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11th Cir. Holds Bankruptcy Chapter 13 to 7 Conversions May Be Dismissed for ‘Abuse’ Under 11 U.S.C. § 707(b)

The U.S. Court of Appeals for the Eleventh Circuit recently held that section 707(b) of the Bankruptcy Code, which allows a bankruptcy court to dismiss a chapter 7 petition if it finds that relief would be an “abuse” as defined in that section, applies to a petition initially filed under chapter 13 and converted to chapter 7.

A copy of the opinion in Pollitzer v. Gebhardt is available at:  Link to Opinion.

A debtor filed bankruptcy under chapter 13 of the Bankruptcy Code, which allows a debtor to restructure his debts and keep his assets by submitting a plan that provides for repayment over three to five years made from the debtor’s future earnings.

After making plan payments for more than two years, the debtor exercised his right to convert the case to a chapter 7 liquidation, which “requires a debtor to transfer nearly all of his prepetition assets to the bankruptcy court for distribution to creditors, but allows the debtor to shield from creditors postpetition income and assets.”

The bankruptcy trustee moved to dismiss the converted petition as “abusive” under § 707(b) of the Code, which Congress enacted to prevent debtors who could afford to repay their debts over time from shielding their postpetition income from creditors by filing for relief under chapter 7.

Specifically, section 707(b) provides that after notice and hearing, “the court, on its own or on a motion filed by the United States trustee, … may dismiss a case filed by an individual debtor under this chapter … if it finds that the granting of relief would be an abuse of the provisions of this chapter.”  The Bankruptcy Code “creates a means-test codified at 11 U.S.C. § 707(b)(2)(A)(i) …[which], if met, requires the court to presume the petition to be abusive.”

The bankruptcy trustee argued that because the debtor’s disposable income was much more than the means-test allowed, he could repay his unsecured creditors.  The debtor argued in opposition that § 707(b) does not apply to a chapter 13 case that is later converted to chapter 7.

The bankruptcy court held that § 707(b) applies to converted cases and dismissed the debtor’s petition. The U.S. District Court affirmed, and the debtor appealed to the Eleventh Circuit.

On appeal, the Eleventh Circuit rejected the debtor’s textual argument that since his case was not filed under chapter 7, but under chapter 13 instead, § 707(b) does not apply. The U.S. trustee, also relying on the text, argued the opposite: namely, that the phrase “’under this chapter” modifies the phrase to which it is immediately adjacent, ‘an individual debtor[,]’ [a]nd, .. because [the debtor] is ‘an individual debtor under [chapter 7],’ § 707(b) applies.”

The Court pointed out that both parties’ interpretations of § 707(b) “are defensible[,]” but “[b]ecause there are unmistakable indications in the Code that Congress intended § 707(b) to apply to converted cases,” it rejected the debtor’s argument.

The Eleventh Circuit began by discussing the “textual evolution of § 707[,]” explaining that Congress initially adopted it in 1984 because it believed courts were not sufficiently exercising their existing power to dismiss petitions “for cause.”

Two decades later, Congress was still dissatisfied with bankruptcy courts’ perceived reluctance to dismiss petitions filed by debtors who could substantially repay their debts, so it “significantly strengthened § 707(b) in 2005” by making “it even easier for bankruptcy courts to dismiss abusive petitions.”

The Court concluded that “[t]his history and statutory evolution” showed that “Congress intended the current version of § 707(b) to be a potent tool for bankruptcy courts to expeditiously dismiss Chapter 7 petitions filed by debtors with income sufficient to pay their creditors.” Such clear congressional intent “would be eviscerated” if the Court adopted the debtor’s argument because “a debtor could file a Chapter 13 petition and, the following day, convert it to a Chapter 7 petition and thereby avoid the [abuse language] incorporated into § 707(b).”

Because this would be an absurd result clearly not intended or authorized by Congress, the Eleventh Circuit affirmed the trial court’s dismissal of the debtor’s petition.

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