Brown v. Barclay (In re Brown)

• Citation: 953 F.3d 617
• Decision Date: 23 March 2020
• Docket Number: No. 18-60029,18-60029
• Parties: IN RE Jason Scott BROWN, Debtor, Kenneth Brown, Appellant, v. Christopher Barclay, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (9th Circuit)

953 F.3d 617

IN RE Jason Scott BROWN, Debtor,

Kenneth Brown, Appellant,

v.Christopher Barclay, Appellee.

No. 18-60029

United States Court of Appeals, Ninth Circuit.

Argued and Submitted November 7, 2019 Pasadena, California

Filed March 23, 2020

Michael G. Doan (argued), Doan Law Firm, Oceanside, California, for Appellant.

Yosina M. Lissebeck (argued), Lissebeck Law, San Diego, California, for Appellee.

Before: Mary M. Schroeder, Michelle T. Friedland, and Ryan D. Nelson, Circuit Judges.

SCHROEDER, Circuit Judge:

OVERVIEW

When a bankruptcy proceeding is converted from a proceeding under Chapter 13 to a proceeding under Chapter 7, the contents of the Chapter 7 estate should be easily ascertainable. Congress therefore enacted 11 U.S.C. § 348(f)(1)(A) to define the converted estate. It provides that the converted estate consists of the assets in the Chapter 13 estate that remain in the possession or control of the debtor at the time of conversion.¹

The problem in this case began when the debtor made unauthorized and fraudulent transfers of funds during the Chapter 13 proceeding. After the Bankruptcy Court converted the proceedings to Chapter 7 in response, the debtor argued that the transferred funds were no longer in the estate. The Bankruptcy Court and the Bankruptcy Appellate Panel ("BAP") disagreed, holding that, under the circumstances, the transferred funds should remain property of the Chapter 7 estate, which would mean the Chapter 7 trustee had authority to recover them. Those courts, however, came up with three different rationales for that result. We agree that the funds should remain property of the estate, but we must endeavor to harmonize that result with the language of § 348(f)(1) and the limited case law interpreting it.

The case arises out of a modest family inheritance. The debtor, Jason Brown, has three brothers, including Appellant Kenneth Brown. When their father died on July 20, 2012, he left his estate to his four sons. In the state court probate proceeding in August 2013, each of the brothers abandoned their interests in the estate to Jason.

Jason then filed his Chapter 13 bankruptcy petition on December 13, 2013 and filed his schedules and Chapter 13 plan on December 21. He scheduled an anticipated inheritance of only $2,500. A few months after that, the state court distributed the net proceeds of the estate to Jason, an amount totaling $55,487.97. Jason almost immediately, and without the approval of the Chapter 13 trustee, transferred $12,372 to each of his brothers.

Upon learning of the unauthorized transfers, the Chapter 13 trustee, as a sanction, sought conversion pursuant to 11 U.S.C. § 1307(c). That section provides that upon request of the trustee, the Bankruptcy Court may convert a case to Chapter 7 for cause. The trustee alleged Jason had abused the bankruptcy system by first failing to disclose the full amount of his anticipated inheritance and then by transferring most of that inheritance to his brothers who no longer had any claim to it. At the hearing on the Chapter 13 trustee’s motion, Jason offered no justification for either the lack of disclosure or the transfers. Jason also acknowledged that he could not account for any of the money, including the funds that he had retained after transferring equal shares to his brothers. The Bankruptcy Court ordered the conversion to Chapter 7 for cause, and, when Jason moved for reconsideration, made an express finding that Jason’s conduct had been in bad faith. The Bankruptcy Court explained that given the uncontradicted evidence of concealment by Jason, and his failure to provide an adequate explanation for his actions, there was ample support for a bad faith finding without holding an additional hearing. It concluded that the transfers were made to avoid payments to creditors.

The Bankruptcy Court then appointed Appellee Christopher Barclay as the Chapter 7 trustee. The trustee moved to recover the funds from all four brothers, including Appellant Kenneth and debtor Jason. Appellant’s position was that the funds transferred to him were not part of the bankruptcy estate after the conversion because they were no longer in the possession or control of the debtor, as required by § 348(f)(1)(A). The Bankruptcy Court disagreed, and offered two different reasons why the funds remained part of the bankruptcy estate. First, the Bankruptcy Court explained that because the transfers were not for ordinary living expenses permitted by statute, but were made in bad faith to avoid creditors, they should be regarded as property of the converted estate. Alternatively, the Bankruptcy Court reasoned that because Jason’s estate had a claim to recover the funds from the brothers, the funds could be said to have remained within his possession or control within the meaning of § 348 (f)(1)(A).

