Yesterday the Supreme Court decided Marrama v. Citizens Bank of Massachusetts. The issue was whether an individual debtor has an absolute right to convert his case from Chapter 7 to Chapter 13, or whether the Bankruptcy Judge has the power to deny the conversion if it was in “bad faith” and therefore would be an abuse of the bankruptcy process. The Court held 5-4 with Stevens writing that the conversion could be denied, with Alito writing a dissent.
My view is that the Court reached the right result, but turned what should have been an easy case into a much more difficult and close case than it should have been, and in so doing, wrote an unnecessarily confused opinion. The problems with the opinions in the case arise from a failure to fully consider the policy and context of the key statutory provisions in the case and the legislative context in which they were enacted.
Even after reading the briefs awhile back and the opinion a couple of times, I confess that the precise timeline of the facts in the case are a bit murky to me. But the precise timing is not as important as the debtor’s basic behavior in the case. As I understand it, sometime before filing his initial bankruptcy case Marrama transferred his sole asset of value, a home in Maine, into a self-settled trust, and then on his schedules he declared that the value of his interest in the trust was zero. This wasn’t Marrama’s only willful misrepresentation in the case, as Stevens notes, but the biggest one. At his 341 hearing, the trustee told Marrama that he intended to recover the Maine property as property of the estate (and presumably would seek to deny his discharge as well). Marrama chalked up the omission to a “scrivener’s error” to which the Bankruptcy Judge later ruled that there is no “Oops” defense to the concealment of assets in bankruptcy.
Once Marrama was busted by the trustee, he decided to convert his case to Chapter 13. I am a bit unclear about how his scam was going to work (please help me out in the comments if I don’t have this exactly right), but my understanding is that it was something like this–once Marraama was busted, he knew the concealed property would be recovered for the estate and he would probably lose his discharge. By converting to Chapter 13, he could retain the property and by refiling correct schedules, he figured he wouldn’t be subject to any concerns about losing his discharge. So the idea is that he would use his initial filing in Chapter 7 as his “one free bite at the apple” of committing bankruptcy fraud, and then if he got busted, he would flip over to 13 with no consequences. I suspect that it is this “one free bite” aspect of the racket and the possibilities for fraud and abuse that led Justice Stevens to note in his opinion that this is “an issue that has arisen with disturbing frequency.”
The opinions themselves are a thicket of textualism. I will not parse them here, as I don’t have much to add to those densely-reasoned textual opinions. The basic textual issue turns on the interpretation of sections 706(a) and (d) of the Bankruptcy Code, which provide:
(a) The debtor may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title. Any waiver of the right to convert a case under this subsection is unenforceable.
(d) Notwithstanding any other provision of 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.
The question in the case is whether the seemingly unqualified language of section (a) (“the debtor may convert”) gives a bankruptcy debtor an absolute right to convert once from Chapter 7 to Chapter 13 unless one of the of the precise conditions enumerated there are triggered–e.g., that the debtor can convert only once and that the debtor may be a debtor under the chapter to which he is converting. Justice Alito’s dissent rests on the argument that this language is unambiguous and exhaustive, “The Code restricts, a Chapter 7 debtor’s conversion right in two–and only two–ways.” Since bad faith conversions are not specifically enumerated, they are permitted.
Justice Stevens’s majority opinion is premised on the observation that Bankruptcy Judges have long held equitable power to prevent fraudulent and inequitable use of the bankruptcy system, a power that is reflected in numerous provisions of the Bankruptcy Code, particularly section 1307(c) which permits the Bankruptcy Court to dismiss or convert a Chapter 13 case “for cause,” which has been interpreted to include filings made in bad faith. Bankruptcy proceedings are equitable proceedings and I think that Justice Stevens is correct in his recognition of the power of Bankruptcy Judges to prevent bad faith abuse of bankruptcy and the longstanding nature of the power. So while I am not surprised by the outcome in the case, which I think is obviously correct, I am surprised only by how close the vote was.
