§ 146.3     Incentives to Convert to Chapter 11 after BAPCPA
Cite as:    Keith M. Lundin, Lundin On Chapter 13, § 146.3, at ¶ ____, LundinOnChapter13.com (last visited __________).
[1]

When conversion or dismissal are the only options, BAPCPA encourages Chapter 13 debtors to consider converting to Chapter 11.

[2]

Section 1307(d) was not amended by BAPCPA:

(d) Except as provided in subsection (e) of this section, at any time before the confirmation of a plan under section 1325 of this title, on request of a party in interest or the United States trustee and after notice and a hearing, the court may convert a case under this chapter to a case under chapter 11 or 12 of this title.1
[3]

After amendment by BAPCPA, “subsection (e)” of § 1307 mandates conversion or dismissal of a Chapter 13 case upon the failure of the debtor to file a tax return under § 1308.2 Prior to BAPCPA, subsection (e), now subsection (f), provided that the bankruptcy court “may not convert a case under this chapter to a case under chapter 7, 11, or 12 of this title, if the debtor is a farmer, unless the debtor requests such conversion.”3 It seems likely that the drafters of BAPCPA failed to change the cross-reference in § 1307(d) to “subsection (f)” when former subsection (e) was bumped down to subsection (f).

[4]

Technicalities aside, at any time before confirmation a Chapter 13 case can be converted to Chapter 11 and there may be decent reasons to do so. Of course, most consumer Chapter 13 debtors cannot command the resources necessary to negotiate a Chapter 11 case. But wealthier Chapter 13 debtors—especially those that are self-employed or engaged in business—should give Chapter 11 a look before converting to Chapter 7 or dismissing the Chapter 13 case altogether.

[5]

One new incentive to consider conversion to Chapter 11 is the disparate effect of conversion on secured claims under § 348(f). As amended by BAPCPA, § 348(f)(1)(B) provides that when a Chapter 13 case is converted to another chapter:

(B) valuations of property and of allowed secured claims in the chapter 13 case shall apply only in a case converted to a case under chapter 11 or 12, but not in a case converted to a case under chapter 7, with allowed secured claims in cases under chapters 11 and 12 reduced to the extent that they have been paid in accordance with the chapter 13 plan.4
[6]

Chapter 13 debtors with manageable property valuations or who have been in Chapter 13 long enough to make meaningful payments to secured claim holders will lose those valuations and will not reduce allowed secured claims to the extent paid during the Chapter 13 case at conversion to Chapter 7. Under § 348(f)(1)(B) at conversion from Chapter 13 to Chapter 11, valuations of property and allowed secured claims during the Chapter 13 case “shall apply” and allowed secured claims in the Chapter 11 case will be “reduced to the extent that they have been paid in accordance with the chapter 13 plan.” These can be substantial benefits that are preserved at conversion to Chapter 11 but not at conversion to Chapter 7.

[7]

Given that conversion from Chapter 13 to Chapter 11 is only permitted before confirmation of a plan,5 it is a bit odd that new § 348(f)(1)(B) preserves the reduction of secured claims to the extent “paid in accordance with the Chapter 13 plan” at conversion to Chapter 11. New § 348(f)(1)(B) does not say “confirmed” Chapter 13 plan, offering the construction that payments to a secured claim holder before confirmation in accordance with the proposed plan might qualify. Because of new § 1326(a)(1)(C),6 there will be preconfirmation payments to lienholders in many Chapter 13 cases. Perhaps § 348(f)(1)(B) will be interpreted to reduce allowed secured claims at conversion to Chapter 11 to the extent preconfirmation “adequate protection” payments were made during the Chapter 13 case.

[8]

Even if the Chapter 11 case fails after conversion from Chapter 13 to Chapter 11, it is arguable that the valuations of property and allowed secured claims in the original Chapter 13 case carry through the Chapter 11 case and allowed secured claims that were reduced by payments in accordance with the Chapter 13 plan control notwithstanding a subsequent (second) conversion from Chapter 11 to Chapter 7. This might be true because there is no statutory provision like § 348(f)(1) that addresses the effects of conversion from Chapter 11 to Chapter 7—valuations and claims allowance during the Chapter 11 case (or during a prior Chapter 13 case) are not invalidated. This raises the argument that Chapter 13 debtors are better off converting from Chapter 13 to Chapter 11 when there is any reasonable prospect of accomplishing a reorganization in Chapter 11. If that prospect subsequently evaporates, the debtor is best positioned to argue that redemption and other issues in the Chapter 7 case are controlled by valuations of property and of allowed secured claims in the Chapter 13 case two conversions earlier.

