News New Movement to Force Chapter 7 Debtors Non-Consumer Debt into Chapter 11

[flashoflight]

As we all know, you don't have the right to get out of a chapter 7 once you are in especially if the bankruptcy has a bad result for you.

I saw an interview with a bankruptcy attorney talking about the new movement by the trustee or creditors to push cases with primarily non-consumer debt (eg. business debt) to chapter 11. As we know, you don't need to take the means test to be eligible for chapter 7 with primarily non-consumer debt. Involuntary servitude in slavery is not allowed by the 13th amendment, so you can't force someone in a 7 to a wage earner's plan (chapter 13). But a party in interest may force a conversion from a chapter 7 to chapter 11 for business entities like partnerships or corporations. But how about individual sole proprietors? This BK lawyer in the interview below had a case where the IRS moved to force an individual case with high income plus primarily non-consumable debt to be forcibly converted to chapter 11. The BK judge signed it and is now being appealed. This is in the 9th district, central district of California.

So right now in the central district of CA, if we have a high income debtor with non-consumer debt skipping the means test, there is a very good chance of a motion under section 706(b) by the trustee or an angry creditor (eg. IRS / Franchise Tax Board) to convert the case to chapter 11. That debtor should consider doing a chapter 13 repayment instead if possible. For now, we have to see what appellate courts will do and whether the supreme court might need to decide this.

https://www.youtube.com/watch?v=tXTSEakiBuM

[shipo]

As we all know, you don't have the right to get out of a chapter 7 once you are in especially if the bankruptcy has a bad result for you.

I saw an interview with a bankruptcy attorney talking about the new movement by the trustee or creditors to push cases with primarily non-consumer debt (eg. business debt) to chapter 11. As we know, you don't need to take the means test to be eligible for chapter 7 with primarily non-consumer debt. Involuntary servitude in slavery is not allowed by the 13th amendment, so you can't force someone in a 7 to a wage earner's plan (chapter 13). But a party in interest may force a conversion from a chapter 7 to chapter 11 for business entities like partnerships or corporations. But how about individual sole proprietors? This BK lawyer in the interview below had a case where the IRS moved to force an individual case with high income plus primarily non-consumable debt to be forcibly converted to chapter 11. The BK judge signed it and is now being appealed. This is in the 9th district, central district of California.

So right now in the central district of CA, if we have a high income debtor with non-consumer debt skipping the means test, there is a very good chance of a motion under section 706(b) by the trustee or an angry creditor (eg. IRS / Franchise Tax Board) to convert the case to chapter 11. That debtor should consider doing a chapter 13 repayment instead if possible. For now, we have to see what appellate courts will do and whether the supreme court might need to decide this.

https://www.youtube.com/watch?v=tXTSEakiBuM

Good information; had this happened back in 2014 I may well have been caught up in this very situation. Easily 80% of my debt had been run up by either my wife's failed business or the run-up of debt in my name by my former business partner for a failed subsidiary business. As it turned out, my attorney didn't really see any option but for me to go Chapter 13 right out of the gate; so maybe this wouldn't have applied to me anyway.

[despritfreya]

This is very interesting however, as the saying goes, “bad facts make bad law” and, while my comments/analysis are in the nature of 20/20 hindsight, the issues confronting this debtor, IMHO, lay at the feet of his attorney.

For this debtor, we are dealing with basically a 2 party dispute. Out of $130k, it appears that all but $9k was related to taxes. This was the first problem with the case although, I must admit, I have many cases were the total tax debt is far in excess of the balance of other debt.

As the UST pointed out,

“According to the Debtor’s Statement of Financial Affairs he made $182,639.00 in 2018; $208,692.00 in 2019 and from January 1, 2020 through May 30, 2020 already bankrolled $104,880.15 with seven months left in the 2020 calendar year. His own schedules reflect a gross monthly income of $21,242.32, and net monthly income of $10,089.40. The Debtor’s Amended Schedule J shows monthly expenses of $7,696.40. Therefore, based on the Debtor’s own admission, he has at least $2,393.00 per month in net disposable income that could be used to repay creditors through a modest plan of reorganization.”

In an effort to get around the ability to pay (totality of the circumstances under 707(a)) the debtor amended Schedule J several times within a short period. Each time he inserted a non-existent payment to the taxing agencies. The first amendment shows a payment of $523 per month. The second amendment shows a payment of $872 per month. This debtor was not making such payments and, as far as I can tell, had not be under an installment agreement with any taxing agency.

