Judge Karlin

08-40810 Werts (Doc. # 131) - Document Text

Case 08-40810 Doc# 131 Filed 08/19/09

SIGNED this 19 day of August, 2009.

Page 1 of 29


In re: )
TROY WERTS, ) Case No. 08-40810
) Chapter 7
Debtors. )




This matter is before the Court on Debtors’ Motion to Convert to Chapter 13 and Debtors’Motion for Intra-District Change of Venue,2 which seeks to transfer this case to Wichita, Kansas.
The United States Trustee (“UST”) objected to the Motion to Convert, arguing that Debtors are not
eligible for Chapter 13 relief. First, he argues that their unsecured debt exceeds the limits set forth
in 11 U.S.C. § 109(e).3 Secondly, he argues that Debtors should forfeit any right to convert to

1Doc. 98.

2Doc. 100.

3All future statutory references are to the bankruptcy code in effect on the date offiling,11 U.S.C.§§ 101 - 1532
(2005), unless otherwise specifically noted.

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Chapter 13 as a result of their pre-petition conduct, and pursuant to § 1307(c), as described in
Marrama v. Citizens State Bank of Massachusetts.4 Included in this bad faith allegation is the
contention that Debtors engaged in fraudulent bankruptcy estate planning, and failed to disclose
several assets and transactions on their schedules. The UST has also objected to the motion to
change venue, but only if the motion to convert is denied.


The parties have stipulated to some facts, which are contained in the Pretrial Order, and theCourt adopts those facts. The Court also conducted an evidentiary hearing, at which hearing it was
able to evaluate the credibility of the witnesses to assist in making these findings of fact.

 The Court has jurisdiction to decide this matter,6 and it is a core proceeding.7

Debtors filed for relief under Chapter 7 of the Bankruptcy Code on June 16, 2008. On the
date they filed their petition, Mr. Werts had accrued general unsecured debts totaling $161,977.71,
and Ms. Werts had accumulated general unsecured debts totaling $100,913.37. In addition to those
amounts, Debtors were jointly liable on a second mortgage on their home. The debt secured by that
second mortgage exceeded the value of the house by $134,760. Both Debtors have regular income.

One or both Debtors first met with an attorney, Sarah Newell, eight or nine months prior to
filing. At that time, they discussed their financial situation, which had recently deteriorated both

4549 U.S. 365, 371-75 (2007) (holding that the broad authority granted to bankruptcy judges to take any action
that is necessary or appropriate “to prevent an abuse of process” is adequate to authorize an immediate denial of a motion
to convert a Chapter 7 case to one under Chapter 13 in lieu of a conversion order that merely postpones the allowance
of equivalent relief and may provide a debtor with an opportunity to take action prejudicial to creditors).

5Doc. 124.

628 U.S.C. § 1334.

728 U.S.C. § 157(b)(2)(A).


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because Ms. Werts, a mortgage broker, had been the victim of a downturn in the mortgage business
and Mr. Werts had left a steady job to start a new restaurant business that was not working out. In
fact, Debtors’ total income had decreased over 40% in 2007, as compared with 2005 and 2006.

Mr. Werts explained that he had entered into a partnership to open an Emerson Biggins
(“EB”) restaurant in Wichita, Kansas. To help start and run that business, Mr. Werts incurred a
substantial amount of credit card debt. He disclosed to counsel that he was expecting a cash
settlement from the remaining partners in the EB business, which turned out to be $75,000, and was
received October 31, 2008.

Ms. Newell provided some pre-bankruptcy planning advice during that first meeting.
According to consistent testimony at trial, counsel did not give Debtors any specific instructions on
how to dispose of the $75,000 payment. Instead, she generally advised them to consider paying
down debt secured by exempt assets (i.e., home mortgage and cars), advised that home furnishings
were exempt, discussed putting money in an exempt retirement account, and essentially indicated
that they needed to get rid of all cash prior to filing or it would become part of the bankruptcy estate
and subject to distribution to creditors.

Counsel also advised Debtors to keep close track of how they used the expected proceeds,
as the Trustee would require this information. Following this advice, Debtors used most of the
$75,000 to pay some routine bills, make several advanced payments on their first and second
mortgages ($21,535 and $7,124, respectively), make car payments ($5,995), buy new furniture for
their house ($5,500), make deck repairs ($750), paint their house ($3,650), pay off an unsecured
consolidation loan that was guaranteed by a friend and former employer of Mr. Werts ($12,235),
pay attorney fees ($3,000) and take a ski vacation in Colorado ($4,117).


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In preparation for filing their bankruptcy petition, one or both Debtors again met with counsel
and provided her with the information necessary to prepare their bankruptcy schedules and Statement
of Financial Affairs (“SOFA”). Notwithstanding the information Debtors had provided to their
counsel, Debtors’ schedules and SOFA contained numerous omissions and errors, including:

Failure to disclose anywhere on the schedules that Mr. Werts had received the
$75,000 payment from the EB partnership within 7 or 8 months of filing;
Failure to disclose that Mr. Werts held an ownership interest in the EB business
within six years of the filing;
Failure to disclose irregular payments made to Debtors’ creditors, including payments
made on Debtors’ mortgage with part of the proceeds from the $75,000 buyout;
Failure to disclose an interest in a 1992 Ford pickup, valued at $4,000, that was
purchased by Ms. Werts’ former husband and his father for her son, but which was
titled in both the child’s name and Debtors’ names because the purchasers lived out
of state;
Understating by over $4,000 the amount of money held in one bank account (the
insurance refund account);
Failure to disclose three of Debtors’ six bank accounts that were open on the petition
date; and
Failure to disclose a bank account at Bank of America that had been closed within
one year of the petition date.
Although the above information was not included in their schedules and SOFA, Debtors had
provided to their counsel the information needed to enable her to include it, except for the following:
their title ownership interest in Ms. Werts’ son’s vehicle, the amount of the funds held in one bank
account (less than $20), which account had not been used for some time by Debtors, the existence
of an incorrect balance in one bank account, and payment for $1,220.29 in clothing.


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Ms. Newell testified, as will be discussed in more detail below, that she either intentionally
omitted the relevant information with the intent to disclose it at a later time, after receiving guidance
from the case trustee who would be appointed, inadvertently omitted the items, or deemed some
information unworthy of inclusion.8 Debtors explained that they had neglected to list the 1992 Ford
Bronco because it was purchased for Ms. Werts’ minor son by his father and grandfather, and
Debtors’ names were on the title of the vehicle solely for insurance and titling purposes. They did
not consider themselves to hold an ownership interest in that vehicle.

