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Palindrome for a Silly Case? A Marrama

posted by John Pottow

The Supreme Court handed down the Marrama opinion, resolving the burning question of bad-faith debtors' conversion rights under 706(a) of the Code:  Marrama v. Citizens Bank

Those namby-pamby softies on debtors?  The Chief Justice, and Justices Scalia, Thomas, and Alito (in dissent, per Justice Alito).  The hard-assed debtor-bashers?  Justices Stevens (writing), Kennedy, Souter, Ginsburg, and Breyer.

Marrama was a badie in Chapter 7: among other transgressions, he tried to hide and fraudulently convey a house in Maine.  An angry trustee and creditor sought recovery, but Marrama schemed to divest the trustee of jurisdiction by converting, under section 706(a), to chapter 13 (which we all recall vests property of the estate under control of the debtor, not the trustee).

Trustee and Citizens cried foul and opposed the conversion.  All courts up the chain agreed, saying that Marrama's bad faith precluded him from converting to 13.  A recurring justification was that 706(d), which qualifies 707(a), says a debtor may not convert to a chapter if he's ineligible to be a debtor under that chapter.  Because Marrama's bad faith would preclude a confirmable plan under 1325(a)(3), he couldn't do anything in 13 (other than flail).  Accordingly, the courts held that because he couldn't be a "real" debtor in chapter 13, he was ineligible to convert thereto.  (I'm simplifying somewhat; also in there is the argument that if he did convert to 13, he could be quickly reconverted back to chapter 7 "for cause" due to his bad faith under section 1307(c).)

The dissenting Justices chafed at what they indirectly implied was yet another step of bankruptcy judge arrogation of power in the face of seemingly clear statutory text.  And they had a good point: if the limitation on who can be a debtor in 13 is supposed to be the true constraint on conversion power, per 706(d), then the proper place to look for those restrictions is 109(e), which defines the dollar amount, income regularity requirements, and other criteria for being a debtor under chapter 13.  So they were right that denying conversion because the debtor was ineligible for chapter 13 vis. section 1325(a)(3) was wrong (or hand-wavey).  Marrama COULD be a debtor under 13.  He wouldn't last long, but he could still be a debtor.  So the majority, at least in my view, bobbled this one.

The reason I think this case is so silly, however, is that this is really a case about section 105.  Everyone knows that bankruptcy judges have equitable powers to prevent an abuse of process.  Here, neither the majority nor dissent got the issue quite right.  It was not that the judge was using 105 to graft additional restrictions on conversion onto section 706 (as the dissent especially tries to suggest).  Rather, the judge was using 105 as an equitable vehicle of procedural economy.  If everyone agrees that a judge may dismiss a chapter 13 case "for cause" under 1307(c), and that "bad faith" may constitute cause, then what the bankruptcy judge decided was that rather than holding a conversion hearing under 706 and then the next day holding a dismissal (or conversion) hearing under 1307, he could collapse the two hearings into one for judicial economy, hearing and resolving the allegations of bad faith at one time.  Properly viewed, the judge was not expanding the scope of 706, he was entering a glorified scheduling order.  At such an omnibus hearing, there is nothing that would prevent (Justice Alito's confusion notwithstanding) a judge from entertaining evidence of what the debtor would propose to pay under a plan were he allowed into chapter 13.

Whatever one's belief on the proper scope of section 105, I find it difficult to begrudge a jurist the discretion to consolidate two redundant hearings for procedural efficiency into one session.  That is not aggrandizement; that is a common-sense lowering of my taxes.

Comments

For those of us who feel that the worst effect of BAPCPA was the erosion, due to its micromanaging of issues, of judicial discretion and authority to make decisions that preserve and enforce fundamental bankruptcy policies and common sense, the Marrama majority opinion is a welcome counterpoint. At least 5 Supreme Court Justices still trust bankruptcy judges.

"Marrama's bad faith would preclude a confirmable plan under 1325(a)(3), he couldn't do anything in 13 (other than flail)."

I would suggest that that is not necessarily the case. There is a distinction between a bad faith filing and the bad faith plan analysis under §1325. The two issues are often intertwined, but are different issues. In re Goddard, 212 B.R. 233 (D.N.J. 1997). Full disclosure and amended schedules can result in confirmation under such circumstances. In fact, the Debtor's attorney told me that the Plan was eventually confirmed in the Goddard case.

