Kenneth Brown v. Christopher Barclay ( 2020 )

FOR PUBLICATION
UNITED STATES COURT OF APPEALS
FOR THE NINTH CIRCUIT
IN RE JASON SCOTT BROWN, No. 18-60029
Debtor,
BAP No.
17-1068
KENNETH BROWN,
Appellant,
OPINION
v.
CHRISTOPHER BARCLAY,
Appellee.
Appeal from the Ninth Circuit
Bankruptcy Appellate Panel
Kurtz, Spraker, and Alston, Bankruptcy Judges, Presiding
Argued and Submitted November 7, 2019
Pasadena, California
Filed March 23, 2020
Before: Mary M. Schroeder, Michelle T. Friedland,
and Ryan D. Nelson, Circuit Judges.
Opinion by Judge Schroeder
2 IN RE BROWN
SUMMARY*
Bankruptcy
The panel affirmed the bankruptcy court and the
Bankruptcy Appellate Panel’s ruling in favor of a Chapter 7
trustee who contended that funds fraudulently transferred by
the debtor remained property of the bankruptcy estate upon
conversion from Chapter 13 to Chapter 7.
Under 11 U.S.C. § 348(f)(1)(A), upon conversion from
Chapter 13 to Chapter 7, the converted estate consists of the
assets that remain in the possession or control of the debtor at
the time of conversion. Here, the debtor made unauthorized
and fraudulent transfers of funds during the Chapter 13
proceeding. The panel held that, following conversion for
cause to Chapter 7, upon the bankruptcy court’s finding of the
debtor’s bad faith in making the transfers, the transferred
funds remained property of the Chapter 7 estate, which meant
that the Chapter 7 trustee had authority to recover them.
Interpreting § 348 in light of the structure of the Bankruptcy
Code as a whole, including its object and policy, the panel
held that, because the debtor transferred the funds with the
fraudulent purpose of avoiding payments to creditors, the
funds remained within his constructive possession or control,
and hence should be considered part of the converted estate.
*
This summary constitutes no part of the opinion of the court. It has
been prepared by court staff for the convenience of the reader.
IN RE BROWN 3
COUNSEL
Michael G. Doan (argued), Doan Law Firm, Oceanside,
California, for Appellant.
Yosina M. Lissebeck (argued), Lissebeck Law, San Diego,
California, for Appellee.
OPINION
SCHROEDER, Circuit Judge:
OVERVIEW
When a bankruptcy proceeding is converted from a
proceeding under Chapter 13 to a proceeding under Chapter
7, the contents of the Chapter 7 estate should be easily
ascertainable. Congress therefore enacted 11 U.S.C.
§ 348(f)(1)(A) to define the converted estate. It provides that
the converted estate consists of the assets in the Chapter 13
estate that remain in the possession or control of the debtor at
the time of conversion.1
The problem in this case began when the debtor made
unauthorized and fraudulent transfers of funds during the
Chapter 13 proceeding. After the Bankruptcy Court
converted the proceedings to Chapter 7 in response, the
debtor argued that the transferred funds were no longer in the
1
Section 348(f)(1)(A) provides “property of the estate in the
converted case shall consist of property of the estate, as of the date of
filing of the petition, that remains in the possession of or is under the
control of the debtor on the date of conversion.”
4 IN RE BROWN
estate. The Bankruptcy Court and the Bankruptcy Appellate
Panel (“BAP”) disagreed, holding that, under the
circumstances, the transferred funds should remain property
of the Chapter 7 estate, which would mean the Chapter 7
trustee had authority to recover them. Those courts, however,
came up with three different rationales for that result. We
agree that the funds should remain property of the estate, but
we must endeavor to harmonize that result with the language
of § 348(f)(1) and the limited case law interpreting it.
The case arises out of a modest family inheritance. The
debtor, Jason Brown, has three brothers, including Appellant
Kenneth Brown. When their father died on July 20, 2012, he
left his estate to his four sons. In the state court probate
proceeding in August 2013, each of the brothers abandoned
their interests in the estate to Jason.
Jason then filed his Chapter 13 bankruptcy petition on
December 13, 2013 and filed his schedules and Chapter 13
plan on December 21. He scheduled an anticipated
inheritance of only $2,500. A few months after that, the state
court distributed the net proceeds of the estate to Jason, an
amount totaling $55,487.97. Jason almost immediately, and
without the approval of the Chapter 13 trustee, transferred
$12,372 to each of his brothers.
