The Final Say: Conversion from Chapter 11 to Chapter 7 is Not a Given | Patterson Belknap Webb & Tyler LLP

It is well established that if you are a Chapter 11 debtor, you do not have the absolute right to convert the case into a Chapter 7 liquidation. A recent 10e The circuit’s decision shows why. Kearney v. Committee on Unsecured Creditors et al., BAP n ° 20-33, 2021 WL 941435 (BAP 10th Cir. 12 March 2021).

The debtor had married a family that owned real estate in New Mexico, Colorado and Arizona and lived off the income of two spending trusts formed by his late wife. The debtor and his two brothers-in-law were co-trustees of the two trusts. Although he received annual distributions from the trusts of approximately $ 800,000, Kearney sued his co-trustees in 2013, alleging mismanagement of the trusts.

In 2017, the debtor filed Chapter 11, after years of ultimately unsuccessful litigation stemming, in part, from the meritorious counter-action of the co-trustees. In February 2019, Judge David T. Thuma of the U.S. District Bankruptcy Court for New Mexico upheld a plan that had been proposed by the Unsecured Creditors Committee.

A few months later, the debtor is indicted for criminal association with a view to committing tax fraud. The debtor hired a criminal defense lawyer, but the bankruptcy court rejected the debtor’s request to retain the services of a defense lawyer.

In February 2020, the debtor decided to convert his case to Chapter 7, alleging that he did not have enough funds to independently pay his defense lawyer. Judge Thuma dismissed this request, ruling that the debtor’s claim was a pretext. In Judge Thuma’s view, the real purpose of the request was to overturn the previously confirmed plan.

The debtor argued that he had the absolute right to convert Chapter 11 to Chapter 7. But his position was contrary to the US Supreme Court precedent set out in Marrama c. Citizens Bank of Massachusetts, 549 United States 365 (2007). There, the Supreme Court noted that bankruptcy judges have broad discretion to prevent abuse of the bankruptcy process and ruled that the Bankruptcy Code article 706 (d) provides adequate authority to allow the dismissal of a conversion motion “instead of a conversion order which only defers the granting of equivalent relief [that] can offer a debtor the possibility of bringing an action injurious to creditors. Identifier. at 366.

Chapter 11 business conversions are governed by Article 1112 of the Bankruptcy Code. Since Article 1112 (f) contains a conversion restriction which mirrors Article 706 (d), Judge Thuma held that Marrama control.

Judge Thuma ruled that a conversion from Chapter 11 to Chapter 7 would be futile as the case would immediately be converted back to Chapter 11 under Section 706 (d) of the Bankruptcy Code. The reason for this decision was simple: The Chapter 11 case under the Confirmed Creditors Plan would offer a superior outcome for all parties compared to a Chapter 7 liquidation.

Ultimately, the 10e Circuit upheld the bankruptcy court’s decision and ruled that “the bankruptcy court did not abuse its discretion by concluding that it would immediately reconvert the debtor’s file …”. Kearney to 100. This case is a reminder that debtors are unwilling to freely convert their Chapter 11 deposits without court approval.

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