Post-confirmation Conversion from 11 to 7: What’s in the Estate?

A problem that continues to divide the courts is what, if any, assets are in the chapter 7 estate when a chapter 11 case is converted to a chapter 7 case after confirmation of a plan of reorganization in the chapter 11 case. The problem arises because §1141(b) and typical plan language provide for vesting of assets in the reorganized debtor and the “disappearance” of the chapter 11 estate upon confirmation.

Pursuant to 11 U.S.C. §1141(b), “[e]xcept as otherwise provided in the plan [of reorganization] or the order confirming the plan, the confirmation of a plan vests all of the property of the estate in the debtor.” See In re Maine Pride Salmon Inc., 180 B.R. 337, 343 (D. Me. 1995) (“under §1141(b) confirmation vests all of the property of the estate in the debtor, unless the plan provides otherwise”). See also In re Pauling Auto Supply Inc., 158 B.R. 789, 793 (N.D. Iowa 1993) (estate terminates upon confirmation); In re T.S.P. Industries Inc., 117 B.R. 375, 377 (N.D. Ill. 1990) (upon confirmation estate property vests in debtor and estate ceases to exist unless plan provides otherwise). Accordingly, some courts have held that the conversion of the case from chapter 11 to chapter 7 does not revest property of the reorganized debtor in the chapter 7 estate. See, e.g., In re Toy King Distributors Inc., 256 B.R. 1, 103-104 n. 116 (M.D. Fla. 2000) (when chapter 11 plan is confirmed, all of the debtor’s property revests in the debtor and, therefore, the bankruptcy estate administered by chapter 7 trustee has no assets); In re Winom Tool and Die, Inc., 173 B.R. 613, 621 (E.D. Mich. 1994) (“property which vests in the debtor under §1141(b) does not revest in the estate upon conversion to chapter 7”); In re H.R.P. Auto Center, 130 B.R. 247, 256 (post-confirmation conversion does not create a new estate or convert property of the debtor into property of the estate); T.S.P. Industries, 117 B.R. at 377-78 (“Once property has been vested in the debtor, conversion will not revest that property in the estate.”). The result of this position is that the chapter 7 trustee may have no assets to administer or sell, making the post-confirmation conversion a pointless exercise, and leading some courts to view dismissal as the only option (unless a new case is filed by the reorganized debtor or an involuntary filed against it).

Other courts take a contrary view, or at least hold that the court may accomplish a revesting of the assets of the reorganized debtor into the chapter 7 estate either through the language of the conversion order or a creative reading of plan language; still others hold that such revesting is automatic, given a unified reading of applicable Code provisions. The court addressed this very fact pattern in In re Maine Pride Salmon Inc., 180 B.R. 337 (Bankr. D. Me. 1995). Maine Pride Salmon dealt with a post-confirmation conversion of a chapter 11 case to a case under chapter 7 of the Code. More to the point, the case involved a post-confirmation, post-conversion sale by the chapter 7 trustee of all of the pre-confirmation assets of the debtor remaining as of the date of conversion. As the court there described: “With §721 operating authority and a cash collateral order, [the chapter 7 trustee] piloted Maine Pride’s business toward a court-approved sale of, among other things, its inventory.” Id. at 339. Moreover, the Maine Pride Salmon court noted that the parties and the court intended “that the Conversion Order should sweep as broadly as possible to guarantee that all the debtor’s preconversion assets…would vest in the chapter 7 estate so that they might be preserved, administered and sold by the chapter 7 trustee…. Thus, the order named every conceivable post-confirmation repository of Maine Pride’s pre-confirmation estate as a source from which assets would flow to the chapter 7 estate.” Id. at 343, n.20. Accordingly, Maine Pride Salmon stands, at a minimum, for the proposition that upon a post-confirmation conversion of a case to a chapter 7 case, the court’s conversion order can revest all of the assets of the debtor and the former chapter 11 estate in the new chapter 7 estate, particularly where the debtor has consented to conversion. Id.

In short, a court entering a conversion order has the power to vest the pre-confirmation debtor assets in the chapter 7 estate, particularly where the debtor consents to the conversion (and such reassignment of assets).

