By Vijay Malik, 2012 J.D. Candidate

Section 348(f)(2) states that in a conversion from Chapter 13, the property of the estate is the property at the time of conversion unless there is “bad faith.”  What is “bad faith” in this context? Let’s take a look at what four courts have held.

The Court in In re Carter, 260 BR 130 (B.W.D. Tenn. 2001) held that life insurance proceeds received by the Debtor shortly after conversion to Chapter 7 but more than 180 days after filing of the Chapter 13 petition were not property of the Chapter 7 estate.  The Court said that conversions should not be deemed to be made in “bad faith” solely because the Debtor could not make payments under the Chapter 13 plan.

The Court in In re Mullican, 417 BR 389 (B.E.D.Tex. 2008) held that conversion to Chapter 7 was done in bad faith when the Debtor received an inheritance more than 180 days after filing. The Court considered it bad faith that the Debtor’s attempt to convert the case rather than devote the inheritance to payment of its Chapter 13 creditors.

The Court in In re Bejarno, 302 BR 559 (B.N.D. Ohio 2003), held that bad faith under § 348(f) required “nefarious planning,” and that the tax refunds and proceeds from an injury claim received by the Debtors prior to conversion but after the filing of the petition did not become property of the Chapter 7 estate.  Because only a small portion of the tax refund and injury claim was likely to be non-exempt, the Court doubted the Debtors had participated in “nefarious planning.”

The Court in In re Brinkley, 323 BR 685 (B.W.D.Ark. 2005) held that although life insurance proceeds received during a Chapter 13 would be property of the estate regardless of whether they were received within 180 days of the petition date, by virtue of §348(f) these funds were not property of the estate once the case was converted to Chapter 7.

In In re Carter, a debtor-wife became entitled to life insurance proceeds following the death of her debtor-husband.  The case was filed more than 180 days prior to the death of the debtor-husband and consequently the debtor-wife obtained her interest in the proceeds outside of bankruptcy’s 180 day window.  The court reasoned that “courts should not find that a bad-faith conversion exists if debtor is unable to complete a Chapter 13 plan due to a change in circumstances or financial hardship.”

The Court in In re Brinkley held similarly:  “Life insurance proceeds that were received by debtor-wife under deceased debtor-husband’s life insurance policy after 180-day period in which Bankruptcy Code treated life insurance benefits as estate property, but before debtors’ case was converted to case under Chapter 7, became property of Chapter 13 estate only as a result of statute that included in Chapter 13 estate any property acquired by debtors during pendency of Chapter 13 case, and therefore policy proceeds were not property of the estate upon case conversion, given absence of allegation or evidence that case was converted in bad faith.”

However, the court in In re Mullican, held “debtors’ bad faith in converting their Chapter 13 case to case under Chapter 7 after debtor-husband lost his job, despite fact that debtor-husband had also inherited a sum sufficient from his late mother that they could easily have satisfied their plan obligations in full, in deliberate attempt to avoid paying unsecured creditors even the minimal 1.04% dividend that they had agreed to pay in their confirmed plan, was sufficient to trigger statutory “bad faith” exception to general rule that property acquired postpetition is not included in property of the estate upon conversion.”  The Court looked past a superficial “change in circumstances” (job loss) to the debtor’s financial position due to the windfall.  Accordingly, because the debtor could have satisfied plan obligations in full, and because the debtor attempted to avoid paying unsecured creditors only approximately 1% of their claims, the Court found bad faith under a totality of the circumstances analysis.  This case is closer to the “nefarious planning” as discussed in In re Carter.

Mr. Malik is a law student at Creighton University in Omaha, Nebraska. Prior to law school, Mr. Malik worked in real estate private equity and investing banking for various firms in New York and Washington, D.C.