[9]

The debtor’s good faith will certainly be at issue if the first conversion from Chapter 13 to Chapter 11 is without prospect of reorganization. A bad-faith conversion from Chapter 13 to Chapter 11 solely for the purpose of further conversion to Chapter 7 is likely to draw sanctions and other troubles not worth whatever benefits are hidden in § 348(f)(1)(B).

[10]

At conversion from Chapter 13 to Chapter 11, new § 348(f)(1)(C) will also apply. Under new § 348(f)(1)(C)(i), a lienholder continues to be secured after conversion from Chapter 13 to any other chapter unless the full amount of the lienholder’s claim “determined under applicable nonbankruptcy law” was paid before conversion, notwithstanding any valuation or determination of the amount of an allowed secured claim during the Chapter 13 case.7 Under new § 348(f)(1)(C)(ii), unless a prebankruptcy default was “fully cured” during the Chapter 13 case, at conversion to Chapter 11, that prebankruptcy default has the effect given by nonbankruptcy law.8

[11]

These two new provisions dampen the benefits of conversion from Chapter 13 to Chapter 11 when payments were made on account of allowed secured claims but lienholders were not paid their full nonbankruptcy entitlements before conversion. This is likely to be true in every Chapter 13 case converted to Chapter 11 (or any other chapter). The effect of these new provisions in the converted case is less certain.

[12]

If a Chapter 13 debtor converts to Chapter 11 after an undersecured claim was bifurcated based on the value of the collateral, that valuation will apply in the Chapter 11 case and payments during the Chapter 13 case consistent with the plan will reduce the allowed secured claim. But after conversion that same creditor “shall continue to be secured” by the collateral to the full amount of its claim “determined under applicable nonbankruptcy law” because that claim was not paid before conversion. Both of these things are true under § 348(f)(1)(B) and (C), as amended by BAPCPA.

[13]

It is not clear what it means that valuations of property and of allowed secured claims apply in the Chapter 11 case and allowed secured claims are reduced to the extent paid in accordance with the Chapter 13 plan when the “unsecured” portion of a crammed down debt from the Chapter 13 case continues to be secured by the collateral. New § 348(f)(1)(C)(i) could be interpreted to drain new § 348(f)(1)(B) of content at conversion from Chapter 13 to Chapter 11 with respect to any undersecured claim that was valued during the Chapter 13 case.

[14]

New § 348(f)(1)(C) could be read to upset the effects of § 348(f)(1)(B) if the Chapter 13 case converts to Chapter 11 and then to Chapter 7 and the debtor seeks to redeem property under § 722. Although the allowed secured claim was reduced by payments in accordance with the Chapter 13 plan before conversion from Chapter 13 to Chapter 11 under § 348(f)(1)(B), unless the secured claim was paid in full before that first conversion, the lienholder continues to be secured to the full amount of its nonbankruptcy debt under § 348(f)(1)(C)(i).

[15]

Section 722 speaks of redemption by paying the lienholder the amount of the “allowed secured claim.” What is the amount of the allowed secured claim when there has been a conversion from Chapter 13 to Chapter 11 and then to Chapter 7 and both § 348(f)(1)(B) and (f)(1)(C)(i) are in play? Imagine a $10,000 debt secured by personal property valued at $6,000 during the Chapter 13 case. The secured claim would be limited to the $6,000 value of the collateral and the $4,000 balance of the debt would be an unsecured claim. Assume $1,500 of the $6,000 secured claim is paid during the Chapter 13 case before conversion. None of the $4,000 unsecured claim was paid.

