Asian Journal- The Filipino-American Community Newspaper

LAST week we discussed the conversion of a chapter 7 case into chapter 13. Today we discuss converting a chapter 13 case to chapter 7. Many debtors who want chapter 7 relief are not eligible either because they fail the chapter 7 means test, or the liquidation analysis, which shows that they have substantial, that are not exempt. These debtors usually have household incomes that are above the median in California. The means test is an objective way of computing disposable income based on IRS standards. This device has many critics because sometimes the result of its application is ridiculous. For instance, a debtor with several dependents will benefit from its application because debtor can claim the higher IRS allocation for rent even if debtor’s actual rent is lower. If debtor has 4 dependents his means test rent is at least $1,400 monthly. If the rent he actually pays is only $700, he can claim the difference of $700 as additional expense when determining disposable income under the means test. On the other hand, a debtor who is married without dependents who actually pays rent of $2,900 can only deduct the amount of $1,100 for rent under the means test. In this situation, the difference of $1,800 of non deductible expense can knock the chapter 7 case into a chapter 13 unless debtor has more qualifying expenses to offset $1,800 because substantial disposable income may result from the fact that only $1,100 of the $2,900 rent is deductible under the means test.

Recently, chapter 13 client finished his plan payments of $24,000 after 5 years. However, trustee filed a motion to dismiss because there was still a balance of $20,000 unpaid. The outstanding balance arose because creditors filed claims that were more than that listed by debtor. Fortunately, client’s household income had decreased and the current fair market value of his residence had declined. In 2004 when his chapter 13 case was filed, the equity in his house was $120,000. If he had filed a chapter 7 in 2004, the trustee would have taken and sold his house and given him his homestead exemption of $75,000 and used the difference to pay off his creditors. Chapter 13 allowed him to keep his house even with $50,000 of non-exempt equity but required him to pay 100% of his credit card debt. With the current housing market meltdown, the equity in his residence was reduced to $40,000, which is within his homestead of exemption of $75,000. And because of the recession, he suffered a pay cut which wiped out his disposable income. The combination of these 2 factors meant that client now qualified for chapter 7 relief and converting his chapter 13 to chapter 7 would discharge the unpaid claims of $20,000. Thus, debtor filed a notice of conversion from chapter 13 to chapter 7 pursuant to § 1307 (a). That section states "debtor may convert a case under this chapter to a case under chapter 7 of this title at any time. Any waiver of the right to convert under this subsection is unenforceable."

Although the law as worded seems to suggest that the right to convert to chapter 7 is absolute, it is not. Case law requires the absence of bad faith on debtor’s part to allow conversion. The existence of bad faith is based on the totality of circumstances and is a matter of proof. The chapter 7 trustee or the US Trustee may object to conversion and may seek dismissal of the case if circumstances warrant. If this happens, the matter will be set for hearing and the court’s decision to allow conversion or dismiss case will be based on evidence presented by the moving party and debtor. Suffice it to say that the burden of proof is on the moving party and courts are not inclined to find bad faith unless the facts are plain and egregious. Further, debtor must qualify for chapter 7 before conversion will be granted pursuant to §1307 (g).

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Lawrence Bautista Yang specializes in bankruptcy, business, real estate and civil litigation and has successfully represented more than five thousand clients in California. Please call Angie, Barbara or Jess at (626) 284-1142 for an appointment at 1000 S. Fremont Ave., Bldg. A-1 Suite 1125 Unit 58, Alhambra, CA 91803.