Textualist opinions by the Supreme Court are often denounced as “wooden” and I think the opinions in Marrama evidence that. This does not seem like a difficult question from the perspective of bankruptcy law and policy. I think what made this a close case is that none of the Justices appear to have even tried to think through the bankruptcy questions that underlie the question.
In my view, the question in this case is pretty straightforward. Justice Alito writes a standard textualist opinion–here’s a list of Code provisions, denial of conversion for bad faith isn’t on it, and the Code provides other roundabout ways of punishing a bad faith conversion:
In sum, the Code expressly gives a debtor who initially files under Chapter 7 the right to convert the case to another chapter so long as the debtor satisfies the requirements of the destination chapter. By contrast, the Code pointedly does not give the bankruptcy courts the authority to deny conversion based on a finding of “bad faith.” There is no justification for disregarding the Code’s scheme.
But note what is lacking from Alito’s rationale–although he states that there is “no justification for disregarding the Code’s scheme” nowhere does he offer any explanation (plausible or otherwise) for why Congress would have possibly wanted to permit bad-faith conversions or to deny Bankruptcy Judges the power to prevent a bad faith conversion. Instead, he simply starts with the premise that Code gives the debtor an absolute right to convert once. If the conversion is in bad faith, Alito speculates that the Court could convert it back immediately “for cause” under section 1307(c), assuming that all of the requirements could be met. But all of the requirements enumerated there seem to apply only to defects in the Chapter 13 filing, and don’t seem to address the fraud in the initial Chapter 7 filing (which is presumably why Marrama immediately filed in Chapter 13, because he thought he could cleanse his concealment by converting).
The problem with reading the statutory provisions in the narrow textualist manner as Alito does is that the reading is stripped of its context (of course, the majority opinion is no better on this point). Again, is there any reason to believe in this section that Congress desired to remove from Bankruptcy Judges the power to prevent bad faith abuse of the bankruptcy courts? Did Congress really intend the debtor to have an absolute power as of right to convert his case once?
The premise of this claim that there is an absolute power to convert resides in one piece of legislative history that Marrama relied on heavily in the case (as does Alito):
Petitioner contends that subsection (a) creates an unqualified right of conversion. He seeks support from language in both the House and Senate Committee Reports on the provision. The Senate Report stated:
“Subsection (a) of this section gives the debtor the one-time absolute right of conversion of a liquidation case to a reorganization or individual repayment plan case. If the case has already once been converted from chapter 11 or 13 to chapter 7, then the debtor does not have that right. The policy of the provision is that the debtor should always be given the opportunity to repay his debts, and a waiver of the right to convert a case is unenforceable.” S. Rep. No. 95–989, p. 94 (1978); see also H. R. Rep. No. 95–595, p. 380 (1977) (using nearly identical language).
This passage has been read to express Congress’s intent that the debtor be given an absolute one-time right to convert–“Subsection (a) of this section gives the debtor the one-time absolute right of conversion of a liquidation case to a reorganization or individual repayment plan case.” But I believe that this is a misreading of the legislative history, and again, I think the misreading arises from a failure to consider the context of the statement. And specifically here, the legislative and historical context, and that the final sentence of this passage actually reflects an important qualification on the “absolute” language at the beginning, a qualification that only emerges from a consideration of the legislative context.
When Congress enacted the 1978 Code, Chapter 13 was a relatively novel process. So-called “wage-earner” plans (predecessors to Chapter 13) had developed spontaneously and piecemeal under the Bankruptcy Act, and in providing for Chapter 13 in the Bankruptcy Code, Congress intended to try ratify, formalize, and regularize the use of Chapter 13. Moreover, Congress wanted to make clear that debtors could elect to file Chapter 13 if they desired and Congress was expressing a goal of encouraging willing debtors to do so. But given the relative novelty of Chapter 13, Congress could not exactly foresee exactly how Chapter 13 would play out in practice.
But one thing is clear from reading the legislative history of the entire Code–Congress believed that the primary reason why debtors would use Chapter 13 (and precisely why Congress wanted to encourage its use in the 1978 Code) was to permit debtors to repay their debts if they wanted to. Why state the proposition as an “absolute right to convert?” Again, reading the legislative history of the Code as a whole, it is because Congress wanted to give debtors the right to try to repay their debts, even if a bankruptcy judge thought it was foolish and that the debtor would be better off in chapter 7 instead. This was an effort to permit debtors who wanted to try to “live up to their moral obligations” to do so, even if meant that they were foregoing the easier ride of Chapter 7.