As to the bank account listed with the incorrect balance ($30 vs $4,639), Debtors explained
that their mortgage company had incorrectly paid escrowed money to two insurance companies,
when one of the policies had been canceled. This caused a severe deficit in their escrow account,
which they were going to have to reimburse. Although Debtors knew that the companythat had been
improperly paid was going to refund the money (which Debtors then immediately repaid to the
escrow company to replenish the escrow account), they did not know the money had been directly
deposited into this bank account within six days before the bankruptcy filing, and they also did not
know exactly what date their counsel would actually file their petition.

Finally, as to one bank account that Debtors had not provided information to their counsel
before filing, that account had not been used for over two years, and only held $13. Debtors had

8The example of this latter category was seen in Debtors’ response to Question 3 on the SOFA (payments to
creditors within 90 days of filing exceeding $600). Ms. Newell said she had not routinely provided detailed information
to this question in any filings, unless it could result in a preference claim for the Trustee, but that she does now as a result
of lessons learned from this case.


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provided information to Ms. Newell about the other omitted bank accounts, but she had failed to
include them. One had no balance and one had a $16 balance.9

On July 29, 2008, approximately six weeks after the initial petition and supporting documents
were filed, Debtors filed an amended SOFA. 10 This amended SOFA did list the $75,000 payment
Mr. Werts received from the EB buyout, but did not correct any of the other errors contained in the
original schedules or SOFA. On August 13, 2008, Debtors filed an amended Schedule B, which
disclosed for the first time a potential sexual harassment claim Ms. Werts may have had against her
former employer as of the date of filing.11 Again, Debtors did not correct any of the other errors on
the schedules at that time.

Following conversations between the UST and Ms. Newell, Debtors filed an Amended
Petition along with an amended Schedule B, Schedule D, Schedule F, Schedule I, Schedule J and
an amended SOFA in November, 2008.12 These amendments corrected all of the errors in Debtors’
original schedules and the original SOFA. On that same date, Debtors amended their Schedule C
to claim an exemption in two term life insurance policies, with no cash value.13

9If one excludes the account that had the unexpected insurance refund deposit, and compares the amounts listed
in the bank accounts in the original schedules ($130) with those listed in the amended schedules ($76.97), Debtors
actually originally overstated the amounts in their accounts, even when they added back in the small amounts in accounts
they had inadvertently omitted.

10Doc. 16.

11Doc. 21. Ms. Werts has since become re-employed with this employer (after certain management employees
left the company), and has taken no steps to pursue this litigation (which is likely the estate’s asset). No evidence was
received about whether Ms. Werts has even taken the required steps under state or federal law to put her employer on
notice that she has a claim, which notification deadlines are often fairly short, and which could bar pursuit of the claim
by her or by the estate.

12Doc. 35.

13Doc. 36.


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In January, 2009, the UST filed an adversary proceeding14 objecting to Debtors’ discharge
pursuant to § 727(a)(2) and (4). The UST also filed a Motion for Dismissal for Abuse under §
707(b)(3).15 Three months later, Debtors’ current attorney, W. Thomas Gilman, substituted his
appearance for that of Ms. Newell. Shortly after Mr. Gilman’s entry of appearance, Debtors filed
the motion to convert to Chapter 13 and motion for intra-district change of venue that are the subject
of this order.

A. Motion to Convert to Chapter 13
1. Debtors are eligible to be Chapter 13 debtors under § 109(e)
Eligibility to be a debtor under Chapter 13 of the Bankruptcy Code is governed by § 109(e).
According to that section, only an individual with “noncontingent, liquidated, unsecured debts that
aggregate less than $336,900” is eligible to be a Chapter 13 debtor.16 One issue in this case is
whether Debtors’ noncontingent, liquidated, unsecured debts exceeded $336,000 on the date of

This issue is governed, in part, by the answer to the following question: whether the
$134,760 undersecured portion of Debtors’ second mortgage should be considered unsecured debt
for purposes of the § 109(e) debt limitation when another section of the Code, § 1322(b)(2),
specifically requires that same debt to be treated as secured for plan confirmation purposes. This
second mortgage note is secured only by a security interest in Debtors’ principal residence.

14Adv. No. 09-7002.

15Doc. 56. That motion is not currently before the Court.

1611 U.S.C. § 109(e).


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Debtors recognize that the vast majorityof courts to have considered this issue, and all circuit

courts, have held that the undersecured portion of a secured debt should be considered unsecured

debt when determining a debtor’s eligibility to proceed under § 109(e).17 In general, these courts

have applied § 506(a), which splits an undersecured claim into a secured portion and an unsecured

portion for bankruptcy purposes, despite the fact the statute speaks in terms of “allowed claims”

rather than “debts” in general, “to prevent ‘raising form over substance and manipulation of the debt

limits’ to achieve Chapter 13 eligibility.”18

For example, in In re Soderlund, the court noted that “[r]efusing to count the undersecured

portion of a secured creditor’s claim as unsecured debt ignores reality and could lead to absurd

19 20

results.” Similarly, the court in In re McClaskie held:

[I]t is an overly technical reading of § 506(a) and its impact upon a case to ignore the

obvious bifurcation which will occur if the claims are filed as scheduled and the

debtor’s valuation of the liened property is unchallenged. Instead, this Court finds

17See, e.g. In re Scovis, 249 F.3d 975, 983 (9th Cir. 2001) (holding a bankruptcy court may look past the
schedules to other evidence submitted when a good faith objection to the debtor's eligibility under § 109(e) is raised and
that entire judgment lien claim against homestead is unsecured for eligibility purposes); In re Balbus, 933 F.2d 246, 247
(4th Cir. 1991); Miller v. United States, 907 F.2d 80, 81-82 (8th Cir. 1990); In the Matter of Day, 747 F.2d 405, 407
(7th Cir. 1984) (holding that a contrary interpretation of § 109(e) could lead to absurd situation where prospective debtor
could create security interest in property with little value to circumvent the debt limits); In re Groh, 405 B.R. 674 (Bankr.

