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IN THE UNITED STATES BANKRUPTCY COURT
FOR THE NORTHERN DISTRICT OF CALIFORNIA
ROY and ANN LANING, No. 96-12497
Memorandum of Decision
Debtors Roy and Ann Laning are both attorneys. They filed
their Chapter 7 petition on July 25, 1996. At that time, they
were in the process of appealing dismissal of a state court action
they had brought against Bruce Laning's former employer for
wrongful termination and defamation.
The Lanings disclosed in their statement of affairs that an
appeal of the suit was pending. However, in answer to item 20 of
schedule B, which requires the listing and value of all contingent
and unliquidated claims of every nature, they answered "none."
On September 18, 1996, the state appellate court partially
reversed the dismissal of the Lanings' complaint. It held that while claims for malpractice and breach of contract were properly
dismissed, the claims for libel, slander, and wrongful termination
should not have been dismissed. The Lanings did not amend their
schedules to reflect this revival of their suit, nor did they
notify the Chapter 7 trustee of this development.
The trustee's counsel learned of the reversal more than six
months after the fact, from counsel for the defendant in the state
court action. After brief negotiation, he entered into an
agreement to settle the suit for $67,500.00. A settlement at this
figure would pay a substantial amount of the creditors in this
case. The court approved the settlement over the Lanings'
objections. The Lanings appealed; their appeal is still pending.
After appealing the order approving the settlement, the
Lanings converted the case to Chapter 13. Their Chapter 13 plan
is now before the court. It is opposed by the Chapter 13 trustee,
the former Chapter 7 trustee, the Internal Revenue Service, and
the former employer. The plan raises two major issues: the good
faith of the Lanings, and their position that conversion undoes
the settlement without consequence.
II. Good Faith
When debtors exercise their right to convert a case from
Chapter 7 to Chapter 13, they must show two separate elements of
good faith. They must show that their plan has been proposed in
good faith, and that the conversion was done in good faith. In re
Spencer, 137 B.R. 506, 514 (Bkrtcy.N.D.Okl.1992). The debtors'
preconversion conduct is highly relevant to a good faith
determination. In re Rasmussen, 888 F.2d 703, 704 (10th
Cir.1989); Neufeld v. Freeman, 794 F.2d 149, 150 (4th Cir.1986).
The Laning's original plan was clearly made in bad faith. It
proposed absurdly nominal payments, with the bulk of the proposed
dividend to creditors coming from their prosecution of the settled
lawsuit. Thus, the risk of loss (and therefore no dividend) was
shifted to the creditors. A few days before the confirmation
hearing, the Lanings proposed a new plan which at least on its
face does not propose to pay creditors out of the proceeds of
their questionable suit. However, their preconversion conduct
makes it impossible for the court to find that the Lanings are
proposing any plan in good faith.
The Lanings failed to properly schedule the lawsuit. Their
schedules falsely stated that they had no unliquidated claims
against anyone. They withheld the favorable appellate ruling from
the trustee and their creditors. They opposed the trustee's
compromise, which was clearly in the best interests of the estate.
The court cannot ignore their misconduct, and their misuse of the
right to convert to collaterally attack the order approving the
compromise. Under these circumstances, the Lanings cannot
demonstrate good faith and their case should be converted back to
Chapter 7. In re Finney, 992 F.2d 43, 45 (4th Cir.1993): In re
Barrett, 964 F.2d 588, 589-90 (6th Cir.1992); In re Thornton, 203
B.R. 648, 652 (Bkrtcy.S.D.Ohio 1996).
III. Status of the Settlement
Underlying their conversion to Chapter 13 is the Lanings'
belief that conversion undid the settlement reached between the
defendant and the Chapter 7 trustee, without any sort of
consequence, even though the compromise was approved by the court.
There is no basis in the Bankruptcy Code for such a naive
interpretation. The effect of conversion from one Chapter to
another is governed by section 348 of the Bankruptcy Code.
Nowhere in the section is there any provision that acts taken
before conversion are voided when a case is converted.
The Lanings base their argument primarily on a single
bankruptcy court decision, In re Wirmel, 134 B.R. 258 (Bkrtcy.S.D.
Ohio 1991). However, in that case the settlement had not been
approved before conversion. Since court approval was a condition
precedent to creation of a binding contract, the bankruptcy estate
was not bound when the case was converted. In this case, however,
a binding contract was created. The Lanings' idea that they can
disregard the settlement has no basis in law.
The only possible argument the court can think of (and it is
more than the Lanings have argued) is that they are entitled to
reject the settlement under section 365(a) of the Code as an
executory contract. There are two flaws in this argument.
First, section 365 only applies to contracts entered into by
the debtor prepetition, not postpetition contracts entered into by
the bankruptcy estate. In re Cannonsburg Environmental
Associates, Ltd., 72 F.3d 1260, 1265-66 (6th Cir.1996); In re
Leslie Fay Companies, Inc., 168 B.R. 294, 300
(Bkrtcy.S.D.N.Y.1994); In re Executive Airport Center, Ltd., 138
B.R. 628, 629 (Bkrtcy. M.D.Fla.1992).
Second, rejection of an executory contract results in a
breach which gives rise to a claim against the estate. 11 U.S.C
section 365(g); Stewart Title v. Old Republic Nat. Title, 83 F.3d
735, 741 (5th Cir.1996). If the contract were rejected the
defendant in the lawsuit would have an unsecured claim for any
excess liability over the amount it has already agreed to pay,
making prosecution of the lawsuit purposeless.
The debtors cannot obtain confirmation of a Chapter 13 plan
due to their preconversion conduct. Even if they could show good
faith, they are not entitled to ignore the binding settlement
approved by the court prior to their conversion to Chapter 13.
Accordingly, the case will be converted back to Chapter 7. An
appropriate order will be entered.
Dated: January 22, 1998 _______________________
U.S. Bankruptcy Judge
CANB DocumentsNorthern District of California