The following is a case update written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. Ca., Ret.), analyzing a recent decision of interest:
In a recent published opinion, the Ninth Circuit Court of Appeals (the Court) affirmed the bankruptcy court’s order converting a chapter 11 case to chapter 7 and further ruled that even though property of the estate had revested in the debtor upon plan confirmation, the debtor was required to turn over the rent and sale proceeds from her rental properties to the chapter 7 trustee because an explicit plan provision required the distribution of future proceeds from those assets to the creditors. Baroni v Seror (In re Baroni), 2022 WL 2062319 (9th Cir. June 8, 2022).
To view the opinion, click here.
Debtor Allana Baroni filed for chapter 13 after defaulting on numerous mortgages on her rental properties. The case was promptly converted to chapter 11 and creditors Bank of New York Mellon (Bank of NYM) and Wells Fargo Bank (collectively “the Banks”) filed secured claims. The debtor disputed these claims, asserting that the Banks lacked authority to enforce the loans. She filed adversary proceedings against the Banks and proposed a plan which would allow her to continue renting the properties, making her loan payments into separate Reserve Accounts while she pursued the adversaries. Under the plan terms, if her challenges failed, she was required to pay the sums in the Reserve Accounts to the Banks within 10 days of the orders. The bankruptcy court confirmed the plan over objections from the Banks.
The debtor made her installment payments into the Reserve Accounts. After three years, she lost the Wells Fargo challenge. When she refused to pay the collected funds and future installments to Wells Fargo, it moved for conversion of the case to chapter 7. After several hearings, the debtor paid Wells Fargo as required and the bankruptcy court denied the conversion motion. A year later she lost the Bank of NYM case but again refused to make the required payments to it, basing her refusal on her receipt of a 1099-C which implied that a servicer had written off the loan balance. This eventually led to Bank of NYM filing its own motion to convert, which the bankruptcy court granted, finding cause based on a material default under the plan terms.
After her reconsideration motion failed, the debtor appealed to the district court, which affirmed. The debtor further appealed to the Court.
In the meantime, the chapter 7 trustee requested turnover of the sale proceeds from the Wells Fargo rental property and the rental proceeds from the Bank of NYM collateral. The debtor did not comply, asserting that the properties and proceeds were not part of the bankruptcy estate because they had revested in her upon plan confirmation. The trustee filed a turnover motion which was granted by the bankruptcy court, relying on a Local Rule as well as caselaw from the Ninth Circuit which held that if a “plan provides for the distribution of future proceeds of an asset to creditors”, those assets revest in the estate upon conversion. That order was appealed to the district court, which affirmed based on the Local Rule only, disagreeing with the grounds based on case authority. The debtor appealed that ruling to the Court, where both appeals were consolidated for hearing and opinion.
The Court first affirmed the conversion order, exercising the applicable abuse of discretion standard of review. It concluded that the default was material and was cause for conversion under § 1112(b)(1) of the Bankruptcy Code, despite the debtor’s belated attempt to cure the default. It looked not only at the discrete default to Bank of NYM, but also the magnitude and age of the default and the debtor’s long delays in repayment, and found the default was material. It then considered whether conversion was in the best interest of creditors, considering the debtor’s arguments that “unusual circumstances” counseled against conversion. It rejected that argument, because defaulting on required plan payments to creditors was always a known possibility under a confirmed plan and nothing about defaulting created unusual circumstances which would temper the application of a conversion remedy.
The Court exercised de novo review to decide whether the sale and rental proceeds were property of the chapter 7 estate. As noted above, the debtor argued the property belonged to her because it had revested at plan confirmation. The Court observed that the Bankruptcy Code is silent as to what constitutes the estate when a chapter 11 is converted after plan confirmation. In framing its conclusions here, the Court looked at its holdings in Hillis Motors, Inc. v Hawaii Automobile Dealers’ Assoc., 997 F. 2d 581 (9th Cir. 1993) (a case considering whether the automatic stay protected the debtor’s property after confirmation) and Pioneer Liquidating Corp. v United States Trustee (In re Consol. Pioneer Mortg. Entities), 264 F. 3d 803 (9th Cir. 2001), which addressed a similar property-of-the-estate issue. Those cases looked at whether explicit provisions of a confirmed plan called for distribution of proceeds of the assets in question to the creditors. The Court concluded the central inquiry was “whether the Plan’s ‘language, purposes, and context’ changed the effect of the general vesting provisions in 11 U.S.C. § 1141 after conversion to Chapter 7.” It ruled that the bankruptcy court should undertake a “holistic analysis of the plan” to decide whether deviation from the vesting rule was appropriate. Applying that analysis here, it found that the debtor’s plan was premised on the collection of the rents and other proceeds for use exclusively to pay the secured creditors and therefore deviation from the default rule was justified as a matter of law. As the Court so aptly stated, “[t]o hold that the unadministered rent and sale proceeds did not revest in the bankruptcy estate upon conversion to Chapter 7 would frustrate the intent of the Plan and is contrary to many of its provisions.”
The second ruling here is the significant one for this author, although its conclusions were foreshadowed by both Hillis Motors and Pioneer. The Court obviously determined that those opinions had not sufficiently clarified the revesting issue, so it published here to solidify its conclusions. If it had allowed the funds at issue to remain with this litigious debtor after she collected them for years and promised to pay them to the secured creditors if she lost her litigation, that would not only have been inconsistent with her promised plan terms but also a miscarriage of justice. This is the correct ruling and a good lesson to future chapter 11 debtors who might believe they can both pledge estate assets in support of plan confirmation but also be able to walk away with them after default causes case conversion.
This review was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, C.D. Ca., Ret.), a member of the ad hoc group. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.