Dear constituency list members of the Insolvency Law Committee, the following is a case update written by Sonia Singh, an associate at Ervin Cohen & Jessup, LLP analyzing a recent case of interest:
In an unpublished decision, the U.S. Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) affirmed the bankruptcy court’s rulings denying a chapter 7 debtor’s motion to convert and motion for reconsideration, based on its determination that the bankruptcy court’s finding that the debtor had sought conversion in bad faith was not clearly erroneous. In re Silver, Bk. No. 2:21-BK-16492-ER, BAP No. CC-22-1101-LFT, 2022 WL 17848965 (9th Cir. BAP Dec. 19, 2022). The BAP agreed with the bankruptcy court that the debtor’s conversion motion was an attempt to unfairly manipulate the Bankruptcy Code, which constituted sufficient bad faith to deny conversion.
To read the full decision, click here.
The debtor filed a chapter 7 petition on the same day that the state court denied his motion for a preliminary injunction in his lawsuit against his mortgage lenders to, among other things, stop the pending foreclosure sale of his residence. Thereafter, the debtor removed the state court action to the bankruptcy court, and the lenders moved to remand. The debtor opposed the lenders’ motion to remand, in which he stated that if the motion were granted, he would likely withdraw his state court complaint and refile in the bankruptcy court. The debtor also filed a separate motion to convert his case to chapter 13, which was unopposed.
The bankruptcy court granted the lenders’ motion to remand and also denied the debtor’s motion to convert based on its finding that forum shopping was the underlying motivation for the debtor’s request for conversion. Specifically, the bankruptcy court determined that the conversion request was brought in bad faith because the debtor filed it solely to defeat the lenders’ motion to remand so he could have his state law claims adjudicated in the bankruptcy court. The debtor filed a motion for reconsideration of the bankruptcy court’s order denying his motion to convert, in which he argued that he did not act in bad faith because he was simply trying to save his home, he had requested dismissal of his state court action, and his financial circumstances had changed so that he was able to pay all his “legitimate” creditors. The bankruptcy court denied the debtor’s motion for reconsideration, finding that the debtor had not shown error in the court’s initial ruling denying his conversion request.
The debtor appealed the denial of the motion to convert and motion for reconsideration, arguing, among other things, that there was no evidence in the record that he had engaged in fraudulent or dishonest behavior. The BAP affirmed the bankruptcy court’s rulings.
The BAP reviewed the bankruptcy court’s denial of the debtor’s motion to convert and denial of his subsequent motion for reconsideration for abuse of discretion.
First, the BAP found that the bankruptcy court did not abuse its discretion in denying the debtor’s motion to convert. The BAP cited Marrama v. Citizens Bank of Mass., 549 U.S. 365, 375 (2007) to clarify that if sufficient bad faith exists to justify dismissal of a potential chapter 13 case, then the bankruptcy court is authorized to immediately deny a motion to convert based on a debtor’s bad faith without first having to order conversion and then dismissing the converted case. The BAP then considered the factors from Leavitt v. Soto (In re Leavitt), 171 F.3d 1219, 1224 (9th Cir. 1999) to evaluate if there was sufficient bad faith to order dismissal of the debtor’s chapter 13 case: “(1) whether the debtor misrepresented facts in his petition or plan, unfairly manipulated the Bankruptcy Code, or otherwise filed his chapter 13 petition or plan in an inequitable manner; (2) the debtor’s history of filings and dismissals; (3) whether the debtor only intended to defeat state court litigation; and, (4) whether egregious behavior is present.” The BAP noted the bankruptcy court’s finding that the debtor’s sole motivation for seeking conversion was forum shopping and its further finding that debtor’s motion to convert was simply another avenue for delay because conversion would have extended the automatic stay and given the debtor more time to litigate claims that the state court already found to be essentially meritless when it denied his motion for a preliminary injunction. With regard to the Leavitt factors, the BAP agreed with the bankruptcy court that although there was no evidence the debtor misrepresented facts in his petition, this was not a requirement for dismissal on bad faith grounds. Rather, because the debtor’s goal was to have the bankruptcy court hear his claims that the state court already found to have little chance of success, the debtor’s motion to convert was an attempt to unfairly manipulate the Bankruptcy Code.
Second, the BAP found that the bankruptcy court did not abuse its discretion in denying the debtor’s motion for reconsideration. The BAP noted that in the debtor’s motion for reconsideration of the bankruptcy court’s order denying his motion to convert, Debtor had simply disagreed with the bankruptcy court’s bad faith finding. The debtor had argued that he filed his petition to save his home from an illegal foreclosure, had not engaged in any deceptive or egregious behavior, had requested dismissal of his state court action, and his financial circumstances had changed. In reviewing the bankruptcy court’s decision denying the reconsideration request, the BAP agreed with the bankruptcy court that the primary purpose of the debtor’s request was to further delay the ability of his lenders to exercise their rights with respect to the property, since conversion would have enabled the debtor to continue to benefit from the automatic stay. The BAP also considered the debtor’s arguments on appeal that reconsideration was warranted because of his changed circumstances since denial of Debtor’s request to convert his case (i.e., rental income in process and the launching of a new business). On appeal, the debtor argued that he no longer qualified for chapter 7 because he had received funds from the state, but the BAP found that the debtor cited no authority for this premise and had not otherwise shown that the bankruptcy court abused its discretion in its initial ruling. The BAP concluded that even if these unsupported facts would have changed the bankruptcy court’s decision, the BAP would not consider them because the debtor had not raised them at the time the bankruptcy court heard his motion for reconsideration.
The BAP accordingly concluded that that the bankruptcy court did not abuse its discretion in denying the debtor’s motion to convert and motion for reconsideration.
This decision is a good reminder that although several factors are considered in determining the presence of bad faith, when a debtor’s sole motivation for filing a chapter 13 case (or request for conversion to chapter 13) is forum shopping, such a finding is sufficient to warrant dismissal of the case (or denial of a request for conversion) for bad faith. The BAP relied on its earlier decision in St. Paul Self Storage Ltd. P’ship v. Port Authority of the City of St. Paul (In re St. Paul Self Storage Ltd. P’ship), 185 B.R. 580 (9th Cir. BAP 1995) where the BAP also affirmed the bankruptcy court’s dismissal of a chapter 11 case based upon findings that the case was filed solely as a litigation tactic, i.e., “to gain a more convenient forum” for its litigation with the appellee. In this decision, the BAP noted the debtor’s actions were just like the chapter 11 debtor in St. Paul Self Storage. In that case, the debtor filed for bankruptcy protection shortly after an adverse ruling in his state court action. The debtor’s motion to convert would have extended the automatic stay and provided him extra time to litigate claims already found to be meritless in the state court action. Therefore, this decision confirms that forum shopping can be sufficient for a bad faith finding to support dismissal. Separately, this decision also confirms that the bankruptcy court can immediately deny a motion to convert if sufficient bad faith exists to justify dismissal of a potential chapter 13 case pursuant to 11 U.S.C. section 105(a), without first ordering conversion.
These materials were written by former Sonia Singh in Beverly Hills, California (email@example.com). Editorial contributions were provided by Summer Shaw in Palm Desert, California (firstname.lastname@example.org).