« My that’s a mighty gavel you have there | Main | Wallace v. Kato »

Supreme Court Decision Update - Marrama v. Citizens Bank of Massachusetts

pockets.jpgMarrama v. Citizens Bank of Massachusetts (PDF of the opinion) is the first of today’s new Supreme decisions, and it’s about the wonderful world of bankruptcy.

QuizLaw Analysis: More specifically, this case is about abuse of the bankruptcy system by scum-bum no moneys trying to skirt their debts. The Supremes rule here that you forfeit what is generally an absolute right to convert a Chapter 7 bankruptcy into a Chapter 13 bankruptcy where you act in bad faith, and the bankruptcy courts have the right to call you out on your bad faith shenanigans (as they can also dismiss an original Chapter 13 bankruptcy for bad faith shenanigans).

So who got themselves in some debt trouble? That would be Robert Marrama who, in 2003, filed for Chapter 7 bankruptcy. His biggest debtor was Citizens Bank of Massachusetts (let’s just call them the Bank). Marrama’s biggest asset was some land up in Maine and, early during the bankruptcy process, he made some misleading and inaccurate statements about the land. For example, he claimed it had zero value, and he also denied that he had transferred any property in the year before he filed for bankruptcy, except in the ordinary course of business. These were both lies: “the Maine property had substantial value, and Marrama had transferred it into [a] newly created trust for no consideration seven months prior to filing his Chapter 13 petition.”

Wait - what’s with the Chapter 13 petition? I thought he filed for Chapter 7? Well he did, originally. However, during the Chapter 7 process, the bankruptcy trustee said he was planning to go after the Maine property to make in an asset of the bankruptcy estate. Marrama then filed to have his bankruptcy converted to Chapter 13. The bankruptcy trustee and the Bank both objected, relying largely on the attempt to hide the Maine property and arguing that this conversion request was being made in bad faith and was an attempt to abuse the bankruptcy process.

Why did he want to convert the bankruptcy? He wanted to convert it because under Chapter 7 bankruptcy the trustee control all the assets. But under Chapter 13 bankruptcy, the debtor (e.g., Marrama) keep control of the assets. So he would keep control of the Maine land under Chapter 13 and could, presumably, work to keep it out of the bankruptcy estate, and out of the grubby hands of the Bank.

So was the bankruptcy converted? No. Marrama tried to claim that he meant to file for Chapter 13 but filed for Chapter 7 because of a “scrivener’s error.” But the Bankruptcy Judge said “that there is no ‘Oops’ defense to the concealment of assets and that the facts established a ‘bad faith’ case.” So Marrama appealed to the First Circuit’s Bankruptcy Appellate Panel, which also rejected his attempt to convert.

On appeal, Marrama’s main argument was to rely on some language in the Bankruptcy Code. In section 706(a), the Code says that a debtor “may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time [and]…[a]ny waiver of the right to convert a case under this subsection is unenforceable.” Marrama said this gave him an absolute right to convert his case. The panel said “nuh-uh.” Their take was that, when you read this with other Bankruptcy Code provisions and rules, there is a right to convert which “is absolute only in the absence of extreme circumstances.” And here, the panel felt that the Maine shenanigans were such extreme shenanigans.

Marrama appealed to the First Circuit which also told him to shove off. First, section 706(a) says “may,” not “shall,” so it’s not really absolute. Second, the First Circuit reminded everyone that bankruptcy courts have total authority to throw out a chapter 13 case (that is, a bankruptcy initially filed as chapter 13) when there’s bad faith. And there’s no reason that rule should be different for an initial chapter 13 petition and a motion to convert a chapter 7 to a chapter 13.

And now we’re at the Supremes? We sure are. This was a 5-4 decision, with the majority opinion penned by Justice Stevens and joined by Justices Kennedy, Souter, Ginsburg and Breyer. Stevens beings by reminding us what section 706(a) says, and also points out the language of 706(d) which says: “Notwithstanding any other provision in 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.”

This 706(d) is the key here. It’s an express limitation to the otherwise “absolute” right to convert a bankruptcy. In other words, Marrama isn’t allowed to convert his bankruptcy if he wouldn’t be allowed to be a Chapter 13 debtor. And Stevens says Marrama wouldn’t be allowed to be a Chapter 13 debtor. If he had initially filed for Chapter 13, his case would’ve been dismissed “for cause,” because of the bad-faith conduct (as bankruptcy courts “routinely treat dismissal for prepetition bad-faith conduct as implicitly authorized by the words ‘for cause’”).

So here’s the key:

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.

So the court retains the authority to protect creditors from “the atypical litigant who has demonstrated that he is not entitled to the relief available to the typical debtor” because he acted fraudulently. In other words, the bankruptcy court needs to ensure that there’s no “abuse of process,” which, according to Stevens is ample reason for the “immediate denial of a motion to convert filed under § 706.”

And what doesn’t the dissent like about this? Well Justice Alito filed the dissent, joined by Chief Justice Johnny, the Scalia and Justice Thomas. Alito and company agree with Marrama that the right to convert is absolute:

The Court, however, holds that a debtor’s conversion right is conditioned upon a bankruptcy judge’s finding of “good faith.” Because the imposition of this condition is inconsistent with the Bankruptcy Code, I respectfully dissent.

Alito thinks the Bankruptcy Code is unambiguous in allowing absolute conversion, with “two - and only two” restrictions. Those restrictions are that you can only convert once, and that you must meet the conditions of a debtor in the chapter you’re trying to convert to. And nothing says the court has the right to deny a conversion request when there’s “bad faith.” So the majority is simply disregarding what Congress wanted.