622 B.R. 865
Bankr. S.D. Tex.2017Background
- Debtor Jorge C. Zamora-Quezada, M.D., P.A. filed a voluntary Chapter 7 petition on June 30, 2016; a Chapter 7 trustee (Schmidt) was appointed and later pursued avoidance claims for large prepetition transfers.
- Initial schedules disclosed modest assets (~$43k) and large unsecured liabilities (over $1.1M, including Hitachi). Amended schedules later disclosed vastly different figures and extensive prepetition insider/affiliate transfers totaling over $3 million and additional creditor claims (amended unsecured claims exceeded $6M).
- Debtor moved to convert the Chapter 7 case to Chapter 11, claiming small‑business status and proposing a plan tied to the outcome of Hitachi’s appeal and affiliate funding; Trustee and Hitachi opposed conversion based on alleged bad faith, asset transfers, misstatements, and lack of viability.
- Fact hearings were held (Jan. 30 & Feb. 14, 2017); the court found much of Debtor/principal testimony not credible, found trustee testimony credible, and received documentary evidence of transfers and the transfer of the operating medical practice to an affiliated entity (the New P.A.).
- The court concluded Debtor had engaged in prepetition and post‑petition bad‑faith conduct (misleading schedules, substantial insider transfers, use of bankruptcy as litigation tactic), had no realistic prospect of rehabilitation because the practice and revenues had been shifted to an affiliate, and therefore denied conversion to Chapter 11.
Issues
| Issue | Plaintiff's Argument (Debtor) | Defendant's Argument (Trustee/Hitachi) | Held |
|---|---|---|---|
| Whether Debtor may convert Chapter 7 to Chapter 11 under §706(a) | Debtor: statutory right to convert; acted in good faith; small‑business status; plan feasible (affiliate funding or trustee to pursue avoidance claims). | Trustee/Hitachi: Debtor engaged in bad faith, concealed/transfered assets, lacks financing and business prospects; conversion would impede recovery. | Denied: court exercised discretion under Marrama and §706 to refuse conversion due to bad faith and ineligibility. |
| Whether prepetition/postpetition conduct constitutes forfeiture of conversion right (bad faith) | Debtor: errors were corrected; conduct does not rise to Marrama bad‑faith standard. | Trustee/Hitachi: concealed assets, delayed amendments, large insider transfers while insolvent, bankruptcy used to avoid bond and receivership. | Held bad faith: concealment, untimely/amended disclosures, and transfers forfeited conversion right. |
| Whether cause under §1112(b) (substantial diminution and lack of rehabilitation) exists | Debtor: affiliates will fund a 100% plan if appeal succeeds; otherwise trustee/plan trustee would pursue avoidance. | Trustee/Hitachi: Debtor’s operating practice and revenue moved to affiliate; estate suffers continuing loss and no reasonable likelihood of rehabilitation. | Held cause exists under §1112(b)(4)(A): substantial/continuing loss and no reasonable likelihood of rehabilitation. |
| Whether gross mismanagement post‑petition warrants denial under §1112(b)(4)(B) | Debtor: no post‑petition gross mismanagement shown; issues are prepetition and cured by amendments. | Trustee/Hitachi: overall mismanagement and failure to cooperate with receiver and trustee justify denial. | Court found insufficient evidence of postpetition gross mismanagement to deny solely on §1112(b)(4)(B), but denial stands on bad faith and §1112(b)(4)(A). |
Key Cases Cited
- Marrama v. Citizens Bank of Mass., 549 U.S. 365 (2007) (prepetition bad faith may forfeit a debtor’s statutory right to convert Chapter 7 to another chapter)
- Law v. Siegel, 134 S. Ct. 1188 (2014) (bankruptcy court may refuse futile procedural formalities to effectuate Code’s ends)
- Czyzewski v. Jevic Holding Corp., 137 S. Ct. 973 (2017) (Chapter 11 contemplates confirmed plan, conversion to Chapter 7, or dismissal; courts must weigh best interests of creditors)
- Timbers of Inwood Forest Assocs. v. Anthony, 808 F.2d 363 (5th Cir.) (case‑specific inquiry under §1112 focusing on best interests of creditors and estate)
- Little Creek Dev. Co. v. Commonwealth Mortgage Corp., 779 F.2d 1068 (5th Cir.) (totality of circumstances/good‑faith standard; no business to preserve supports denial)
- Jacobsen v. Moser (In re Jacobsen), 609 F.3d 647 (5th Cir.) (bad‑faith conduct may be cause for dismissal/denial under §1112)
- Grogan v. Garner, 498 U.S. 279 (1991) (distinction between honest‑but‑unfortunate debtors and debtors who act in bad faith)