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How an Unwary Debtor Caused the Dismissal of a Chapter 11 Bankruptcy Case
Bankruptcy is like being in a lobster trap. They are both easy to get into, difficult to move around in once inside, and difficult to get out of. This concept is particularly true when it concerns a chapter 11 bankruptcy. Filing for chapter 11 bankruptcy requires an experienced attorney at the helm to help steer the debtor around trouble.
Scenario: The Unwary Debtor
In a recent case, an unwary debtor filed chapter 11 and was guided by a non-bankruptcy attorney. The debtor neglected to take the required credit counseling prior to filing. In order to avoid a certain dismissal, the debtor checked the box on the petition stating that he was incapacitated, asserting that he had “a mental illness or mental deficiency that makes me incapable of realizing or making rational decisions about finances.”
The debtor (and his attorney) failed to understand the implications of that claim, which coupled with the duties of a chapter 11 debtor-in-possession, made the debtor ineligible to be in control of his own future. The United States Trustee filed a motion to dismiss or convert the case to a case filed under chapter 7. The debtor’s bankruptcy petition clearly illustrated his inability to administer the bankruptcy estate.
Dismissal or Conversion of Chapter 11 Bankruptcy
The dismissal or conversion of a Chapter 11 bankruptcy proceeding is governed by Section 1112(b)(1) of the Bankruptcy Code, which provides as follows:
(b)(1) Except as provided in paragraph (2) and subsection (c), on request of a party in interest, and after notice and a hearing, the court shall convert a case under this chapter to a case under chapter 7 or dismiss a case under this chapter, whichever is in the best interests of creditors and the estate, for cause unless the court determines that the appointment under section 1104(a) of a trustee or examiner is in the best interests of creditors and the estate.
11 U.S.C. 1112(b)(1). The term “cause” has been defined in Section 1112(b)(4) of the Bankruptcy Code and includes:
(A) substantial or continuing loss to or diminution of the estate and the absence of a reasonable likelihood of rehabilitation
(B) gross mismanagement of the estate
(C) failure to maintain appropriate insurance that poses a risk to the estate or to the public
(D) unauthorized use of cash collateral substantially harmful to one or more creditors
(E) failure to comply with an order of the court
(F) unexcused failure to satisfy timely any filing or reporting requirement established by this title or by any rule applicable to a case under this chapter
(G) failure to attend the meeting of creditors convened under section 341(a) or an examination ordered under rule 2004 of the Federal Rules of Bankruptcy Procedure without good cause shown by the debtor
(H) failure timely to provide information or attend meetings reasonably requested by the United States trustee (or the bankruptcy administrator, if any)
(I) failure timely to pay taxes owed after the date of the order for relief or to file tax returns due after the date of the order for relief
(J) failure to file a disclosure statement, or to file or confirm a plan, within the time fixed by this title or by order of the court
(K) failure to pay any fees or charges required under chapter 123 of title 28
(L) revocation of an order of confirmation under section 1144
(M) inability to effectuate substantial consummation of a confirmed plan
(N) material default by the debtor with respect to a confirmed plan
(O) termination of a confirmed plan by reason of the occurrence of a condition specified in the plan
(P) failure of the debtor to pay any domestic support obligation that first becomes payable after the date of the filing of the petition.
As illustrated by the In re Shar court, the legislative history of this section explains:
[s]ubsection (b) gives wide discretion to the court to make an appropriate disposition of the case when a party in interest requests. The court is permitted to convert a reorganization case to a liquidation case or to dismiss the case, whichever is in the best interest of creditors and the estate, only for cause. Cause may include…[the ten factors listed in § 1112(b)]. The list is not exhaustive. The court will be able to consider other factors as they arise, and to use its equitable powers to reach an appropriate result in individual cases.
In re Shar, 253 B.R. 621, 628 (Bankr. D.N.J 1999) (citing H.R. Rep. No. 595, 95th Cong., 1st Sess. 405-06(1977), U.S. Code Cong. & Admin. News 5963, 6361-62 (1977)). The enumerated list is non-exclusive. Matter of Newark Airport/Hotel Ltd. Partnership, 156 B.R. 444, 448 (Bankr. D.N.J. 1993) (“Though lack of ‘good faith’ is not included in the list of ‘causes’ in § 1112(b), that list is not exhaustive and it is generally agreed that lack of ‘good faith’ is sufficient ‘cause’ for dismissal or conversion.”)(emphasis added)). “If cause exists, the court must determine whether conversion or dismissal is in the best interest of the estate and its creditors.” In re Biolitec, Inc., 528 B.R. 261, 267 (Bankr. D.N.J. 2014). “Dismissal may be appropriate where a debtor’s assets have been liquidated and there is nothing left to reorganize.” In re Biolitec, Inc., 528 B.R. at 267.
In the present case, the debtor did not have the mental capacity to manage the bankruptcy estate. As supported by the Debtor’s bankruptcy petition, the Debtor stated he’s not required to receive a briefing about creditor counseling as a result of “Incapacity – I have a mental illness or a mental deficiency that makes me incapable of realizing or making rational decisions about finances.”
Because there were assets to administer and creditors (one represented by me) that argued that conversion to chapter 7 was in the best interest of creditors, the Bankruptcy Court agreed that dismissal was inappropriate and converted this case to Chapter 7, whereby a fiduciary can be appointed to properly maintain the bankruptcy estate.
If you're considering bankrupcy, make sure you check all the right boxes by contacting an experience bankruptcy attorney in New Jersey.
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