Why does all of this matter? Consider now the rest of the legislative history applicable to Marrama–“The policy of the provision is that the debtor should always be given the opportunity to repay his debts, and a waiver of the right to convert a case is unenforceable.” Thus the legislative history expressly states, “The policy of the provision is that the debtor should always be given the opportunity to repay his debts.” A debtor who is seeking to convert to chapter 13 in bad faith, such as Marrama, is quite plainly not seeking to convert for the purpose of being given an opportunity to repay his debts, thus the expressly stated policy of the purported absolute right to convert would not be advanced by permitting conversion in such a case.
In other words, in creating a supposed “absolute right to convert” Congress anticipated at the time that those debtors who would be using Chapter 13 under the “new” Code would be only those who were doing so only to repay their debts, and this was the express policy of permitting conversion. And this understanding is manifest throughout the language and structure of Chapter 13. Congress sought to regulate the more obvious abuses that could be anticipated under Chapter 13, such as plans where the debtor would actually pay less than under Chapter 7.
So it seems evident that Congress simply did not anticipate that a debtor might try to use conversion as a tool of bad faith abuse as Marrama did here. All Congress seems to have had in mind would be good faith debtors, not bad faith, so it didn’t anticipate abuse of the conversion right (even now the scam itself is not obvious). So, instead, Congress simply expressed that the policy of the section was to enable good faith debtors to convert, thereby implying that this was the condition on the absolute right to convert.
And this explains why Alito can point to no policy purpose that would be advanced by permitting bad faith conversions, because Congress’s policy was to permit only good faith conversions.
And so what about bad faith conversions? Well, here Stevens has it exactly right–given that Congress only meant to permit good faith conversions, and didn’t (and couldn’t) anticipate all bad faith conversions, bad faith conversions could be policed by the Bankruptcy Court’s ancient and well-established repository equitable powers to prevent bad faith abuse of the bankruptcy process. On this point, then, Stevens is correct.
In the end, the Court fortunately ended up reaching the correct result in the case, although it was only a close case because both the majority and the dissent take a wooden approach to statutory interpretation that didn’t consider the context, and that the outcome would have made more sense had they done so.
Update:
One of the Comments provides a useful explanation for why the debtor may have sought conversion to Chapter 13:
Second, and more likely in my view, is that he knew if he stayed in Chapter 7, the trustee would liquidate the assets he fraudulently transferred. A debtor does not have a unilateral right to dismiss a Chapter 7 case, and remaining in 7 would certainly lead to liquidation — especially in light of the provision of the BK code that says a debtor cannot exempt fraudulently transferred assets. However, if a debtor in Chapter 13 fails to file a confirmable plan, or fails to make the plan payments, the case is usually dismissed. I think this was his goal. So Marrama, knowing the trustee represented a speeding locomotive headed down the tracks squarely at him, simply wanted to jump off the tracks, even if it meant having to deal with his creditors one by one. Perhaps his state exemption law would additionally not bar him from exempting the fraudulently transferred assets.
Update:
Also, to be clear–I don’t believe I’m making an argument that the Court should prefer policy analysis to plain language (and don’t intend to do so). After all, both the majority and the dissent’s opinions are grounded in plain language and both are plausbible. The question is what to do with the silence in sec. 706 about whether the silence as to a bad faith exception excludes reading the language against this background assumption of judicial equitable power. So I’m simply saying that given that both readings are plausible, only one of the two makes any sense when read in the context of the legislative history and policy purpose of the statutory language and explains the particular structure of the statute in a way that makes sense. Instead, the dissent’s opinion misunderstands the legislative history to justify its interpretation of the statutory silence as implying an absolute right to convert, so my quibble is not with textualism per se, but the use of legislative context. I’ve never understood textualism to imply that one should ignore the context and purposes of the statute.