Some courts also reason that any result other than revesting of remaining assets of the reorganized debtor and the chapter 11 estate into the chapter 7 estate would render absurd and meaningless the remedies that Congress has provided in 11 U.S.C. §1112(b)(7)-(9). See, 11 U.S.C. §1112(b)(7) (court may convert for inability to consummate plan); 11 U.S.C. §1112(b)(8) (subsection allows conversion in the event of “material default by the debtor with respect to a confirmed plan.”); 11 U.S.C. §1112(b)(9) (court may convert in the event of termination of a plan pursuant to a plan term). This view contends that Congress contemplated post-confirmation conversion and that such a step would provide meaningful relief to creditors otherwise damaged by the plan default. However, if the chapter 7 estate is, by definition, asset-less, what relief is provided by that provision? As one court recently stated,
Congress specifically made both inability to effectuate substantial confirmation of a confirmed plan and material default by a debtor with respect to a confirmed plan grounds for conversion of a chapter 11 case to chapter 7. 11 U.S.C. §1112(b)(7), (8), (9). These provisions make no sense if there is no point to chapter 7 administration. See In re Smith, 201 B.R. 267, 274 (D. Nev. 1996), aff’d 141 F.3d 1179 (9th Cir. 1998). The far better view, consistent with an integrated interpretation of the Code, is that upon conversion the chapter 7 estate consists of all remaining assets held for the benefit of creditors. In re Consolidated Pioneer Mortgage Entities, 248 B.R. 368, 379-83 (9th Cir. BAP 2000).

In re RJW Lumber Co., 262 B.R. 91, 93 (Bankr. N.D. Cal. 2001). A number of courts find that pre-confirmation assets must revest in the chapter 7 estate upon conversion from chapter 11 in order to effectuate §§1112(b)(7) – (9). See Smith v. Lee (In re Smith), 201 B.R. 267 (D. Nev. 1996), aff’d mem., 141 F.3d 1179, 1998 WL 133445 (9th Cir. 1998); Abbott v. Blackwelder Furniture Co of Statesville Inc., 33 B.R. 399 (W.D.N.C. 1983); In re Calania Corp., 188 B.R. 41 (Bankr. M.D. Fla. 1995); Benzner v. United Jersey Bank (In re Midway Inc.), 166 B.R. 585 (Bankr. D. N.J. 1994); In re Pauling Auto Supply Inc., 158 B.R. 789 (Bankr. N.D. Iowa 1993); In re NTG Industries Inc., 118 B.R. 606 (Bankr. N.D. Ill. 1990). Any other reading—the argument continues-- would compel either an involuntary petition against the reorganized debtor or a myriad of collection suits against the reorganized debtor—the very antithesis of bankruptcy relief and orderly administration, and Congress could not have intended such an absurd reading of the Code.
Proponents of “revesting” also note that the “nothing in the estate” cases ignore the language of §§348 and 541 of the Bankruptcy Code. Section 348(a) provides that conversion of a case constitutes an order for relief under the “new” chapter but does not effect a change in the date of the “commencement of the case.” Thus, upon conversion from chapter 11 to chapter 7, the date of the “commencement” of the chapter 7 case is the original chapter 11 petition date. 11 U.S.C. §348(a). Section 541 provides that the commencement of a case creates an estate and that the property of the chapter 7 estate consists of “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. §541(a)(1) (emphasis supplied). Thus, it is the debtor’s property—including property which was once “vested” pursuant to 11 U.S.C. §1141—which is swept into the chapter 7 estate. Sections 105 and 348(b) provide the court with the flexibility to deal with, and exclude from the chapter 7 estate, any assets transferred during the chapter 11 to bona fide purchasers, and to recognize liens granted or retained under the plan.

Also, prior to conversion, any creditor of the debtor could have commenced an involuntary chapter 7 case against the “reorganized” debtor due to the defaults under the plan—such creditors have claims against the reorganized debtor—and such chapter 7 estate, once the order for relief entered, would clearly have included all of the property of the debtor at that time. See e.g., In re Troutman Enterprises, Inc., 253 B.R. 8 (6th Cir. B.A.P. 2000). In light of §§1112(b)(7)-(9), proponents of revesting argue, Congress could not have intended that a post-confirmation involuntary would have one result, but a post-confirmation conversion another. The Code should be interpreted to avoid absurd results.