S.D. Ca. 2009) (noting that result required by statute—that the undersecured portion of debt against homestead must
be included in § 109(e) eligibility determination—may well, in the current economic environment, make many debtors
whose residences had decreased in value ineligible for relief); In re Grenchik, 386 B.R. 915 (Bankr. S.D. Ga. 2007
(collecting cases); In re Hanson, 282 B.R. 240, 245 (Bankr. D. Colo. 2002) (holding that creditors whose liens were
subject to avoidance as a preference had to be treated as holding unsecured claims for purpose of determining eligibility);
and In re Bos, 108 B.R. 740, 742 (Bankr. D. Mont. 1989) (finding that under facts of that case, “[i]t would defy fair play
to allow a Debtor to assert that ... for eligibility requirements, the secured claim is valued $279,800 while for repayment
upon confirmation under § 1325(a)(5), the claim will be repaid at $201,700").
18In re Scovis, 249 F.3d at 983 (quoting In re Soderlund, 236 B.R. 271, 274 (9th Cir. BAP 1999)). See also
In re Grenchik, 386 B.R. at 908 (citing two cases holding that § 506 only applies in the treatment of claims and not in
the calculation of debt, and noting they are in the decided minority).

19236 B.R. 271, 274 (9th Cir. BAP 1999).

2092 B.R. 285 (Bankr. S.D. Ohio 1988).


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that the claims process is to be assumed, given the debtor’s schedules of values and
liabilities, absent a showing of bad faith. To do otherwise is to ignore obvious

And, although decided at a time when the debt limits were significantly lower than they are currently,

the Seventh Circuit in Matter of Day explained the type of problems that could be created by

ignoring the true nature of undersecured debts, as follows:

These decisions avoid the temptation to raise form over substance and
represent a common-sense solution to a statutory interpretation problem not
considered by Congress. As noted by the court in Ballard [4 B.R. 271 (Bankr. E.D.
Va. 1980], a contrary interpretation of section 109(e) could lead, at the limit, to the
absurd situation where a prospective Chapter 13 debtor with $449,998 in unsecured
debts creates a security interest for $349,999 in property with little or no value. If
courts cannot look beyond the mere existence of documents creating such an interest,
this maneuver produces secured debts of $349,999 and unsecured debts of
$99,999-amounts within section 109(e). Surely Congress did not intend for debtors
to so easily circumvent the $100,000 limitation on unsecured debts in Chapter 13

The Court finds the reasoning of those cases persuasive and adopts their approach. Therefore, the

Court finds that the undersecured portion of a secured debt should be treated as an unsecured debt

for§ 109(e) debt limitation calculations.

Debtors alternatively argue that the § 506 analysis should not be applied when the debt in

question will be treated as fully secured by operation of law, specifically § 1322(b)(2), which

requires that a claim secured only by a security interest in the debtors’ principal residence cannot be

21Id. at 287.

22In the Matter of Day, 747 F.2d at 407.

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23 24

bifurcated and crammed down. Debtors rely on two cases, In Re Soderlund and In Re Winder,
for this proposition, but the Court is not persuaded.

Admittedly, § 1322(b)(2) prohibits Chapter 13 debtors from modifying a mortgage on their
principal residence if any portion of that mortgage is secured by the value of the real property.25 The
effect of this statute is to prohibit Debtors from “cramming down” their mortgage, which would
allow them to bifurcate the mortgage into a secured portion equal to the value of the property, and
an unsecured portion equal to the undersecured portion of the claim. Debtors contend it is unfair to
require them to treat the claim as fully secured under § 1322(b)(2), and pay that debt in full during
the plan, but then treat that same “unsecured” portion as part of unsecured debt to determine
eligibility under § 109(e).

Although the Court agrees with Debtors that the operation of § 1322(b)(2) makes this
analysis seem less fair to these Debtors, the Court nevertheless finds that the application of §
1322(b)(2) does not create an exception to the general rule. As the court indicated in In re Groh,
“[w]hile there is some appeal to looking to a debtor's eligibility as of the moment of filing, In re
Scovis . . . makes very clear that events like obvious lien avoidance should be considered in

23236 B.R. 271, 274-75, n.5 (9th Cir. BAP 1999) (holding that the § 506 analysis should be made in determining
eligibility, but in dicta stating that the analysis may be different “if the debts in question were entitled to the protection
afforded by §1322(b)(2), i.e., a claim secured only by a security interest in real property that is the debtor’s principal

24171 B.R. 728, 731 (Bankr. D. Conn. 1994) (stating that although a “good faith argument might be made that
Nobelman v. American Savings Bank, 508 U.S. 324, ... (1993), compels the treatment of such an undersecured claim as
a fully secured claim for the purposes of Chapter 13 eligibility,” the court declined to so find).

25This Court has previously held that if junior mortgagees are wholly unsecured, they may be treated as general
unsecured claims in the Chapter 13 plan after a proper Motion to Strip is filed and served on the impacted mortgagee.
Centex Home Equity Co., LLC, v. Woodling, 2004 Bankr.LEXIS 1751 (Bankr. D. Kan. 2004).


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determining a debtor's eligibility. There is no reason why the same rationale would not apply to a
lien strip-off under 11 U.S.C. § 506(a) and § 1322(b) as it did to a lien avoidance under § 522.” 26

This Court agrees with the Groh analysis, and declines to graft additional content onto §
109(e) that Congress did not choose to include, to wit, that the section does not apply to those debts
that are truly undersecured, but that will be treated as fully secured for confirmation purposes. The
Court, therefore, holds that the undersecured portion of a debt must be included within the unsecured
portion of the debt limits in § 109(e) even when the debt in question is a mortgage on the debtors’
primary residence.27

The Debtors next alternatively argue that because each of them has unsecured debt less than
$336,900, because not all of their unsecured debt is joint debt, they should be allowed to proceed as
debtors in a Chapter 13 case. The UST objects to this argument, claiming § 109(e) requires both
spouse’s debts to be considered together when determining whether they fall under the unsecured
debt limit. The parties have not provided any case law addressing this issue, and the Court was
unable to locate any cases directly on point.28

26405 B.R. at 678.

27The Court notes that an even stronger argument for deviation from this rule could be made in the case of
automobiles subject to the hanging paragraph at the end of § 1325(a). Claims subject to that statutory provision are not
only excluded from bifurcation under § 506, but also require payment in full of the entire debt over the life of a Chapter
13 plan. At least in cases involving long term debts, such as home mortgages, debtors are not required to pay the entire
debt over the life of the plan.

