Smith, Matter of, No. 86-2683

• Court: United States Courts of Appeals. United States Court of Appeals (7th Circuit)
• Writing for the Court: Before CUDAHY, RIPPLE and MANION; MANION
• Citation: 848 F.2d 813
• Parties: 18 Collier Bankr.Cas.2d 1375, 17 Bankr.Ct.Dec. 1358, Bankr. L. Rep. P 72,325 In the Matter of Kenneth W. SMITH, Debtor. Appeal of STATE OF INDIANA.
• Docket Number: No. 86-2683
• Decision Date: 09 June 1988

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848 F.2d 813 18 Collier Bankr.Cas.2d 1375, 17 Bankr.Ct.Dec. 1358,
Bankr. L. Rep. P 72,325 In the Matter of Kenneth W. SMITH, Debtor.
Appeal of STATE OF INDIANA. No. 86-2683. United States Court of Appeals,
Seventh Circuit. Argued Feb. 26, 1987.
Decided June 9, 1988.

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John Emry, Office of Atty. Gen., Indianapolis, Ind., for plaintiff-appellant.

Patricia L. Marshall, Hopper & Opperman, Indianapolis, Ind., for defendant-appellee.

Before CUDAHY, RIPPLE and MANION, Circuit Judges.

MANION, Circuit Judge.

The State of Indiana, one of debtor Kenneth Smith's unsecured judgment creditors, appealed the bankruptcy court's confirmation of Smith's Chapter 13 plan. The district court affirmed, and the State again appeals. Because the bankruptcy court did not consider Smith's pre-filing conduct in determining whether he proposed his plan in good faith, we reverse and remand.

I. NATURE OF THE CASE

Smith owned and operated a home repair business in Indiana which fleeced senior citizens by making repairs which Smith knew were not necessary. On August 29, 1984, the State obtained a judgment against him in state court based upon his numerous violations of the Indiana Deceptive Consumer Sales Act, Ind. Code Sec. 24-5-0.5-1, et seq. (1982), State v. All City, Inc., slip op. No. 35,009 (Johnson Cir.Ct. Aug. 29, 1984). The judgment, for which Smith is personally liable, included $11,000 in civil penalties to be paid into the State's treasury and $37,748 unlawfully received from aggrieved consumers to be paid to the State on the consumers' behalf and to be held in escrow for distribution to those consumers when paid by Smith. Smith did not appeal that judgment. The State did not charge Smith under its criminal laws and the judgment amount is not restitution to crime victims.

Three months later, on November 30, 1984, Smith, as a voluntary debtor, filed a Chapter 13 bankruptcy petition. Chapter 13 adjusts debts of "an individual with regular income." 11 U.S.C. Sec. 109(e). It allows a debtor to keep his assets, but he must use his future income to pay his creditors. Chapter 7, in contrast, liquidates the debtor's assets (with certain exemptions) and distributes the proceeds among his creditors. The debtor, however, keeps his future income, which means that his future earnings are excluded from the assets which may be distributed. 11 U.S.C. Sec. 541(a)(6). After that distribution occurs, the debtor's debts are discharged. Certain debts, however, are not dischargeable under Chapter 7. See 11 U.S.C. Sec. 523. Among the exceptions to discharge in Chapter 7 are a debt for money obtained by false pretenses or actual fraud, 11 U.S.C. Sec. 523(a)(2)(A), and a debt for a penalty payable to a governmental unit, 11 U.S.C. Sec. 523(a)(7). Smith concedes that both parts of the judgment he owes to the State are nondischargeable under Chapter 7. A discharge under Chapter 13, in contrast, could discharge Smith from those debts. See In re Rimgale, 669 F.2d 426, 428 (7th Cir.1982). Whether Smith was eligible to invoke Chapter 13 is the question here.

A debtor begins a Chapter 13 case by filing a petition with the clerk of the bankruptcy court. 11 U.S.C. Sec. 301. In his petition, Smith estimated his future monthly take-home pay to be $1,040, with monthly expenses (not including debts to be paid) of $921.83. In addition to the $48,748 judgment owed to the State, he listed five other judgments among his unsecured debts. The State's judgment equaled 50.4 percent of Smith's total unsecured debt of almost $97,000. The other unsecured debt primarily arose from Smith's repair business. Only 6.9 percent of the unsecured debt consisted of consumer debt.

Under Bankruptcy Rule 3015, the debtor must file a plan within 15 days after filing the Chapter 13 petition. Smith timely presented his Chapter 13 plan and submitted a modified plan for reasons unrelated to this appeal on March 4, 1985. Smith's plan ultimately divided the creditors into four classes: Class 1, an unidentifiable unsecured creditor entitled to priority under 11 U.S.C. Sec. 507 (wages owed to employees, or taxes); Class 2, mortgagees on his real property; Class 3, a lienor on his car; and Class 4, the unsecured creditors, including the State. The plan provided

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for $115.41 per month to be paid for five years as follows:

$31.79 to the Class 1 creditor;

$73.17 to the Class 2 creditors;

the Class 3 creditor received the deed to the car;

the remaining amount, $10.45 per month, to the Class 4 creditors.

