By: Scott B. Riddle, Esq.

In an opinion entered today in the case of Marrama v. Citizens Bank of Massachusetts, No. 05-996 (February 21, 2007), the United States Supreme Court held that an individual debtor does not have an unqualified right to convert from a Chapter 7 case to a Chapter 13 case.

The Court, by Justive Stevens, identified the issue to be decided –

An issue that has arisen with disturbing frequency is whether a debtor who acts in bad faith prior to, or in the  course of, filing a Chapter 13 petition by, for example,fraudulently concealing significant assets, thereby forfeits his right to obtain Chapter 13 relief. The issue may arise at the outset of a Chapter 13 case in response to a motion  by creditors or by the United States trustee either to dismiss the case or to convert it to Chapter 7, see §1307(c). It also may arise in a Chapter 7 case when a debtor files a motion under §706(a) to convert to Chapter 13. In the former context, despite the absence of any statutory provision specifically addressing the issue, the federal courts are virtually unanimous that prepetition bad-faith conduct may cause a forfeiture of any right to proceed with a Chapter 13 case.1 In the latter context, however, some courts have suggested that even a bad-faith debtor has an absolute right to convert at least one Chapter 7 proceeding into a Chapter 13 case even though the case will thereafter be dismissed or immediately returned to Chapter 7.2 We granted certiorari to decide whether the Code mandates that procedural anomaly. 547 U. S. ____ (2006).

The basic facts are as follows —  

In verified schedules attached to his petition, Marrama made a number of statements about his principal asset, a house in Maine, that were misleading or inaccurate. For instance, while he disclosed that he was the sole beneficiary of the trust that owned the property, he listed its value as zero. He also denied that he had transferred any property other than in the ordinary course of business during the year preceding the filing of his petition. Neither statement was true. In fact, the Maine property had substantial value, and Marrama had transferred it into the newly created trust for no consideration seven months prior to filing his Chapter 13 petition. Marrama later admitted that the purpose of the transfer was to protect the property from his creditors. After Marrama’s examination at the meeting of creditors, see 11 U. S. C. §341, the trustee advised Marrama’s counsel that he intended to recover the Maine property as an asset of the estate. Thereafter, Marrama filed a "Verified Notice of Conversion to Chapter 13."

Relying primarily on Marrama’s attempt to conceal the Maine property from his creditors,the trustee contended that the request to convert was made in bad faith and would constitute an abuse of the bankruptcy process. The Bank opposed the conversion on similar grounds.

The Court then analyzed the legal issue –

The two provisions of the Bankruptcy Code most relevant to our resolution of the issue are subsections (a) and (d) of 11 U. S. C. §706, which provide:

(a) The debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.

(d) Notwithstanding any other provision of this section, a case may not be converted to a case under another chapter of this title unless the debtor may be a debtor under such chapter.

There are at least two possible reasons why Marrama may not qualify as such a debtor, one arising under §109(e) of the Code, and the other turning on the construction of the word "cause" in §1307(c). The former provision imposes a limit on the amount of indebtedness that an individual may have in order to qualify for Chapter 13 relief. More pertinently, the latter provision, §1307(c), provides that a Chapter 13 proceeding may be either dismissed or converted to a Chapter 7 proceeding "for cause" and includes a nonexclusive list of 10 causes justifying that relief.8 None of the specified causes mentionsprepetition bad-faith conduct (although subparagraph 10 does identify one form of Chapter 7 error which is necessarily prepetition conduct that would justify dismissal of a Chapter 13 case).9 Bankruptcy courts nevertheless routinely treat dismissal for prepetition bad-faith conduct as implicitly authorized by the words "for cause." See n. 1, supra. In practical effect, a ruling that an individual’s Chapter 13 case should be dismissed or converted to Chapter 7 because of prepetition bad-faith conduct, including fraudulent acts committed in an earlier Chapter 7 proceeding, is tantamount to a ruling that the individual does not qualify as a debtor under Chapter 13. That individual, in other words, is not a member of the class of "honest but unfortunate debtor[s]" that the bankruptcy laws were enacted to protect. See Grogan v. Garner, 498 U. S., at 287. The text of §706(d) therefore provides adequate authority for the denial of his motion to convert.