28Debtors do direct the Court to the following quotation from Colliers On Bankruptcy: “Subsection e [of §109]
recognizes that a debtor under Chapter 13 must deal with future family expenses and family income as well as preexisting
family debts. It attempts to facilitate the treatment of the family as a unit to the extent possible by authorizing spouses
to achieve Chapter 13 debtor status jointly if the aggregate of their debts is within the applicable limits. However, in some
cases, adding the debts of the spouse will cause those debts to exceed the statutory limits and the limits are not doubled
in a joint case. In such cases, only one spouse may be able to file as a Chapter 13 debtor. Alternatively, if few of the
debts are joint, each spouse may be able to file a separate Chapter 13 case.” Colliers on Bankruptcy, ¶ 109.06[4]
(15th ed. rev. 2007) (emphasis added).


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The statute, which is the first place the Court must look, states:
Only an individual with regular income that owes, on the date of the filing of the petition,
noncontingent, liquidated, unsecured debts of less than $336,900 and noncontingent,
liquidated, secured debts of less than $1,010,650, or an individual with regular income and
such individual’s spouse, . . . , that owe, on the date of the filing of the petition,
noncontingent, liquidated, unsecured debts that aggregate less than $336,900 and
noncontingent, liquidated, secured debts of less than $1,010,650 may be a debtor under

chapter 13 [of the Bankruptcy Code].29
The UST focuses on the portion of the statute that reads “an individual with regular income and such
individual’s spouse . . . that owe . . . unsecured debts that aggregate less than $336,900” to support
its claim that all debts of both spouses must be combined for purposes of § 109(e).

The Court has located one case that addressed this issue, but it was presented in a
significantly different procedural posture. In In re Weiser,30 the debtors filed a joint Chapter 13
petition. One of their creditors objected to confirmation of their plan on the basis that the debtors
were ineligible for relief under Chapter 13 because their combined noncontingent and liquidated
unsecured debts exceeded the § 109(e) limits. At the confirmation hearing, debtors’ attorney made
an oral motion to bifurcate the case, apparently in an attempt to cure the § 109(e) problem. The court
held that the motion to bifurcate was untimely “in view of the fact that it was not made until the
hearing on the lenders’ objections to confirmation.”31 The court also noted that it was not aware of
any procedure for bifurcating a joint case absent an amended filing or the dismissal of the pending
case and the filing of two new individual cases.32

2911 U.S.C. § 109(e).

30391 B.R. 902 (Bankr. S.D. Fla. 2008).

31Id. at 908.



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The instant case is in a substantially different procedural posture than was present in Weiser.
This case was initially filed as a joint Chapter 7, where the debt limits in § 109(e) were simply
inapplicable. Debtors are currently before the Court on a motion to convert their case to Chapter 13,
and have announced, in the event they are not allowed to proceed in a joint case, their willingness
to bifurcate this case in order to qualify as Chapter 13 debtors. This action is being taken before a
Chapter 13 plan has even been filed. This is significantly different than in Weiser, where the court
denied the oral request to bifurcate because it was presented too late in the proceeding.

The Court finds that the statute in question does not mandate that married persons combine
their unsecured debt (regardless which spouse has personal liability for that debt) for purposes of the
debt limits in § 109(e). Rather, § 109(e) provides for two groups of people who can be Chapter 13
debtors. The first of these groups includes individuals with regular income who meet the debt limits.
If an individual has regular income, and that individual’s debts are below the limits established by
§ 109(e), then that individual qualifies to be a Chapter 13 debtor.

The second group provided for under § 109(e) includes individuals with regular income and
their spouse, provided their aggregate debts do not exceed the debt limits. This additional provision
is necessary to avoid situations where married couples would prefer to file a joint Chapter 13
proceeding, but only one spouse has regular income. Without specifically including the spouse of
an individual with regular income in § 109(e), single income couples could be precluded from filing
a joint Chapter 13 case because the spouse without regular income would not qualify.


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In general, filing a Chapter 13, instead of proceeding under Chapter 7, is viewed favorably
by Congress, and many statutory provisions reflect that policy choice.33 To read § 109(e) in the
manner proposed by the UST, which would essentially only allow married debtors half of the debt
limits allowed for individual debtors, would clearly not further the goal of encouraging Chapter 13

The Court finds that a more reasonable reading of the statute, and one that furthers the goal
of encouraging Chapter 13 filings, is that the provision dealing with “an individual with regular
income and such individual’s spouse” is intended to apply in those cases where the spouse could not
otherwise be a Chapter 13 debtor, because he or she is not “an individual with regular income.” If
each spouse has regular income, and each spouse separately qualifies under the debt limits of §
109(e), then each spouse should be entitled to file his or her own Chapter 13 case—even if the debts
of both spouses together would exceed the debt limits.34

If a husband and wife can each file separate Chapter 13 proceedings, where their own
individual debt is within the § 109(e) limits, the Court can think of no reason why a husband and
wife could not file a joint petition, as authorized by § 302(b). A similar issue was raised in the

33For example, debtors in Chapter 13 proceedings are entitled to a “superdischarge” which, although not as
expansive as it was prior when the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 became effective
(11 U.S.C. §§ 101 -1532 (2005)), still allows debtors to discharge some debts that would be non-dischargeable in a
Chapter 7 proceeding, such as debts incurred as part of a property settlement in a divorce case. See §§ 1328 and

34See In re Feltman, 285 B.R. 82, 86 (Bankr. D. D. Col. 2002) (holding that § 302 does not compel a husband
and wife to file a joint petition, but rather that they are entitled to file separate Chapter 13 cases if they so desire). It is
important to note that the facts of this case are such that a significant portion of each Debtors’ debts are individual and
are not joint debts. The outcome of this case would certainly be different if all of the debts in question were joint debts,
and Debtors were attempting to divide those joint debts so as to qualify under § 109(e). See, e.g. In re Cronkleton, 18

B.R. 792, 793 (Bankr. Ohio 1982) (holding that where each debtor was co-maker on all debts and each owed the entire
obligation, the “attempted splitting of this obligation between the two debtors in order to qualify under the debt limitation
ceiling contained in § 109(e) under the guise that the remainder of the debt is ‘contingent’ is not permissible.”).

