The following is a case update written by Pardis Akhavan, Resnik Hayes Moradi LLP, analyzing a recent decision of interest:
In re Cabral, 2020 WL 6556998 (November 5, 2020), the United States Bankruptcy Appellate Panel of the Ninth Circuit (“BAP”) affirmed the bankruptcy court’s decision denying Debtors’ motion to dismiss their Chapter 7 case for cause under Section 707(a). In an unpublished decision, the BAP held that “the bankruptcy court correctly articulated the standard that prejudice exists where assets that would have been available for distribution to creditors are lost because of the dismissal.” To view the memo disposition, click here.
Anselmo and Alma Cabral (“Debtors”) filed their Chapter 13 petition in June 2015. Debtors’ Chapter 13 plan was confirmed about five months later. Four and a half years into their plan, Mr. Cabral’s loss of work caused the Debtors to be unable to afford their plan payments and the Debtors converted their case to chapter 7. The Chapter 7 Trustee then began efforts to sell the Debtor’s home which he believed had about $128,587 of non-exempt equity. The Debtors immediately moved to dismiss the Chapter 7 case arguing that “they would not have agreed to conversion had they known their home’s equity would be put at risk” and that they converted the case based on the bad legal advice of their attorney. They proposed that upon dismissal of the Chapter 7 case, they would “file a new Chapter 13 case that would pay 100 percent to unsecured creditors over five years.”
The chapter 7 Trustee and the United States Trustee filed oppositions and argued that “the Debtors had not met their burden of proving the dismissal would not prejudice creditors” and that granting Debtors’ motion to dismiss the Chapter 7 case “would be unfair and prejudicial because their proposal would, in effect, allow Debtors a ten-year plan that would require creditors to wait another five years to be paid.”
The bankruptcy court agreed and denied the Debtors’ motion and found “that bad legal advice did not constitute cause for dismissal, and there was no guarantee Debtors would refile or could repay creditors were the case to be dismissed.”
The BAP affirmed finding that the bankruptcy court did not abuse its discretion when it denied Debtors’ motion to dismiss the case under 707(a).
The BAP began its analysis by looking at Section 707(a) which permits a bankruptcy court to dismiss a chapter 7 case “only for cause.” Since cause is not defined in the statute, the BAP said the bankruptcy court must use the totality of circumstances to determine cause and that the debtor “has the burden to demonstrate that creditors will not be prejudiced by dismissal.” [emphasis added]
On appeal, the Debtors admitted that “bad legal advice does not constitute cause for dismissal.” Nevertheless, they asserted that “counsel’s failure to warn them of the potential consequences of conversion ‘was meant to serve as an equitable consideration to determine whether there is cause for dismissal.’” “Debtors contended that the bankruptcy court erred in finding that their proposal [to refile for Chapter 13 and pay 100 percent of the unsecured claims] was too speculative to ensure that creditors would not be prejudiced by dismissal.”
To support their argument and to establish good faith, the Debtors distinguished Bartee v. Ainsworth (In re Bartee), 317 B.R. 362 (9th Cir. BAP 2004) which the bankruptcy court relied heavily on in its ruling. There the Bartees
“had been uncooperative and less than candid about their financial affairs, and their repayment proposal was not supported by any documentary evidence or affidavits. In contrast, Debtors argued that they were truthful in their schedules, performed under a chapter 13 plan for four and a half years, and provided declarations and documentation to support their proposal to pay creditors after dismissal.”
The BAP acknowledged that the facts of this case differ from Bartee but emphasized “that creditors in this case would suffer prejudice were Debtors permitted to dismiss” their Chapter 7 case, file another Chapter 13 case as they proposed because “creditors presently have the opportunity for reasonably prompt and highly certain payments in this case.” “Forcing creditors to trade that outcome for one in which they would rely on the Debtors to file a new Chapter 13 case, propose and confirm a plan, and perform under that plan for five years would be prejudicial as it would delay payment and increase the potential harm to creditors from non-payment.”
The Debtors argued that “their presumed good faith,” i.e., “their performance under a longstanding chapter 13 case that was unsuccessful through no fault of theirs and relying on the advice of counsel in converting their case to one under chapter 7 acts as a mitigating factor against the uncertainty of payment that their case dismissal would create.” The BAP rejected that argument, pointing out that “the bankruptcy court may evaluate a voluntary motion to dismiss using both legal and equitable considerations but that the equitable considerations do not come into play when a debtor is unable to show that creditors would not be prejudiced by dismissal.” The BAP reasoned that the courts should approve voluntary case dismissals only where “the payment of creditors is provided or and such payment is reasonably prompt and certain.” In other words, where the dismissal would not prejudice the creditors.
As to Debtors’ lack of bad faith, the BAP noted that “although bad faith conduct by Debtors would certainly prejudice creditors’ ability to be paid, the good faith of Debtors, by itself, does not remove or even necessarily lessen the prejudice to creditors.”
The BAP added finally that the dismissal would also be prejudicial to creditors because if the Debtors waited until January 1, 2021 to file the new case, they could use amended California Code of Civil Procedure § 704.730 to take a significantly larger homestead exemption which would reduce the distributions to unsecured creditors to little or nothing.
The facts in Cabral created a horrible situation for the debtors. But courts are generally unwilling to permit debtors to change their minds about chapter 7 even where it was a huge mistake to file, or as here, convert to chapter 7 in the first place. The debtors here seemed to be acting “in good faith” and had a stellar performance for four years under their chapter 13 plan but the statutory language requires a showing of cause to dismiss and under Ninth Circuit precedence that means “such dismissal will cause ‘no legal prejudice’ to interested parties.” The only Ninth Circuit case cited in the BAP memorandum decision is Schroeder v. Int’l Airport Inn P’ship (In re Int’l Airport Inn P’ship), 517 F.2d 510, 512 (9th Cir. 1975) which states “[U]nless dismissal will cause some plain legal prejudice to the creditors, it normally will be proper.”
It cannot be said that dismissal is always prejudicial when there are assets to administer and distribute to creditors, but the focus must be on the rights of the creditors – i.e., are they better off in a dismissal?
Note: The Debtor moved for an order requiring the chapter 7 Trustee to abandon the property on the basis that there was no equity in the home on the original petition date. That hearing is set for argument on March 17, 2021.
These materials were authored by Pardis Akhavan of Resnik Hayes Moradi LLP. Editorial contributions were made by M. Douglas Flahaut of Arent Fox LLP.
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