Summary of a Recent
Judicial Development in
Bankruptcy

Engaging in Bad-Faith Conduct May Forfeit
Debtor's Right to Convert

Walt McCarter
National AgLaw Center Research Associate

Summary of Decision

In Marrama v. Citizens Bank, 127 S. Ct. 1105 (2007), a plurality of the United States Supreme Court held that a Chapter 7 debtor may forfeit his right to proceed under Chapter 13, via conversion of his case, by engaging in bad-faith conduct.

Background

On March 11, 2003, Robert Marrama filed a bankruptcy petition under Chapter 7, thereby creating an estate consisting of all his property "wherever located and by whomever held." Id. at 1108. Respondent Citizens Bank of Massachusetts was the principal creditor, and Respondent Mark DeGiacomo was the trustee of that estate. Id.

In his petition, Marrama made several misleading or inaccurate statements about his house in Maine. Id. He listed its value as zero, and also denied transferring any property other than in the ordinary course of business during the year preceding the filing of his petition. Id. In fact, the property had substantial value, and Marrama had transferred it into the trust seven months prior to filing his Chapter 13 petition. Id. He later admitted that he had transferred the property to protect it from creditors. Id. He also tried to obtain a homestead exemption on a rental property in Massachusetts, and lied about an anticipated tax refund. Id. at 1109.

After the trustee informed Marrama's counsel that he intended to recover the Maine property as an asset of the estate, Marrama tried to convert to Chapter 13. Id. at 1108. Both the trustee and the Bank filed objections alleging bad-faith and contending that to allow the conversion would constitute an abuse of the bankruptcy process. Id. at 1108.

At the hearing, Marrama claimed that his misstatements about the Maine property were attributable to "scrivener's error," and that he had recently become eligible to proceed under Chapter 13 rather than Chapter 7. Id. at 1108-1109.

The bankruptcy judge ruled that the facts established a "bad faith" case, and denied the request for conversion. Id. at 1109. The Bankruptcy Appellate Court for the First Circuit and the First Circuit Court of Appeals affirmed, rejecting Marrama's argument that § 706(a) gives a Chapter 7 debtor an absolute right to convert to Chapter 13. Id. The United States Supreme Court granted certiorari.

Arguments

Marrama argued that he had an absolute right to convert his case from Chapter 7 to Chapter 13 under the plain language of § 706(a) of the Bankruptcy Code, which provides that a Chapter 7 debtor "may convert a case" so long as it has not been converted previously. Id. at 1110.

Citizens Bank and DeGiacomo argued that the statute uses the word "may" rather than "shall," thus giving courts discretion to construe a "bad faith" exception to the general rule, and thereby avoid abuse of the bankruptcy process. Id. at 1108.

Analysis and Holdings

Plurality

The Court affirmed the First Circuit's opinion and held that there is a bad faith exception to the right to convert from Chapter 7 to Chapter 13. Id. at 1109. The plurality reasoned, "§ 1307(c) provides that a Chapter 13 proceeding may be either dismissed or converted to a Chapter 7 proceeding 'for cause' . . . . Bankruptcy courts . . . routinely treat dismissal for prepetition bad-faith conduct as implicitly authorized by the words 'for cause.'" Id. at 1110-1111.

Dissent

The dissent rejected the plurality's conclusion that the language of § 1307(c) creates a bad-faith exception to a debtor's right to convert, stating that "[u]nder the clear terms of the Bankruptcy Code, a debtor who initially files a petition under Chapter 7 has the right to convert the case to another chapter under which the case is eligible to proceed," and thus the imposition of a bad-faith exception is inconsistent with the statute. Id. at 1112. The dissent also pointed out that "[n]othing 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." Id. at 1113.

The case was decided on February 21, 2007.