Section 1328 provides, with certain exceptions, that a debtor's remaining debts are discharged after he completes all payments under the plan. The parties agree that if the plan is confirmed, the debt Smith owes to the State would be discharged when he completes payments under his Chapter 13 plan. 11 U.S.C. Sec. 1328(a). While the plan applies all of Smith's projected disposable income to make payments, the State will have received less than 2 percent of its claim when Smith completes his plan.

Section 1325 provides that "the court shall confirm a plan if" the plan satisfies certain criteria. ¹ At issue in this case is Sec. 1325(a)(3), which provides in pertinent part that "the plan has been proposed in good faith and not by any means forbidden by law."

II. NATURE OF THE PROCEEDINGS

Section 1324 requires the bankruptcy court to hold a hearing before confirming a Chapter 13 plan. Any party in interest may object to confirming the plan. Sec. 1324. The State did, filing an objection to confirmation and a motion to dismiss the petition or to convert the action to one under Chapter 7. No other creditor objected.

The State's objection to the confirmation and its motion were both based upon Smith's lack of good faith in filing the petition. The State claimed that Smith filed his petition solely to avoid paying the state court judgment. The State pointed to the short time--less than 100 days--between the entry of judgment and Smith's filing bankruptcy, the fact that the State is the largest unsecured creditor, and the fact that the State will receive less than 2 percent of its claim.

In a written opinion entered on October 23, 1985, the bankruptcy court confirmed Smith's Chapter 13 plan. In re Smith, No. IP 84-4584-WP-B (Bankr.S.D.Ind. Oct. 23, 1985). The bankruptcy court found that the plan was proposed in good faith, but expressly excluded evidence regarding how the debts arose: "The State's attempt to persuade the Court to consider pre-petition activities is improper.... [T]he important point of inquiry upon confirmation of a Plan is the Plan itself. A debtor's prepetition activities do not enter into the Court's

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evaluation." The bankruptcy court did not discuss whether the petition was filed in good faith.

The State appealed the bankruptcy court's confirmation to the district court. The district court affirmed. In re Smith, No. IP 85-1700-C (S.D.Ind. Sept. 26, 1986). The district court did briefly discuss whether Smith filed his petition in bad faith and held that as a matter of law the fact that a debtor proposes to discharge a debt that would be nondischargeable under Chapter 7 is not by itself sufficient for finding that the petition was filed in bad faith. In addition, Smith did not dispute the amount or validity of the debt he owed to the State, and did not file the petition to stall pending litigation. Therefore, the district court reasoned, "the Bankruptcy Court's failure to find that the Chapter 13 petition was filed in bad faith was not an abuse of discretion." ² The court went on to hold that the bankruptcy court correctly did not consider Smith's pre-petition conduct in determining whether the plan was proposed in good faith, and that the bankruptcy court did not abuse its discretion in finding that Smith's plan was proposed in good faith. ³

III. JURISDICTION

Jurisdiction in the bankruptcy court was proper pursuant to 28 U.S.C. Sec. 157 and 28 U.S.C. Sec. 1334. Sec. 157(b)(2)(L) provides that confirmation of a plan is a "core proceeding." Under Sec. 157(b)(1) bankruptcy judges may hear and determine all core proceedings and may enter final judgments in those proceedings. Jurisdiction in the district court was proper pursuant to 28 U.S.C. Sec. 158(a) and is proper in this court pursuant to 28 U.S.C. Sec. 158(d). See 5 King, Collier on Bankruptcy paragraphs 1300.20 to 1300.21 (15th ed. 1988).

IV. ANALYSIS

A.

"The purpose of chapter 13 is to enable an individual, under court supervision and

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protection, to develop and perform under a plan for the repayment of his debts over an extended period." H.R.Rep. No. 95-595, 95th Cong., 1st Sess. 118 (1977), reprinted in 1978 U.S.Code Cong. & Admin.News 5963, 6079. "The premises of the bill ... are that use of the bankruptcy law should be a last resort; that if it is used, debtors should attempt repayment under chapter 13, ... and finally, whether the debtor uses chapter 7 ... or chapter 13, ... bankruptcy relief should be effective, and should provide the debtor with a fresh start." H.R.Rep. No. 95-595, supra, at 118, reprinted in 1978 U.S.Code Cong. & Admin.News at 6078-79. See 5 Collier on Bankruptcy, supra, paragraphs 1300.01 to 1300.02; In re Rimgale, 669 F.2d 426, 427 (7th Cir.1982).

" 'The good faith requirement is one of the central, perhaps the most important confirmation finding to be made by the court in any Chapter 13 case.' " Rimgale, supra, 669 F.2d at 431 n. 14 (quoting In re Kull, 12 B.R. 654, 658 (S.D.Ga.1981), aff'd sub nom. In re Kitchens, 702 F.2d 885 (11th Cir.1983)). Yet "[t]he term, 'good faith,' is not defined in the Code or in its legislative history, and courts have said that no precise or comprehensive definition is possible." In re Hawes, 73 B.R. 584, 587 (Bankr.E.D.Wis.1987). See In re Chaffin, 816 F.2d 1070, 1073 (5th Cir.1987), modified on reconsideration on other grounds, 836 F.2d 215 (5th Cir.1988). As accurately summarized by one recent case:

The...