In addition, Ninth Circuit authority supports post-confirmation, post-conversion revesting of the debtor’s and the chapter 11 estate’s pre-confirmation assets in the chapter 7 estate. In re Consolidated Pioneer Mortgage Entities, 264 F.3d 803 (9th Cir. 2001). See also, Smith v. John Peter Lee, Ltd. (In re Smith), 141 F.3d 1179, 1998 WL 133445 (9th Cir.). In Consolidated Pioneer Mortgage Entities, the court noted that the chapter 11 plan in that case did not provide that remaining assets would revest in the estate in the event of conversion. However, the plan generally provided that the post-confirmation assets were being operated to pay creditors, and provided for standard post-confirmation supervision of distributions by the court and standard retention of jurisdiction clauses. Based upon these provisions, the court found that, notwithstanding the vesting provisions of the plan and §1141, assets held by the reorganized debtor became “assets of the estate upon conversion to chapter 7” because, under the language of §1141(b) the plan “otherwise provided” for revesting. 264 F.3d at 808. This is arguably creative reading of the plan, and seems to stand for the proposition that unless the plan language clearly prohibits revesting upon conversion, such revesting in the chapter 7 estate will occur. As the RJW Lumber court noted, Consolidated Pioneer Mortgage Entities “[s]tands for the correct proposition that property revests in the chapter 7 estate unless the chapter 11 plan unambiguously provided to the contrary. Thus, where property has been sold pursuant to the plan it cannot be recovered by the chapter 7 trustee. However, where property has not been transferred or hypothecated, such that it can be administered by the chapter 7 trustee without infringing on the rights of third parties, it becomes property of the estate upon conversion.” 262 B.R. at 93, n. 2.
In a recent unreported order in In re Sea Dog Brewing Co., No. 00-11861 (Bankr. D. Me., Dec. 12, 2002), the court was faced with objections to a chapter 7 trustee’s motion to sell assets filed by a creditor and a landlord who claimed that the chapter 7 trustee had nothing to sell because the case had converted from chapter 11 to chapter 7 and, in the chapter 11 case, a plan had been confirmed (with language vesting assets in the reorganized debtor, but no revesting clause) and the court had ruled that the plan was substantially consummated. The court overruled the objections, and allowed the sale of all of the remaining assets of the reorganized debtor and the former chapter 11 estate. In its ruling the court held as follows: “this Court, pursuant to 18 U.S.C. §1334(e), has jurisdiction over all remaining assets of the Debtor as of the date of the conversion of the Debtor’s case under chapter 11 of United States Bankruptcy Code, 11 U.S.C. §§101-1330 (the “Code” or the “Bankruptcy Code”) to a case under chapter 7 of the Code on or about Nov. 13, 2002, pursuant to this court’s order of that date (the “Conversion Order”), and the chapter 7 estate consisted of all of the debtor’s property as described in §541(a) of the Code and all property of the debtor’s original chapter 11 estate which vested in the debtor pursuant to §1141(b). The trustee has good title to the Purchased Assets. Without limiting the foregoing, the court finds and concludes that all such assets are assets of the chapter 7 estate because of: (1) the language of and effect of the interface of 11 U.S.C. §§348 and 541(a); (b) the clear intention of the debtor to include all such assets in the chapter 7 estate as evidenced by the language of the debtor’s motion to convert; (c) the effect of the Conversion Order, which contemplates inclusion of such assets in the chapter 7 estate; (d) the court’s agreement with the rationale set forth in In re Maine Pride Salmon Inc., 180 B.R. 337 (Bankr. D. Me. 1995) and In re RJW Lumber Co., 262 B.R. 91 (Bankr. N.D. Cal. 2001); and (3) the court’s opinion that a unified reading of §§348, 541, 1112(b)(7)-(9) of the Code and 28 U.S.C. §1334(e) compels such a finding under the facts and circumstances of this case and given the evidence presented to the Court.”

These cases underscore the importance of giving this issue some thought in connection with the drafting of the plan and the confirmation order. While the debtor may not wish to have revesting provisions, the creditors’ committee and other interests may be best served by insuring that the plan provides for revesting of all assets remaining with the reorganized debtor at post-confirmation conversion. Indeed, a number of courts insist on such a provision in the plan and in the confirmation order. See, RJW Lumber, 262 B.R. at 93 (“…, the court usually makes such a provision [for returning property to the chapter 7 estate upon conversion] in its confirmation order. The court did not do so in this case.”). Since § 1141(b) allows the plan to govern on this point, inclusion of revesting language may avoid needless litigation post-conversion.

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