[16]

At conversion, the collateral is now worth $5,000. If the debtor converts directly to Chapter 7 and moves to redeem the collateral under § 722, what would be the redemption amount? Under § 348(f)(1)(B), valuations of property and of allowed secured claims in the Chapter 13 case do not apply in a case converted to Chapter 7 and allowed secured claims are not reduced to the extent that they were paid in accordance with the Chapter 13 plan. Because the full amount of the lienholder’s claim determined under nonbankruptcy law ($10,000) was not paid before conversion, the entire debt continues to be “secured” by the collateral under § 348(f)(1)(C). After conversion to Chapter 7, the $8,500 that has not been paid to the lienholder is secured by collateral worth $5,000 and the debtor would have to pay $5,000 to redeem the collateral in the Chapter 7 case.

[17]

What would be the redemption amount if the debtor first converts to Chapter 11 and then to Chapter 7? Under § 348(f)(1)(B), the $6,000 valuation of the collateral would “apply” in the Chapter 11 case and the allowed secured claim of the lienholder ($6,000) would be reduced by the $1,500 paid during the Chapter 13 case. Going into the Chapter 11 case, the lienholder has a $4,500 allowed secured claim and an $8,500 debt determined under nonbankruptcy law.

[18]

But because the entire $10,000 debt was not paid in full at conversion from Chapter 13 to Chapter 11, the claim of the lienholder (balance of $8,500) continues to be “secured” by the collateral. So, what is the allowed secured claim for purposes of redemption under § 722 when the Chapter 11 case is converted to Chapter 7? The debtor has an argument that nothing in the Bankruptcy Code undoes the valuation and allowance of the secured claim that came out of the Chapter 13 case. By this logic, the debtor can redeem after the second conversion for $4,500. Based on § 348(f)(1)(C)(i), the lienholder will argue that its $8,500 claim is secured by collateral worth $5,000 and § 348(f)(1)(C) trumps § 348(f)(1)(B) when a Chapter 13 case is converted to Chapter 11 and then to Chapter 7.

[19]

Perhaps the debtor has the better of this dispute given the specificity with which new § 348(f)(1)(B) preserves the effects of the Chapter 13 case at conversion to Chapter 11. There is no provision in new § 348(f) similar to subparagraph (C)(i) that is applicable at conversion from Chapter 11 to Chapter 7. Congress focused in BAPCPA on “continuing” the lien of a secured creditor at conversion from Chapter 13 to Chapter 7 notwithstanding payment of some or all of the allowed secured claim during the Chapter 13 case prior to conversion. There is no similar protection for lienholders in § 348(f) at conversion from Chapter 11 to Chapter 7.

[20]

Ironically, the positions of the debtor and the lienholder in this example reverse when the payments made during the Chapter 13 case are less than the reduction in value over time as a result of depreciation. If only $500 was paid to the holder of the $6,000 secured claim before conversion from Chapter 13, the debtor would be “better” off in Chapter 7 when the allowed secured claim would be $5,000 for redemption purposes.

[21]

It is at least interesting that the House Report states a more limited effect for new § 348(f)(1)(C): “If the Chapter 13 case is converted to one under Chapter 7, then the creditor holding security as of the petition date shall continue to be secured unless its claim was paid in full as of the conversion date.”9 New § 348(f)(1)(C) is not written with the limitation that creditors continue to be secured only at conversion from Chapter 13 to Chapter 7. Although new § 348(f)(1)(B) provides a different treatment at conversion to Chapter 11 or 12 than at conversion to Chapter 7, that distinction is not mentioned in new § 348(f)(1)(C). Is it possible that Congress did not intend to create tension between new § 348(f)(1)(B) and (C) at conversion to Chapter 11 or 12?

[22]

After conversion from Chapter 13 to Chapter 11, the debtor should be able to value and cram down claims that were entitled to special treatment during the Chapter 13 case. There is no special treatment in Chapter 11 for the 910-day PMSI car claims or claims secured by any other thing of value when the debt is incurred within a year of the petition of the sort described in the hanging sentence at the end of § 1325(a).10 BAPCPA did not restrict the application of § 506 or the use of cramdown to certain kinds of debts and collateral in a Chapter 11 case as BAPCPA did in a Chapter 13 case under the hanging sentence at the end of § 1325(a).

