion,” 11 U.S.C. §348(e), and then caused the reappointment of a chapter 7 trustee. The decision also marks a victory for bankruptcy courts in that the Supreme Court’s decision not only provides a broad reading of their §105(a) powers, but also appears to extend that interpretive breadth to their “inherent powers” as well.