PSP: That's an interesting point about differing types of bad faith. I guess Marrama would be different from Goddard because presumably the bad faith would justify dismissal or conversion under 1307 well before a confirmation hearing ever got around to being scheduled. But I like the pointing out of the distinction; good catch.

As Marrama's attorney, I was interested in your analysis. The majority was right on a couple of points: 1) the right to convert is absolute in all but the most egregious cases; 2) Marrama never had a chance to show that his case was not egregious. He should have had an evidentiary hearing. Other than that, I agree with the minority that the procedure established by the Code and the Rules should be followed. We never filed a plan; the rules specifically provide that that you don't have to file a plan until the case is converted. Thus there was absolutely no evidence before the bankrutpcy court from which the bankruptcy judge could determine that the plan had been filed in bad faith! That's the minority's basic point, I think; follow the procedure in the Code and Rules in making a decision on bad faith. I do agree, however, that it is appropriate on a motion to convert for the bankruptcy judge to take at least some evidence on the issue of §109(e) eligibility. In Marrama's case, however, eligibility under §109(e) was never challenged. If SCOTUS really felt this was an appropriate case to expand either "inherent authority" or §105, it should have affirmed but remanded for an evidentiary hearing. The issue is not whether bankruptcy judges should be trusted; rather, the issue is how much power do we want them to have. Should they have only the power that Congress has granted them, or can they do pretty much anything they want, no matter who gets hurt? In Marrama's case, all that money that the trustee spent in defending his position is money that could have been paid to creditors. The trustee objected because this is an asset case and stands to get paid. If it were a no asset case, he wouldn't have cared, nor would Citizens Bank. (Please note that the trustee and I are quite friendly and in his position I might have done the same thing.)

David G. Baker, Boston, MA

David Baker: Thanks so much for your comment! I think it's great to have closer contact to cases like this and am excited to hear from counsel. I also appreciate your honesty about advocating zealously for your client but also recognizing the trustee's position (at least in an academic forum). Let me say this: I agree with you that it makes sense for your client to get an evidentiary hearing. If he was to be booted out for bad faith (and not allowed to convert to 13 due to his bad faith), and if he felt a proposed 13 plan would have rebutted his bad faith, he should have been accorded the chance to so present one, and perhaps the hearing should have been continued to allow him to present one, unless the judge felt that (1) he was stonewalling, or (2) no amount of creditor dividend could remedy the debtor's bad faith (which seems sort of harsh to me, but I'm not yet prepared to say that would have been an abuse of discretion). I should also add that my understanding is that a judge can dismiss a 13 the day after it's filed (ie., even if the debtor hasn't filed a plan yet). So I don't see any requirement that a debtor has a "right" to have his plan reviewed by a judge contemplating dismissal, but I do agree that it makes eminent sense and that a judge should have a good reason for not so considering.

John: I agree with your view of this as a substantive matter. There is no absolute requirement that there be an evidentiary hearing, and a court is free to say that any case that is converted ought to be immediately dismissed or converted back. But if that's the case, isn't that a pretty strong argument against invoking 105 at all? After all, if the statute by its terms establishes an express mechanism that will get to the same substantive result -- while ostensibly respecting the seemingly clear statutory text permitting the debtor to convert to a 13 -- wouldn't it make sense to adhere to that statutory scheme? In this sense, I agree with you that there is a sense in which this was a case about very little. In my view, the lower courts were wrong in purporting to deny the conversion. But if they really wanted to, they could have styled the paper differently (granting conversion and then converting back), and gotten to the same place. On this view, there is ample authority to prevent debtor abuse (as the majority was concerned about) without doing violence to the statutory text that seems by its terms to give the debtor a right to convert.

Craig: I'm with you. This pin-head is getting pretty fine for us angels, though. I guess the only place I drift away a bit is that I'm not sure how much "violence" the Court did to the text of the Code. If you just stare at 706 all day long, then yes, maybe it seems violent; but if you read 706 with the rest of the code (including 105), then I mind less. (And to show I'm not a 105-addict, I think I'd have problems with a judge using 105 to let someone convert to a 13 with more than the statutorily permissible debtload.) But I think we're close enough that I can declare Mission Accomplished!

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