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context of allowing debtors to claim separate allowances for housing expenses in a means test
calculation in In re Crego. 35 In Crego, the debtors, who lived apart, sought to claim two separate
household expenses on Form 22. In responding to the trustee’s objection, the Court stated:

Of course, in any of these cases, a trustee's objection could be overcome by having
the spouses file separate petitions. However, “machinations” such as forcing the
Debtors to pay a second filing fee, file another set of schedules and plan, and arrange
a new set of hearings “elevates form over substance.” In this case, the Court does
not find that the circumstances necessitate forcing either of the Debtors to file
separate petitions, as separation of the cases would not make more money available
to the unsecured creditors than there is in this joint case. In fact, there may well be
less money available due to the expenses incurred in filing a second petition.36

Section 302 provides that “[t]he filing of a joint petition under Chapter 13 by a husband and
wife does not automatically result in the substantive consolidation of the two debtors’ estates.”37
Instead, § 302(b) provides that “after the commencement of a joint case, the court shall determine
the extent, if any, to which the debtors’ estates shall be consolidated.” To read § 109(e) in a manner
that would allow married debtors to each file their own Chapter 13 cases, but forbid them from doing
so jointly, is counterintuitive in light of § 302 and would elevate form over substance. Because the
separate estates in this case have never been substantively consolidated, Debtors in this case could
seek to bifurcate their current joint case and proceed as two separate cases, each under Chapter 13.
That said, the Court sees no reason to read § 109(e) in a manner that would require them to waste
their resources and judicial resources jumping through such hoops if there would be no benefit to
anyone in doing so.

35387 B.R. 225 (Bankr. E.D. Wis. 2008).

36Id. at 229 (internal citations omitted).

371 Keith M.. Lundin, Chapter 13 Bankruptcy § 7.1, p. 7-2 (3d ed. 2000 and Supp. 2007-1).

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Allowing Debtors in this case to proceed as Chapter 13 Debtors, while keeping their estates
separate based upon their own individual debt obligations, does pose some potential procedural
difficulties, and could thus require bifurcation. For example, it could be necessary for Debtors to
file individual Chapter 13 plans, if they are repaying separate debt.38 As noted below, the Court will
grant Debtors’ motion to change venue to Wichita, which will result in the reassignment of the case
to a new judge and a new Chapter 13 Trustee. The Court believes that the newly assigned judge and
Chapter 13 Trustee should determine how this case is handled, procedurally, and will defer to them
to resolve any procedural issues that may arise following conversion to Chapter 13.39

Debtors did not engage in prepetition bad faith that would bar
conversion of their Chapter 7 case to one under Chapter 13.
In Marrama v. Citizens State Bank of Massachusetts,40 the Supreme Court held that a debtor
does not have an absolute right to convert to Chapter 13, and in fact can forfeit the ability to proceed
under Chapter 13, if the court finds that the debtor had engaged in prepetition bad faith conduct
sufficient to establish “cause” that would ultimately warrant dismissal or reconversion of a Chapter
13 case. Section 1307(c) provides that on a motion by a party in interest or the trustee, the court
“may convert a case under this chapter to a case under chapter 7 of this title, or may dismiss a case

38See Id. at § 7.1, p. 7-4.

39For example, 28 U.S.C. § 1930 and the Bankruptcy Court Miscellaneous Fee Schedule attached thereto,
specifically provide, at paragraph ¶ 19, that if joint debtors move to reconsolidate or bifurcate their cases, that motion
incurs a fee equivalent to the current filing fee for the chapter under which the joint case was commenced.

40549 U.S. 365.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 17 of 29

under this chapter . . . for cause . . . .” 41 Thus, it is appropriate for bankruptcy courts to evaluate a
motion based on § 1307(c) when a Chapter 7 debtor seeks to convert a case to Chapter 13.

The Court must first decide who has the burden of proof on this issue. Because denying a
debtor’s motion to convert from Chapter 7 to Chapter 13 has essentially the same result as
conversion or dismissal under § 1307, “courts should apply the same good faith standard when
evaluating a debtor’s motion to convert to Chapter 13 as is utilized when considering dismissal or
conversion of a case under § 1307(c).”42 “Under this standard, whether a debtor is filing under
chapter 13 in the first instance or seeking chapter 13 relief via conversion from chapter 7, the ‘key
inquiry’ for courts attempting to ascertain a debtor's good faith ‘is whether the debtor is seeking to
abuse the bankruptcy process.’”43

Although neither the parties nor the Court were able to locate any Tenth Circuit precedent
on the issue, the overwhelming majority of Courts have held that the party moving to dismiss or
convert a case under § 1307(c) bears the burden of showing that the case was not filed in good
faith.44 This Court agrees with the reasoning of the majority, and holds that, although a debtor bears
the burden of proving that a plan was filed in good faith under § 1325(a), the burden of showing that

41Also see In re Alexander, 363 B.R. 917, 925 (10th Cir. BAP 2007) (citing In re Gier, 986 F.2d 1326, 1329
(10th Cir. 1993)).

42In re Condon, 358 B.R. 317, 326 (6th Cir. BAP 2007).

43Id. (quoting In re Alt, 305 F.3d 413, 419 (6th Cir. 2002)).

44See, e.g., In re Condon, 358 B.R. at 326 (holding that creditor opposing conversion to Chapter 13 bears burden
of showing that case would be subject to conversion or dismissal under § 1307(c)); In re Sullivan, 326 B.R. 204, 211
(1st Cir. BAP 2005) (holding that under § 1307(c), objecting creditor bears the burden of proof, while under §
1325(a)(3), debtor bears the burden of proof); and In re Haque, 334 B.R. 486, 489 (Bankr. D. Mass. 2005) (holding that
while debtor bears the burden of proof under § 1325(a)(3), objecting creditor bears the burden of proof under § 1307(c)).