[23]

Section 348(f)(1)(B) provides that valuation of property and of allowed secured claims during the Chapter 13 case will apply at conversion to Chapter 11. With respect to 910-day PMSI car claims and claims secured by any other thing of value incurred within a year of the Chapter 13 petition, § 506 did not apply during the Chapter 13 case, and thus there would be no valuations of property or of allowed secured claims to apply at conversion to Chapter 11. There is twisted irony that at conversion from Chapter 13 to Chapter 11 (or 12), valuations of property and of allowed secured claims during the Chapter 13 case apply and allowed secured claims are reduced by payments made during the Chapter 13 case, but 910-day PMSI car claims and claims secured by any other thing of value when the debt was incurred within a year of the Chapter 13 petition forfeit the special protection from valuation and claim splitting they may have had during the Chapter 13 case after conversion to Chapter 11.

[24]

After conversion from Chapter 13 to Chapter 11, there are no rules to guide the debtor with respect to the filing of documents. The Official Form for an individual Chapter 11 debtor’s Statement of Current Monthly Income—Official Form B22B—is different from the Official Form used for that purpose by the Chapter 13 debtor—Official Form B22C.11 If the individual Chapter 11 case reaches confirmation after conversion from Chapter 13, a disposable income calculation consistent with § 1325(b)(2) may be necessary.

[25]

At conversion from Chapter 13 to Chapter 11, there is no Bankruptcy Rule that prescribes the effect of conversion on time periods in the Chapter 11 case. Interim Rule 1019 restarts many important time periods at conversion from Chapter 13 to Chapter 7,12 but that Rule is silent about conversion from Chapter 13 to Chapter 11.

[26]

This is a gap that the rules drafters might want to fill, especially with respect to the time period for filing a complaint objecting to the dischargeability of a debt under Bankruptcy Rule 4007. BAPCPA amended § 1328(a) to add as exceptions to discharge at the completion of payments in a Chapter 13 case debts of the sort described in § 523(a)(2) and (a)(4).13 Under Bankruptcy Rule 4007, the holder of a claim that might be nondischargeable under § 523(a)(2) or (a)(4) must file a complaint to determine dischargeability within 60 days after the first date set for the meeting of creditors under § 341(a).14 Prior to BAPCPA, § 523(a)(2) and (a)(4) were not exceptions to discharge in a Chapter 13 case at the completion of payments under § 1328(a) and there was no reason to wonder whether the deadline for filing a complaint under Bankruptcy Rule 4007 would restart at conversion from Chapter 13 to Chapter 11. Now the issue is alive and should be addressed by the Bankruptcy Rules.

[27]

If the 60-day period runs during the Chapter 13 case before conversion to Chapter 11, the debtor will argue that the creditor has had one bite at the Bankruptcy Rule 4007 apple and the 60-day time period should not restart just because the case was converted from Chapter 13 to Chapter 11. Creditors will respond that the incentives for filing complaints objecting to dischargeability under § 523(a)(2) or (a)(4) are different and less pressing in a reorganization case, thus the time period should restart when a Chapter 13 case is converted to Chapter 11. Different and perhaps clearer policy is implicated when there is a Chapter 7 case somewhere in the stream of conversions.15

[28]

For the time being, because a discharge under Chapter 11 does not discharge an individual Chapter 11 debtor from any debt excepted from discharge by § 523,16 there will be creditors holding claims that might be nondischargeable under § 523(a)(2) and (a)(4) in either Chapter 13 or Chapter 11 and the effect of conversion on the 60-day deadline in Interim Rule 4007(c) could be a source of litigation. Debtors will argue that the first date set for the meeting of creditors referred to in Interim Rule 4007(c) is the meeting of creditors during the Chapter 13 case before conversion. The creditor holding a debt that might be nondischargeable under § 523(a)(2) or (a)(4) will point out that there is a first date set for the meeting of creditors in the Chapter 11 case after conversion from Chapter 13 that would restart the 60-day period under Interim Rule 4007(c). That Bankruptcy Rule 1019(2) specifically provides a new time period for filing a complaint objecting to the dischargeability of a debt under Bankruptcy Rule 4007 when a Chapter 13 case is converted to Chapter 7 and there is no similar provision at conversion of a Chapter 13 case to Chapter 11 is some evidence that a new time period does not commence under Interim Rule 4007(c) at conversion from Chapter 13 to Chapter 11.