Interestingly, it was not the UST who eventually sought conversion to Chapter 11. It was the IRS. The IRS pointed out the problems with including non-existent tax payments and that the debtor was making a voluntary contribution to a retirement plan of over $400.00 per month. Lastly, the Debtor listed a child support payment of at least $1,300 per month but failed to disclose that such payment would end in June, 2021. (I note that the case was filed on May 30, 2020 - could this have been timed to avoid the requirement to list any change in expenses happening within 1 year after the Petition date?) The bottom line, according to the IRS, after removing bogus monthly tax payments, disallowing the voluntary retirement deduction, and the end of the child support payment the IRS stated that the Debtor could afford a plan payment of $3,047.00 per month. At that rate, he could have paid all creditors, in full, in less than 45 months.

Whether or not on appeal, the US District Court will determine that an individual cannot be forced into a Chapter 11 (the Section 706 argument vs. involuntary servitude) remains to be seen - I support the Debtor’s position. Bottom line here is you don’t play games with Schedule I and J. Amending Schedule I and J numerous times to try to “save” the case is inexcusable. The case should have been dismissed or converted to a Chapter 13. I must note that, on June 4, 2021 the debtor filed a Motion to convert the Chapter 11 to Chapter 13. A Hearing on the Motion is set for June 29, 2021.

Lastly, I want to mention that it has been my experience that it is usual for the IRS to take such an aggressive posture. I have seen such posturing when dealing with high earners such as physicians and other “professionals” who owe substantially more than this debtor. The debtor in this case is a first responder who, in my opinion, does not deserve this level of scrutiny unless there is something else going on. I wish him the best.

Des.

[flashoflight]

despritfreya
Thanks. Just looked up this case. What a mess.

I think the other lesson is use extreme caution if the bulk of your debt belongs to angry creditors such as the IRS or an angry judgment creditor who will spend extra money on legal fees just to make you homeless or punt you into an 11. Outside of bankruptcy, I know the Franchise Tax Board is really bad too.

I noticed the IRS is opposing the conversion from chapter 13 to chapter 11 without a hearing. I wonder what they're so concerned about to oppose the poor guy from going 11 to 13 without a hearing.

[justbroke]

I had written a bunch of stuff which was mostly along the same line of questions as Des. It's a complex case full with a lot of debtor-specific facts.

[despritfreya]

. . . The case should have been dismissed or converted to a Chapter 13. I must note that, on June 4, 2021 the debtor filed a Motion to convert the Chapter 11 to Chapter 13. A Hearing on the Motion is set for June 29, 2021.

Just a follow up as the Hearing was today. . .

Docket Entry 100: Hearing Held (Bk Motion) (RE: related document(s) 91 Motion to Convert Case) - Motion Is Granted. Movant To Submit Order. (Deramus, Glenda) (Entered: 06/29/2021)

IMHO the case is where it should have been from day 1 if the debtor really wanted to file bk.

Des.

[justbroke]

I too think that this first responder deserves a discharge under Chapter 13. Imagine the implications of a Chapter 11 for "ordinary" individuals. By ordinary I mean those debtors who are not in the top 2% of earners. By ordinary, I don't mean the sole proprietor with a gross income of over $330K/year (and only has a net income of $100K).

[despritfreya]

Imagine the implications of a Chapter 11 for "ordinary" individuals. By ordinary I mean those debtors who are not in the top 2% of earners. By ordinary, I don't mean the sole proprietor with a gross income of over $330K/year (and only has a net income of $100 K).

Ah. . . but "ordinary" folks do file 11's and many are successful. There are advantages and disadvantages.

One big advantage is that the debtor serves as the Trustee and keeps control over everything. But for the Initial Debtor Interview and 341 meeting, the Debtor is not hounded by the UST's office so long as he/she files Monthly Operating Reports and pays the required quarterly fees to the UST.

Another advantage is that Plan payments don't start until some time after the Plan is Confirmed and the Plan can be longer than 60 months. Most we ever had was 84 months but priority claims must be paid within 60 months from the day the case was filed.

The disadvantages such as the need to have at least one impaired class vote in favor of the Plan can be worked through if the attorney knows what he/she is doing. Another disadvantage is that interest must be paid on the priority tax claims.

Of course, the overall cost in legal fees could be high but a well thought out case that is really nothing more than an over-grown 13 should not cost much more than a Chapter 13. Our "simple" 11's can be completed for around $15k - maybe less. When you factor in the attorney and trustee fees in a 13 you are probably pretty close to this. However, complicated cases, even for individuals, can run into the 6 figures.

Des.

[justbroke]

Okay despritfreya, maybe extra-ordinary people, indeed. I was absolutely frightened by the prospects of what you described. The fact that the debtor-in-possession is the Trustee (unless UST decides otherwise), the reporting, and just getting the plan confirmed, would have been a harrowing experience for my attorney. Of course my attorney was a fool... so there's that.