Case 08-40810 Doc# 131 Filed 08/19/09 Page 18 of 29

a case was filed in bad faith so as to require conversion or dismissal under § 1307(c) falls on the
party seeking such conversion or dismissal.45
The Trustee alleges Debtors engaged in the following “bad acts” that should disqualify these
Debtors from converting their case:

Failure to disclose the $75,000 payment received from the EB transaction;
Failure to disclose Mr. Werts’ ownership interest in EB;
Failure to disclose several bank accounts (and the wrong balance in one);
Failure to disclose an ownership interest in Ms. Werts’ son’s automobile; and
Improperly disposing of the $75,000 payment through pre-bankruptcy estate
Whether a Chapter 13 case has been filed in bad faith must be determined by looking at a totality of

the circumstances.46

Some factors to consider when analyzing bad faith under § 1307(c) include:

the nature of the debt, including the question of whether the debt would be
nondischargeable in a Chapter 7 proceeding; the timing of the petition; how the debt
arose; the debtor's motive in filing the petition; how the debtor's actions affected
creditors; the debtor's treatment of creditors both before and after the petition was
filed; and whether the debtor has been forthcoming with the bankruptcy court and the

The last factor is the one that is the core of t he UST argument—whether Debtors were forthcoming

with the Court and creditors, in light of numerous errors in their schedules and SOFA.

45The Court notes, however, that in this case the burden of proof is not a determinative factor, as even if the
burden of proof rested on Debtors, the Court finds they would have met that burden.

46In re Gier, 986 F.2d at 1329.

47In re Condon, 358 B.R. at 326.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 19 of 29

Debtors acknowledge that significant deficiencies existed in their schedules, and admit they
amended their schedules once they understood both the seriousness of the matter, and that they were
required to provide all the information requested by the schedules and SOFA. However, they claim
not only did they not intend to conceal estate assets or the information pertinent to the EB
transaction, but that they had provided all of this information regarding EB to their attorney prior to
filing, and that it was her professional decision not to initially include the information on the
schedules and SOFA. Debtors’ argument on this point was supported at trial both by the testimony
of the Chapter 7 Trustee and by the testimony of the attorney who elected to omit the information.

First, Patricia Hamilton, the Chapter 7 Trustee, testified concerning her contacts with Ms.
Newell and the inaccuracies in the schedules and SOFA. Ms. Hamilton testified that after her initial
review of this case, based on her extensive experience as a Trustee, she believed there must be some
inaccuracies in the petition and SOFA. According to Ms. Hamilton, it is unusual to see debtors with
such large debt, particularly unsecured debt, without either substantially more assets or without some
business involvement.

Ms. Hamilton testified that she mentioned the apparent discrepancies in the schedules to
another attorney, who informed Ms. Hamilton that he had been retained to represent Debtors at their
first meeting of creditors (which ended their conversation). As a result of that conversation,
however, that attorney contacted Ms. Newell and informed her of Ms. Hamilton’s concerns. Ms.
Newell then immediately contacted Ms. Hamilton to discuss the case and informed Ms. Hamilton
that there were some inaccuracies in the schedules and SOFA. Ms. Newell informed Ms. Hamilton
that because she had been unsure how to disclose the EB payment, because Debtors did not include
it as income on their taxes, she had specifically advised Debtors not to include it in the initial filing,


Case 08-40810 Doc# 131 Filed 08/19/09 Page 20 of 29

advising them that she would later contact the appointed Chapter 7 Trustee to discuss how to reflect
this transaction. Ms. Hamilton testified that as a result of that late disclosure, she sought additional
information from Ms. Newell, who freely provided all information sought by Ms. Hamilton.

Ms. Newell also admitted that Debtors did disclose to her all of the information about the EB
transaction, pre-petition, and that it was her sole decision not to initially include it on the schedules.
According to Ms. Newell, she could not ascertain where to place the information on the schedules
or the SOFA, and she decided to simply omit the information until she could have a conversation
with the appointed Trustee. Ms. Newell also testified that the other errors and omissions in the
schedules and SOFA were also a result of her errors, and, except as has been specifically addressed
elsewhere in this opinion, Debtors had provided her with full and accurate information with the
understanding she would include that information on the schedules.

Debtors’ testimony was consistent with that of both Ms. Hamilton and Ms. Newell. Debtors
indicated that they provided all of relevant information to Ms. Newell and that it was Ms. Newell’s
decision to omit certain information. Debtors testified that they only cursorily reviewed the
schedules and SOFA prior to signing them, but that they assumed Ms. Newell had properly included
all the information that legally needed to be included and trusted her professional judgment about
what needed to be included, and what need not be. They also indicated that they did not truly
understand that the documents were being signed under penalty of perjury, despite the exceedingly
clear language so stating contained immediately above their signature blocks on both the schedules
and the SOFA. Similarly, Debtors also testified under oath at their first meeting of creditors that the
information contained in the schedules was true, correct and complete, which it clearly was not.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 21 of 29

Debtors were also required to provide explanations to the Trustee for items that were either
incorrect or omitted from their schedules, in the very few instances where such errors or omissions
were not a result of Ms. Newell’s actions. In one instance, Debtors failed to accurately disclose the
balance of a checking account. As outlined above, Debtors clearly and persuasively explained how
that direct deposit had occurred, that they were unaware the deposit had been made as of the date of
filing, and that they never really consider this refund to be “their” money, since they needed to return
the money to their mortgage company to hold in escrow or they would be facing a very large escrow
shortage. Although their belief was legally incorrect, the Court finds Debtors’ explanation credible,
and thus finds that there was no bad faith involved in their failure to initially include this directly-
deposited amount on their schedules. It was an honest error by Debtors, complicated by the timing
of the deposit.

Debtors also testified that they failed to provide Ms. Newell with the information on one
bank account. They explained that the account had not been used for some time, had a very small
balance, and that they had simply forgotten about the account when turning over all of their financial
information to counsel. The Court also finds this testimony to be credible, especially given the fact
that there appears to have been no motive48 for Debtors to have failed to disclose this account or to
try and conceal its existence, especiallyconsidering the de minimis balance contained in the account.

Although the Court ultimately finds that the numerous errors and omissions do not constitute
bad faith under the totality of the circumstances, the Court cannot gloss these facts without additional
comment both as to the decisions of Debtors’ original counsel in filing the petition and SOFA, and

48See In re Ford, 492 F.3d 1148, 1156 (10th Cir. 2007) (noting that a debtor’s inadvertence in failing to disclose
an asset in bankruptcy can be established by showing either that the debtor had no knowledge of the asset or the debtor
had no motive to conceal it).


