Court found that there is a Bad Faith Exception to a Debtor’s Right to Dismiss a Chapter 13 case, and Converted Case to Chapter 7

Court found that there is a Bad Faith Exception to a Debtor’s Right to Dismiss a Chapter 13 case, and Converted Case to Chapter 7

The issue before the Court is whether a chapter 13 debtor has an absolute right to dismiss a case under § 1307(b) of the Bankruptcy Code where the debtor has acted in bad faith and failed to disclose property of the estate. After a voluntary dismissal of this case, the chapter 13 trustee moved to vacate the order of dismissal and reinstate the case.

The Debtor’s spouse tragically died in a fertilizer storage explosion on April 17, 2013, Texas. The Debtor and a minor child from a prior marriage survived him. After his death, the community provided donations to the Debtor, the decedent’s son, and the Debtor’s family. The Debtor also obtained proceeds from the decedent’s life insurance. Between the donations and life insurance proceeds, the Debtor received approximately $700,000. The Debtor spent all the money without accounting for property of the decedent and funds donated for the benefit of the decedent’s minor child, a child who resided with his biological mother after his father’s death.

The Debtor’s spouse died intestate. Under state law, two-thirds of the decedent’s separate property and half of the community property passed to his son. On April 27, 2016, the decedent’s father was appointed as administrator of the probate estate, and he requested an accounting from the Debtor for property owned by the decedent. Nine days later, the Debtor filed for bankruptcy protection under chapter 13, which stayed the probate claims against the Debtor and prevented the administrator from obtaining the Debtor’s financial records.

There were serious problems within the bankruptcy case. In her first and amended schedules, the Debtor failed to list multiple prepetition assets, including a jet ski, a trailer, and storage space. More importantly, although the Debtor listed “potential recovery of damages related to  explosion” as an asset, she failed to disclose a pending prepetition wrongful death lawsuit relating to the death of her deceased spouse. In her statement of financial affairs and under penalty of perjury, she stated she was not involved in any lawsuits within one year prior to the chapter 13 filing. She also testified that she lent money to several friends, but did not list any gifts or potential causes of action against third parties in her schedules. Inexplicably, the Debtor failed to list the probate estate administrator or the decedent’s son as a creditor.

In addition to failing to schedule or disclose the pending wrongful death lawsuit, the Debtor never filed an application to employ special counsel for up to four law firms, all of which were retained and signed prepetition contracts with the Debtor. These attorneys were aware of the bankruptcy case and consulted with the Debtor’s bankruptcy attorney, yet they never obtained approval for employment from the Court. They apparently attempted to circumvent the Court’s authority by bypassing the Debtor’s bankruptcy attorney and by advising the Debtor what to do within the bankruptcy case.

There were also problems with documentation provided to the chapter 13 trustee and plaintiffs in two adversary proceedings filed against the Debtor by the probate estate administrator and by the next friend of the decedent’s son. The problems were primarily due to the Debtor failing to produce bank records, deposit records, wire transfer records, copies of checks, proof of insurance, documentation of the decedent’s life insurance, records of vehicle transfers, and records of bills of sale for assets claimed by the probate estate administrator and the next friend of the decedent’s child. The Court compelled the Debtor to produce all documents on October 20, 2016, but seven months later, the trustee and adversary proceeding plaintiffs still had not received a number of documents.

The Debtor created further problems by never presenting a confirmable chapter 13 plan. On July 20, 2016, confirmation of the first plan was denied. The Court sustained the trustee’s objection to confirmation and issued an order instructing the Debtor to file a confirmable plan within a month or the case would be converted or dismissed. Ten months later, after extensive delays, the plan was still not confirmable because the Debtor was two months behind on trustee payments, her schedules were not complete, and the amended plan did not provide any of the necessary amendments. Moreover, during this period the Debtor failed to appear at multiple confirmation hearings.

One day before the final confirmation hearing, and the day she was supposed to accept the settlement offer, the Debtor filed a motion to dismiss her case and the Court, unaware of the negotiated settlement, granted the motion. The Debtor did not request approval of a compromise and settlement from the Court, nor did she disclose the settlement in her motion to dismiss. The trustee and the adversary proceeding plaintiffs objected to the dismissal of the case and requested that the case be reinstated as a chapter 13 case. At the hearing on the motion to reinstate the case, the Debtor testified that she and her personal injury lawyers had agreed to a $780,000 settlement against one defendant. She further testified that her non-court approved lawyers told her it was permissible to dismiss her case now that they had reached a settlement. Debtor’s bankruptcy counsel asserted that § 1307(b) provides an absolute right to dismissal. The Court disagreed, reinstated the case, and converted it to chapter 7, sua sponte.

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