NINTH CIRCUIT | Key Points
The Bankruptcy Appellate Panel for the Ninth Circuit recently found that assets fraudulently transferred by a debtor during his Chapter 13 bankruptcy proceedings constituted assets of the bankruptcy estate despite a forced conversion of the proceedings from Chapter 13 to Chapter 7. In re Brown, 953 F.3d 617, 618 (9th Cir. 2020). In Brown, Jason Brown petitioned for debt relief under Chapter 13 of the bankruptcy code. In his bankruptcy schedules he noted an anticipated inheritance of $2,500 from his father’s probate estate. However, a few months later the trustee of his father’s estate distributed over $55,000 to Jason. “[A]lmost immediately, and without the approval of the Chapter 13 trustee,” Jason transferred in excess of $12,000 to each of his three brothers.
Due to the unapproved transfers, as a sanction the trustee sought a forced conversion to Chapter 7 under 11 USC § 348(f)(1)(A). Usually, in Chapter 7 proceedings assets that are not in the debtor’s possession or control at the time of filing are not considered assets of the bankruptcy estate. However, here the bankruptcy court expressly found Jason acted in bad faith and that “the transfers were made to avoid payments to creditors.” The trustee successfully moved to recover all the inherited funds. Jason’s brother appealed arguing the funds transferred to him were not “in possession or control” of Jason at the time of the conversion and therefore were not part of Jason’s bankruptcy estate.
On appeal, the Chapter 7 trustee countered the funds must be considered as part of the estate “to prevent abuse of the system.” The Court agreed and concluded that it was undisputed Jason tried to avoid paying his creditors by transferring funds to his brothers so the fraudulently transferred funds “remained in his constructive possession or control” (emphasis added) and therefore “should be considered property of the converted estate under § 348(f)(1)(A). This decision is well-reasoned and supports the bankruptcy code’s “firm policy of not rewarding bad-faith debtors.”