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as to Debtors’ own cavalier treatment of their bankruptcy filing. First, as an experienced bankruptcy
attorney, and an attorney who assists a Chapter 7 Trustee, Ms. Newell clearly understands the degree
of reliance that trustees must and do place in sworn schedules. Based on that experience, the Court
would have expected Ms. Newell to consult with other members of her firm, one of whom is a long-
standing Chapter 7 trustee and who undoubtedly has reviewed hundreds and maybe thousands of
schedules and SOFAs, to obtain advice where to put the information about the EB transaction with
which she struggled.49

Notwithstanding these concerns, the Court is convinced by the consistent testimony of Ms.
Hamilton, both Debtors, and Ms. Newell, herself, that she had no intent to hide information from the
Trustee, creditors or the Court, but that instead, she made a serious error in professional judgment
when she did not abide by the mantra of all good debtors’ attorneys, which is to “disclose, disclose
and disclose.”50 This judge cannot think of a fact pattern where it would be proper to intentionally
fail to include information on the schedules or SOFA about a debtor’s recent receipt of $75,000, with
the intent to later call the case trustee and discuss the information. As the dissent in Marrama noted:

A debtor who is convinced that he or she can successfully conceal assets has a significant
incentive to pursue Chapter 7 liquidation in lieu of a Chapter 13 restructuring. If successful,
the debtor preserves wealth; if unsuccessful, the debtor can convert to Chapter 13 and land
largely where the debtor would have been if he or she had fully disclosed all assets and
proceeded in Chapter 13 in the first instance.51

49Clearly, by the time of the November amendments, counsel had learned that there were many places on the
forms where the information could logically have fit, as she added information about the EB venture no less than in the
following four places at that time: Question 2 on the SOFA concerning income from employment or business, Question
10 on the SOFA regarding transfers of property within two years of filing, Question 18 on the SOFA requiring name and
location of any business interests within six year of filing, or Question 19 on the SOFA, which requires debtors to list
bookkeepers or accountants who have business records within two years of filing.

50Ms. Newell’s testimony at trial, and her demeanor, reflect that she regrets these errors, has learned from the
experience, and has reformed her practice.

51549 U.S. at 382-383.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 23 of 29

The case trustee, the United States Trustee, the Court, and the creditors have the right to immediately
receive all pertinent information from the outset of the case. The schedules and SOFA explicitly
mandate what information is required, and counsel never gets to choose to not disclose all that

If Ms. Newell was unsure where the information should be placed, or how it should be
categorized, the appropriate action would have been to use her best judgment and disclose it
somewhere. Even electing to add an asterisk and to insert an additional sheet outlining the
transaction, would have been preferable to simply omitting the information because of counsel’s
difficulty understanding the perfect place to disclose it. Had that been done, the case trustee and
creditors would have at least known about the payment and could have inquired further, if needed.

The Court is similarly disturbed with Debtors’ apparent complacency about their duty to file
accurate schedules.52 Although Debtors testified they did not actually realize the schedules were
being signed under oath, and would have taken them much more seriously had they understood the
severity of the consequences for errors, these are two mature, college-educated debtors who have or
have had responsible positions in the financial world. The Court believes they likely understood the
importance of filing signed documents in a court of law, and certainly understood at the first meeting
of creditors that they were being put under oath prior to attesting to the accuracy of their schedules
and SOFA.

52By way of example, Debtors’unsecured debts were apparently overstated in their original schedules by almost
double ($262,000 compared with $405,000), and debtors did not read their schedules carefully enough to even catch that
error. Accordingly, although this Court holds debtors’ counsel to high standards of accuracy, the Court recognizes they
cannot be perfect and that debtors are expected to carefully read what is presented to them and sign ONLY after that
careful review.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 24 of 29

That said, the Court understands that these Debtors elected to rely too much upon their
attorney’s advice that it was acceptable to exclude certain items as long as the information was orally
disclosed to the trustee, and relied on their counsel’s experience to accurately place in the schedules
whatever was legally required from the information they had provided her. Because their counsel
admits Debtors had provided, pre-filing, the most significant information that was omitted, the Court
will not at this juncture punish Debtors for the omissions of their attorney.

Accordingly, although the Court is troubled by the actions of each Debtor and Ms. Newell
regarding the errors and omissions on the schedules, the Court does not find that those actions rise
to the level of bad faith that would render Debtors ineligible for Chapter 13 relief. Critical to this
finding is the testimony of the Chapter 7 Trustee, who testified that once her initial concerns about
the schedules were discussed with counsel, Debtors were at all times cooperative in providing
follow-up documentation about all bank accounts and other identified issues, they answered all of
her questions in a timely fashion, and, most importantly, that she never felt Debtors were being
deceptive or uncooperative in their responses to her. When the Court assessed each Debtors’
credibility during their testimony, this judge came away with the same impression.

The Court also finds that Debtors’ actions in disposing of the $75,000 payment from the EB
buyout in the 7-8 months prior to the filing of the case do not rise to the level of bad faith. Typically,
engaging in pre-bankruptcy planning by converting non-exempt assets into exempt assets, without
more, does not constitute bad faith.53 However, the UST contends that bad faith does exist here

53In re Warren, 512 F.3d 1241, 1249, 1250 (10th Cir. 2008) (holding “we are most reluctant ... to recognize a
conversion of nonexempt assets to exempt assets as fraudulent,” but declining to fully embrace the proposition that “a
debtor’s right to make full use of statutory exemptions is fundamental to bankruptcy law.”); and In re Carey, 938 F.2d
1073 (10th Cir. 1991) (holding “We start with the premise that ‘the conversion of nonexempt to exempt property for the
purpose of placing the property out of reach of creditors, without more, will not deprive debtor of exemption to which
he otherwise would be entitled” and citing to House and Senate Reports accompanying the Bankruptcy Reform Act of


Case 08-40810 Doc# 131 Filed 08/19/09 Page 25 of 29

because Debtors accumulated a fairly significant amount of unsecured debt in connection with the
EB business, itself, and should have used the $75,000 payment to repaysome of that debt, rather than
using it to pay down their mortgage or for a family vacation.

In response, Debtors testified that they did in fact intend to use the EB payment to repay some
of their business debt. However, Ms. Newell specifically advised them that the law allowed them
to use the money in a fashion that would best benefit their future financial fresh start, rather than that
of their creditors or the bankruptcy estate. Debtors stated that they simply followed the pre-
bankruptcy planning advice offered by their attorney, and were not acting in bad faith.