The BAP majority agreed with the Bankruptcy Court’s first rationale, holding that because the funds were not spent in good faith on ordinary living expenses, they remained part of the converted estate. Judge Spraker wrote a separate concurring opinion. In his view, a claim to avoid the transfer of funds accrued to the Chapter 13 trustee before conversion, and that claim was unaffected by § 348(f)(1)(A).

In his appeal to this court, Appellant does not dispute the finding of bad faith but contends only that funds transferred to him were no longer in the literal possession or control of his brother, the debtor Jason, at the time of conversion, and hence not recoverable as part of the Chapter 7 estate. The trustee argues, however, that the property defined by § 348 must include fraudulently transferred funds to prevent abuse of the system. This dispute thus concerns the interpretation of § 348(f)(1)(A), a provision that does not directly address the issue of fraudulent transfers. As in other contexts, we must interpret a problematic section of the Bankruptcy Code in light of the structure of the Code as a whole, including its object and policy. See Hawkins v. Franchise Tax Bd. , 769 F.3d 662, 666 (9th Cir. 2014) (citing Children’s Hosp. & Health Ctr. v. Belshe , 188 F.3d 1090, 1096 (9th Cir. 1999) ).

DISCUSSION

Section 348 comes into play when a bankruptcy proceeding is converted from Chapter 13 to Chapter 7. We therefore look first to the nature of each type of proceeding.

Chapter 13 bankruptcy is a voluntary proceeding that allows a debtor to retain control over some assets while the debtor repays creditors over a three-to-five-year period. In exchange for retaining control of some assets, the property accumulated during the repayment period becomes part of the bankruptcy estate and is used to repay creditors. See 11 U.S.C. § 1306(a)(1) (including in the Chapter 13 estate "all property ... that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12").

In contrast, Chapter 7 allows debtors to discharge their existing debts immediately without a long-term payment plan. But in exchange, the debtor must relinquish control of and liquidate all existing assets. The Chapter 7 trustee is to sell the property of the estate, 11 U.S.C. § 704(a)(1), and then distribute the proceeds to the debtor’s creditors, 11 U.S.C. § 726. Unlike in Chapter 13 proceedings, wages or other assets acquired by the debtor post-petition are not property of the estate, and therefore creditors do not have access to them. See Harris v. Viegelahn , 575 U.S. 510, 135 S. Ct. 1829, 1835, 191 L.Ed.2d 783 (2015) ("Thus, while a Chapter 7 debtor must forfeit virtually all his prepetition property, he is able to make a ‘fresh start’ by shielding from creditors his postpetition earnings and acquisitions.").

An issue that arises is how to define the contents of the estate that is converted from Chapter 13 to Chapter 7. One option would be to apply Chapter 7’s rule that all assets acquired after the filing of the initial petition are retained by the debtor and do not become part of the bankruptcy estate. This approach would bar creditors from obtaining assets that were acquired by the debtor after the Chapter 13 petition was filed. In essence, this approach would put the debtor where he would have been, had he filed in Chapter 7 initially. Applying Chapter 7’s rule upon conversion would therefore allow the debtor to keep assets that were acquired after the initial voluntary Chapter 13 petition was filed.

Another approach would be to apply Chapter 13’s rule that assets acquired after the petition is filed become part of the estate. Thus, assets acquired after the Chapter 13 petition was filed would, upon conversion to Chapter 7, become part of the converted estate. This approach would give a debtor’s creditors, upon conversion to Chapter 7, access to all such assets. Such an approach would put the debtor in a worse position than if the petition had been filed in Chapter 7 initially.

Congress tried to resolve the issue in § 348(f)(1)(A), which effectively adopted the Chapter 7 approach, by defining the converted estate to exclude assets acquired after the initial filing. This provision limits the converted estate in two ways. First, to avoid penalizing the debtor who initially engaged in voluntary bankruptcy under Chapter 13, Congress restricted the assets of the converted estate to property "as of the date of filing of the [voluntary] petition." 11 U.S.C. § 348(f)(1)(A). This means that, after conversion to Chapter 7, creditors are barred from recovering property that was acquired by the debtor after filing the Chapter 13 petition. See, e.g. , Harris , 135 S. Ct. at 1837 (holding that wages acquired by the debtor after filing for Chapter 13 bankruptcy and not distributed at the time of conversion, are not property of the converted estate under section 348(f)(1)(A) ).

Second, and of immediate concern here, Congress, in § 348(f)(1)(A), limited the property of the converted estate to include only property that "remains in the possession...