Business Law

Rob Harris’ e-Bulletin re Wu v. Markosian

Dear constituency list members of the Insolvency Law Committee,

The following is a case update analyzing a recent decision of interest:

SUMMARY

The United States Bankruptcy Appellate Panel of the Ninth Circuit (the “BAP”) has affirmed a bankruptcy court’s ruling that individual debtor’s chapter 11 post-petition earnings which are property of the estate under § 1115 revert to him or her upon a subsequent conversion to chapter 7.  Wu v. Markosian (In re Markosian) – 9th Cir. BAP (3/12/14).  Click HERE http://cdn.ca9.uscourts.gov/datastore/bap/2014/03/12/Markosian-13-1339.pdfto read this decision.

FACTS

On February 7, 2009, debtors and appellees Ara and Anait Markosian filed a chapter 7 bankruptcy petition.  The United States Trustee moved to dismiss their case for abuse based on high income and their ability to pay their creditors.  In response, the Markosians converted their case to chapter 11 on February 11, 2010.  The Markosians could not, however, confirm a plan due to a decrease in income owing to Mrs. Markosian’s loss of her job.  Thus, on March 7, 2012, the Markosians reconverted their case to chapter 7.  In the following month, Mr. Markosian received a $102,498.421 bonus from his employer for personal services provided during the period that the case was under chapter 11.

The Markosians turned over the bonus to the Chapter 7 trustee and filed a motion to address whether the bonus was property of their chapter 11 estate, partially exempt property of the chapter 7 bankruptcy estate or property excluded from the chapter 7 estate.  The Trustee opposed.  

The bankruptcy court, adopting the reasoning of In re Evans, 464 B.R. 429, 438-41 (Bankr. D. Col. 2011), entered an order granting the Markosians’ motion, finding that the bonus constituted earnings from personal services within the meaning of Bankruptcy Code §1115(a)(2), but the bonus ceased to be property of the estate upon conversion to chapter 7.  The Trustee timely appealed to the Bankruptcy Appellate Panel (“BAP”).

REASONING

The issue on appeal was whether an individual debtor’s chapter 11 post-petition earnings, which are property of the estate under § 1115, revert to him or her upon a subsequent conversion to chapter 7.  The issue was a matter of first impression in the Ninth Circuit.

In affirming the bankruptcy court’s order compelling the Trustee to return the bonus, the BAP initially focused on the distinction between estate and debtors’ property delineated by Bankruptcy Code §§ 541(a)(6) and (7).  The BAP noted that “[u]nder § 541(a)(6), “earnings from services performed by individual debtors after the commencement of the case are the debtor’s property which are excluded from property of the estate.” 

The BAP observed next that Bankruptcy Code §1115, added by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005, makes an individual chapter 11 debtor’s post-petition earnings property of the estate.  The bankruptcy court found that the bonus received by Mr. Markosian post-conversion was property of the Markosians’ chapter 11 estate under § 1115(a)(2).  The BAP disagreed, though that finding was not appealed, stating that § 1115 does not apply upon conversion from chapter 11 to chapter 7. 

The BAP focused instead upon Bankruptcy Code § 348, which governs the effect of a conversion.  The BAP agreed with the bankruptcy court that § 348(f)(1)(A) excludes a debtor’s post-petition earnings from property of a chapter 7 estate upon conversion from chapter 13 but that there is no parallel provision for chapter 11 debtors.  As a consequence, the BAP held that it had to look more broadly to § 348(a) – a section that applies to all cases under Title 11.  The BAP stated that “[w]here a case is converted from Chapter 11 to Chapter 7, property of the estate is determined by the filing date of the Chapter 11 petition, and not by the conversion date” citing Magallanes v. Williams (In re Magallanes), 96 B.R. 253, 255 (9th Cir. BAP 1988). 

The BAP then simply applied the earnings exception of section 541 to a case that, for analytical purposes, it treated as having been commenced on the date of conversion: “[a]s of the petition date, § 541(a)(6) excludes from the chapter 7 estate earnings from services performed by individual debtors after the commencement of the case.  Therefore, by operation of § 348(a), personal service income that came into Debtors’ chapter 11 estate is recharacterized as property of the debtor under § 541(a)(6) when the case is converted to chapter 7.  Accordingly, upon conversion, the bonus reverted to Debtors.”  The BAP spends the balance of its opinion explaining away contrary views espoused by other courts that have come to different conclusions.

The BAP provides sound policy reasons to explain why it elected not to stretch to fill a statutory void that Congress left in amending § 348 in 1994 to add subsection (f)(1)(A): “[i]n the end, there is no reason to treat chapter 11 debtors differently than chapter 13 debtors in this context.  As the Evans court pointed out, at the time Congress enacted § 348(f), it ‘clearly conveyed its purpose to avoid penalizing debtors who first attempt a repayment plan . . . [t]here is no policy reason as to ‘why the creditors should not be put back in precisely the same position as they would have been had the debtor never sought to repay his debts . . . .’ 464 B.R. at 441.”

AUTHOR’S COMMENT

The failure by Congress to enact a provision parallel to § 348(f)(1)(A) for chapter 11 debtors so that all debtors’ post-petition earnings from property of a chapter 7 estate upon conversion are treated identically is disappointing.  Courts often abandon plain language statutory interpretation to try to make sense of BAPCPA, more often than not at the expense of a blameless debtor.  Here, the BAP’s refusal to attempt “to divine Congressional intent from congressional silence” and create a rule that works differently for Chapter 11 and Chapter 13 debtors in identical circumstances generated an equitable and consistent outcome.  Until Congress decides to address the void in section 348, In re Markosian will serve as well-reasoned authority to assist practitioners in dispensing appropriate advice to individual Chapter 11 clients with ongoing income from employment who must convert their cases to Chapter 7.

These materials were written by Robert G. Harris (rob@bindermalter.com), a partner in the Silicon Valley firm Binder & Malter, LLP.  Mr. Harris is an advisor to the Insolvency Law Committee and a member of the State Bar Business Law Section Executive Committee.  Editorial contributions were provided by ILC member, Everett Green (Everett.L.Green@usdoj.gov). 

Thank you for your continued support of the Committee.

Best regards,

Insolvency Law Committee


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