[29]

For the legitimate converter, Chapter 11 after BAPCPA may be more hospitable than before. Detailed elsewhere,17 BAPCPA significantly amended Chapter 11 with respect to individual debtors. In particular, new § 1129(a)(15), together with amended § 1129(b)(2)(B)(ii), rework the absolute priorities rule at confirmation to permit an individual Chapter 11 debtor to retain property of the estate over the objections of a class of unsecured claims when the plan distributes property valued at not less than five years of projected disposable income as defined in § 1325(b)(2).18 These modifications to the basic rules for confirmation will make Chapter 11 a realistic possibility for more debtors who own small businesses and live out of those businesses. Chapter 13, of course, remains the less complicated of the two chapters, but for a debtor who has attempted a Chapter 13 case that is not working, conversion to Chapter 11 will be more attractive than before BAPCPA.


 

1  11 U.S.C. § 1307(d), discussed in § 321.1 [ Standing, Procedure and Grounds for Conversion to Chapter 11 ] § 146.1  Standing, Procedure and Grounds for Conversion to Chapter 11.

 

2  11 U.S.C. § 1307(e), discussed in § 529.1 [ New Grounds for Conversion after BAPCPA ] § 141.4  Cause for Conversion Added or Changed by BAPCPA.

 

3  11 U.S.C. § 1307(f), formerly subsection (e).

 

4  11 U.S.C. § 348(f)(1)(B), also discussed in § 533.1 [ Lienholders’ Rights at Conversion under § 348(f) ] § 145.3  Lienholders’ Rights at Conversion under § 348(f) after BAPCPA.

 

5  See 11 U.S.C. § 1307(d), quoted above.

 

6  11 U.S.C. § 1326(a)(1)(C), discussed in § 401.1 [ Preconfirmation Payments ] § 44.6  Preconfirmation Payments after BAPCPA.

 

7  11 U.S.C. § 348(f)(1)(C)(i), discussed in § 533.1 [ Lienholders’ Rights at Conversion under § 348(f) ] § 145.3  Lienholders’ Rights at Conversion under § 348(f) after BAPCPA.

 

8  11 U.S.C. § 348(f)(1)(C)(ii), discussed in § 533.1 [ Lienholders’ Rights at Conversion under § 348(f) ] § 145.3  Lienholders’ Rights at Conversion under § 348(f) after BAPCPA.

 

9  H.R. Rep. No. 109-31, at 85.

 

10  See 11 U.S.C. § 1325(a), discussed in § 451.1 [ In General: Modification Without § 506 ] § 75.1  In General: Modification Without § 506.

 

11  Official Form B22C is discussed in §§ 379.1 [ Form B22C: Statement of Current Monthly Income ] § 36.19  Form 122C-1: Statement of Current Monthly Income, 379.2 [ Form B22C: Commitment Period Calculation ] § 36.20  Form 122C-1: Commitment Period Calculation and 380.1 [ Form B22C: Disposable Income Calculation ] § 36.21  Form 122C-2: Disposable Income Calculation.

 

12  See Interim Bankr. R. 1019, discussed in § 530.1 [ New Deadlines and Filing Requirements after Conversion ] § 142.2  Deadlines and Filing Requirements at Conversion after BAPCPA.

 

13  See §§ 549.1 [ False Representations and Fraud: § 523(a)(2) ] § 159.2  False Representations and Fraud: § 523(a)(2) and 550.1 [ Fraud and Defalcation: § 523(a)(4) ] § 159.3  Fraud and Defalcation: § 523(a)(4).

 

14  Interim Bankr. R. 4007(c), discussed in § 544.1 [ Time for Determining Dischargeability of Debt ] § 156.3  Time for Determining Dischargeability of Debt.

 

15  See § 539.1 [ Reconversion to or from Chapter 13 ] § 150.2  Reconversion to Chapter 13 after BAPCPA.

 

16  See 11 U.S.C. § 1141(d)(2).

 

17  See § 8.5  Other Chapters Too Expensive, Too Complicated or Unfriendly.

 

18   See § 8.5  Other Chapters Too Expensive, Too Complicated or Unfriendly