Tenth Circuit Rules that Conversion from Chapter 11 Bankruptcy to Chapter 7 not a Given Right of Debtor

Tenth Circuit Rules that Conversion from Chapter 11 Bankruptcy to Chapter 7 not a Given Right of Debtor

It is well-known that conversion of a Chapter 11 bankruptcy proceeding into a Chapter 7 liquidation by way of debtor’s unfettered right, is an implausible task. Same was held in the recent decision of the Tenth Circuit in the matter of Kearney v. Unsecured Creditors Committee et al., BAP No. 20-33, 2021 WL 941435 (B.A.P. 10th Cir. Mar. 12, 2021).

In the above mentioned case, the debtor had married into a family which owned real estate assets in New Mexico, Colorado and Arizona. The debtor used to live on the income from two spendthrift trusts made by his late wife. The debtor and his two brothers-in-law were made co-trustees of both the trusts. Even after receiving annual distributions from the trusts of around $800,000, the debtor sued his co-trustee in the year 2013, claiming improper management of the two trusts. Subsequently, in 2011, the debtor filed a Chapter 11 bankruptcy petition, following years of ultimately unsuccessful litigation relating to co-trustees’ meritorious countersuit. A few months later, the debtor was charge for conspiracy to commit tax fraud. He hired a criminal defense attorney. However, the bankruptcy court denied the debtor’s application to retain the defense counsel.

In 2020, the debtor approached the bankruptcy court with plea to convert his Chapter 11 bankruptcy to Chapter 7. He alleged that he had insufficient funds to independently pay the attorney fees. The court denied the motion and held that debtor’s request was pretextual.[1] As per Judge Thuma, the real reason behind the request was to negate the previously confirmed plan. The debtor put forth an argument that he had an absolute right to cover his Chapter 11 into Chapter 7. However, to the contrary, the Supreme Court had ruled in the matter of Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365 (2007), whereby it noted that the bankruptcy judges have a wide discretion to prevent an abuse of the bankruptcy process and held that Section 706(d[2]) of the Bankruptcy Code provides for adequate authority to allow the denial of a motion to covert “in lieu of a conversion order that merely postpones the allowance of equivalent relief [that] may provide a debtor with an opportunity to take action prejudicial to creditors.”[3]

Section 1112[4] of the Bankruptcy Code covers the topic of conversions of Chapter 11. Section 1112(f) provides for conversion restriction which mirrored Section 706(d).  The court held that a conversion from Chapter 11 to Chapter 7 would be of no use since the matter would immediately be reconverted to Chapter 11 under Section 706(d) of the Bankruptcy Code. This is because the Chapter 11 case under the creditor’s confirmed plan would provide a better outcome for all the parties when compared to Chapter 7 liquidation. The Tenth Circuit affirmed the bankruptcy court’s decision and stated that “the Bankruptcy Court did not abuse its discretion in concluding it would immediately reconvert Debtor’s case….”

The judgment is a strong reminder to the debtors that they lack the volition to convert their Chapter 11 without the court approval.

[1] Kearney v. Official Comm. of Unsecured Creditors, 18-544 RB/KK (D.N.M. Sep.28, 2018)

[2] 11 U.S.C. § 706(d)

[3] Kearney v. Official Comm. of Unsecured Creditors, 18-544 RB/KK (D.N.M. Sep.28, 2018) at 366

[4] 11 U.S.C. § 1112