The Court agrees that the pre-bankruptcy planning in this case is more troubling because the
$75,000 lump sum received pre-petition was effectively derived from the money that Debtor had
borrowed to start the EB business. However, given the totality of the facts in this case, including the
legally-correct advice offered to Debtors by Ms. Newell and the fact that Mr. Werts could not have
reasonably predicted the bad outcome of the EB transaction when he incurred the debts, the Court
does not find that Debtors engaged in pre-bankruptcy planning in this case in a manner or to a degree
that amounts to bad faith. The vast majority of the money went to establishing Debtor’s future
financial stability, which fit the advice they had received from counsel.54

Finally, the Trustee suggests these Debtors’ luxurious lifestyle is reason to deny them Chapter
13 relief. The first problem with this argument is that Debtors incurred the significant part of that

1978 that “As under current law, the debtor will be permitted to convertnonexempt property into exempt property before
filing a bankruptcy petition. The practice is not fraudulent as to creditors, and permits the debtor to make full use of the
exemptions to which he is entitled under the law”).

54The Court finds it was decidedly poor judgment for Debtors to spend over $1,000 on clothing, or over $4,000
on a ski vacation in light of their financial situation, but that such poor judgment does not here rise to the level of bad


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lifestyle, especially the now $500,000 house, in 2000, or eight years prior to filing bankruptcy, and
at a time when both Debtors earned substantially more income. They bought this house long before
Mr. Werts decided to leave his stable job for employment with a restaurant franchise that he had
every reason to think would succeed because he had “put it under a microscope” before leaving that
stable job. Similarly, the house (which may well be too expensive for these Debtors’ present
income) was also purchased years before Ms. Werts’ income precipitously declined because of the
decline in the real estate market. Although it is not financially wise to “spend up” to the amount of
one’s income, without having a significant safetynet, the Court believes Debtors that neither of these
events were predictable.

Furthermore, at trial, Debtors admitted that they can no longer afford this house with their
current income. They pledged that, if allowed to convert, they would propose a plan whereby the
second mortgagee would voluntarily agree to have its lien stripped down to the value remaining for
that mortgage and if that creditor declines to do so, they will surrender the house. Nothing in this
opinion will prevent creditors or the Chapter 13 Trustee from objecting to confirmation on the basis
that any plan that Debtors ultimately file is not good faith, including that their expenses are not
reasonable and necessary.55

After carefully reviewing all the exhibits and testimony, and considering those facts under
the totality of the circumstances, the Court finds that this case was not filed in bad faith. The Court
is not left with the impression that Debtors intentionally misrepresented facts in their petition,

55Indeed, the Supreme Court, in Marrama v. Citizens Bank of Massachusetts, 549 U.S. at 375 n.11, cited with
approval the following quotation from In re Love, 957 F.2d 1350, 1356 (7th Cir. 1992): “Because dismissal is harsh ...
the bankruptcy court should be more reluctant to dismiss a petition ... for lack of good faith than to reject a plan for lack
of good faith under Section 1325(a).”


Case 08-40810 Doc# 131 Filed 08/19/09 Page 27 of 29

unfairly manipulated the Bankruptcy Code, or otherwise filed the petition in an inequitable manner.
The Court also finds it important that the errors and omissions, although significant, do not appear
to have had a direct impact on creditors. None of the information omitted from the schedules, with
the exception of the bank account that held the directly-deposited insurance refund, would likely
have resulted in increased funds for the bankruptcy estate. Although a lack of harm to creditors is
not required for a showing of bad faith, the Court does find that it substantiates Debtors’ claims that
they did not have the intent to be deceitful or misleading, or to conceal assets.

Accordingly, based upon this Court’s finding that Debtors’ actions prior to filing this case
did not rise to a level of bad faith that would prevent conversion, the Court finds that the case would
not be subject to dismissal or conversion under 1307(c). Therefore, the motion to convert will not
be denied on that basis, either.

B. Motion for Change of Venue
Debtors have requested that, in the event the motion to convert is granted, they be allowed
to transfer this case to Wichita, Kansas in an intra-district change of venue. The UST has stated in
the Pretrial Order56 that it does not object to this transfer if the motion to convert is granted.

The Court finds that transfer is appropriate. With the case proceeding under Chapter 13, a
new case trustee will have to be appointed and much of the analysis will have to begin anew. For
example, the important analysis a Chapter 13 Trustee must perform, including whether any plan
meets the best interest of the creditors test, whether the plan is feasible, and whether the plan has
been filed in good faith, has not yet been done by the professionals, so transfer to another Trustee
and another court will not result in significant duplication of effort. Furthermore, it makes sense to

56Doc. 124, § 8, p. 7.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 28 of 29

allow this case to proceed in Wichita since Debtors reside in Wichita and their attorney regularly
practices in Wichita. Therefore, the Court will grant the motion to change venue.

The Court finds that Debtors’ motion to convert to a Chapter 13 proceeding and for intradivision
change of venue should be granted. While the undersecured portion of Debtors’ second
mortgage is considered unsecured debt when analyzing whether Debtors are eligible to be Chapter
13 debtors under § 109(e), the Debtors may nevertheless proceed as Chapter 13 Debtors, since both
spouses are eligible under § 109(e) to be Chapter 13 debtors because each has debt that falls below
the unsecured debt limit and each has regular income. The Court also finds that this case was not
filed in bad faith, despite the rather extensive errors and omissions contained in the schedules and
SOFA, and that it should therefore not be dismissed on that basis.

IT IS, THEREFORE, BY THE COURT ORDERED that Debtors’ Motion to Convert to
Chapter 1357 is granted.

IT IS FURTHER ORDERED that Debtors’ Motion for Intra-District Change of Venue58
is granted. This case will be transferred to the Court’s Wichita Division for all further proceedings.
In addition, after consultation with the Wichita, Kansas Clerk’s office, the Court sets this to the
Court’s confirmation docket on October 7, 2009 at 10:30 a.m. Although the case may not be in a
posture for confirmation at that time, this Court sets this matter to that docket so that the parties, and
the new Clerk’s office, will better be able to track this proceeding.

57Doc. 98.
58Doc. 100.


Case 08-40810 Doc# 131 Filed 08/19/09 Page 29 of 29

IT IS FURTHER ORDERED that the hearing set for August 25, 2009 at 1:30 in this Court
is canceled, since the case is being transferred to the Wichita division.


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