The class of honest but unfortunate debtors who do possess an absolute right to convert their cases from Chapter 7 to Chapter 13 includes the vast majority of the hundreds of thousands of individuals who file Chapter 7 petitions each year. Congress sought to give these individuals the chance to repay their debts should they acquire the means to do so. Moreover, as the Court of Appeals observed, the reference in §706(a) to the unenforceability of a waiver of the right to convert functions "as a consumer protection provision against adhesion contracts, whereby a debtor’s creditors might be precluded from attempting to prescribe a waiver of the debtor’s right to convert to chapter 13 as a non-negotiable condition of its contractual agreements." 430 F. 3d, at 479.

A statutory provision protecting a borrower from waiver is not a shield against forfeiture. Nothing in the text of either §706 or §1307(c) (or the legislative history of either provision) limits the authority of the court to take appropriate action in response to fraudulent conduct by the atypical litigant who has demonstrated that he is not entitled to the relief available to the typical debtor. On the contrary, the broad authority granted to bankruptcy judges to take any action that is necessary or appropriate "to prevent an abuse of process" described in §105(a) of the Code, is surely adequate to authorize an immediate denial of a motion to convert filed under §706 in lieu of a conversion order that merely postpones the allowance of
equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors. Indeed, as the Solicitor General has argued in his brief amicus curiae, even if §105(a) had not been enacted, the inherent power of every federal court to sanction ‘abusive
litigation practices,’ see Roadway Express, Inc. v. Piper, 447 U. S. 752, 765 (1980), might well provide an adequate justification for a prompt, rather than a delayed, ruling on an unmeritorious attempt to qualify as a debtor under Chapter 13. Accordingly, the judgment of the Court of Appeals is affirmed.

Justices Alito, joined by Justices Scalia, Thomas and Chief Justice Roberts dissented –

The Code restricts a Chapter 7 debtor?s conversion right in two "and only two" ways. First, §706(a) makes clear that the right to convert is available only once: A debtor may convert so long as "the case has not been converted [to Chapter 7] under section 1112, 1208, or 1307 of this title." Second, §706(d) provides that a debtor wishing to convert to another chapter must meet the conditions that are needed in order to "be a debtor under such chapter." Nothing in §706(a) or any other provision of the Code suggests that a bankruptcy judge has the discretion to override a debtor’s exercise of the §706(a) conversion right on a ground not set out in the Code. Thus, a straightforward reading of the Code suggests that a Chapter 7 debtor has the right to convert the debtor’s case to Chapter 13 (or another chapter) provided that the two express statutory conditions contained in §706 are satisfied. …

In sum, the Code expressly gives a debtor who initially files under Chapter 7 the right to convert the case to another chapter so long as the debtor satisfies the requirements
of the destination chapter. By contrast, the Code pointedly does not give the bankruptcy courts the authority to deny conversion based on a finding of "bad faith." There is no justification for disregarding the Code’s scheme.

In reaching the conclusion that a bankruptcy judge may override a Chapter 7 debtor’s conversion right based on a finding of  "bad faith," the Court reasons as follows. Under
§706(d), a Chapter 7 debtor may not convert to another chapter "unless the debtor may be a debtor under such chapter." Under §1307(c), a Chapter 13 proceeding may be dismissed or converted to Chapter 7 "for cause." One such "cause" recognized by bankruptcy courts is "bad faith." Therefore, a Chapter 7 debtor who has proceeded in "bad faith" and wishes to convert his or her case to Chapter 13 is not eligible to "be a debtor" under Chapter 13 because the debtor’s case would be subject to dismissal or reconversion to Chapter 7 pursuant to §1307(c). I cannot agree with this strained reading of the Code. The requirements that must be met in order to "be a debtor" under Chapter 13 are set forth in 11 U. S. C. A.
§109 (main ed. and Supp. 2006), which is appropriately titled "Who may be a debtor." The two requirements that are specific to Chapter 13 appear in subsection (e). First, Chapter 13 is restricted to individuals, with or without their spouses, with regular income. Second, a debtor may not proceed under Chapter 13 if specified debt limits are exceeded.