Upon learning of the unauthorized transfers, the Chapter
13 trustee, as a sanction, sought conversion pursuant to
11 U.S.C. § 1307(c). That section provides that upon request
of the trustee, the Bankruptcy Court may convert a case to
Chapter 7 for cause. The trustee alleged Jason had abused the
bankruptcy system by first failing to disclose the full amount
of his anticipated inheritance and then by transferring most of
that inheritance to his brothers who no longer had any claim
IN RE BROWN 5
to it. At the hearing on the Chapter 13 trustee’s motion, Jason
offered no justification for either the lack of disclosure or the
transfers. Jason also acknowledged that he could not account
for any of the money, including the funds that he had retained
after transferring equal shares to his brothers. The
Bankruptcy Court ordered the conversion to Chapter 7 for
cause, and, when Jason moved for reconsideration, made an
express finding that Jason’s conduct had been in bad faith.
The Bankruptcy Court explained that given the
uncontradicted evidence of concealment by Jason, and his
failure to provide an adequate explanation for his actions,
there was ample support for a bad faith finding without
holding an additional hearing. It concluded that the transfers
were made to avoid payments to creditors.
The Bankruptcy Court then appointed Appellee
Christopher Barclay as the Chapter 7 trustee. The trustee
moved to recover the funds from all four brothers, including
Appellant Kenneth and debtor Jason. Appellant’s position
was that the funds transferred to him were not part of the
bankruptcy estate after the conversion because they were no
longer in the possession or control of the debtor, as required
by § 348(f)(1)(A). The Bankruptcy Court disagreed, and
offered two different reasons why the funds remained part of
the bankruptcy estate. First, the Bankruptcy Court explained
that because the transfers were not for ordinary living
expenses permitted by statute, but were made in bad faith to
avoid creditors, they should be regarded as property of the
converted estate. Alternatively, the Bankruptcy Court
reasoned that because Jason’s estate had a claim to recover
the funds from the brothers, the funds could be said to have
remained within his possession or control within the meaning
of § 348 (f)(1)(A).
6 IN RE BROWN
The BAP majority agreed with the Bankruptcy Court’s
first rationale, holding that because the funds were not spent
in good faith on ordinary living expenses, they remained part
of the converted estate. Judge Spraker wrote a separate
concurring opinion. In his view, a claim to avoid the transfer
of funds accrued to the Chapter 13 trustee before conversion,
and that claim was unaffected by § 348(f)(1)(A).
In his appeal to this court, Appellant does not dispute the
finding of bad faith but contends only that funds transferred
to him were no longer in the literal possession or control of
his brother, the debtor Jason, at the time of conversion, and
hence not recoverable as part of the Chapter 7 estate. The
trustee argues, however, that the property defined by § 348
must include fraudulently transferred funds to prevent abuse
of the system. This dispute thus concerns the interpretation
of § 348(f)(1)(A), a provision that does not directly address
the issue of fraudulent transfers. As in other contexts, we
must interpret a problematic section of the Bankruptcy Code
in light of the structure of the Code as a whole, including its
object and policy. See Hawkins v. Franchise Tax Bd.,
769 F.3d 662, 666 (9th Cir. 2014) (citing Children’s Hosp. &
Health Ctr. v. Belshe, 188 F.3d 1090, 1096 (9th Cir. 1999)).
DISCUSSION
Section 348 comes into play when a bankruptcy
proceeding is converted from Chapter 13 to Chapter 7. We
therefore look first to the nature of each type of proceeding.
Chapter 13 bankruptcy is a voluntary proceeding that
allows a debtor to retain control over some assets while the
debtor repays creditors over a three-to-five-year period. In
exchange for retaining control of some assets, the property
IN RE BROWN 7
accumulated during the repayment period becomes part of the
bankruptcy estate and is used to repay creditors. See
11 U.S.C. § 1306(a)(1) (including in the Chapter 13 estate
“all property . . . that the debtor acquires after the
commencement of the case but before the case is closed,
dismissed, or converted to a case under chapter 7, 11, or 12”).
In contrast, Chapter 7 allows debtors to discharge their
existing debts immediately without a long-term payment
plan. But in exchange, the debtor must relinquish control of
and liquidate all existing assets. The Chapter 7 trustee is to
sell the property of the estate, 11 U.S.C. § 704(a)(1), and then
distribute the proceeds to the debtor’s creditors, 11 U.S.C.
§ 726. Unlike in Chapter 13 proceedings, wages or other
assets acquired by the debtor post-petition are not property of
the estate, and therefore creditors do not have access to them.
See Harris v. Viegelahn, 135 S. Ct. 1829, 1835 (2015)
(“Thus, while a Chapter 7 debtor must forfeit virtually all his
prepetition property, he is able to make a ‘fresh start’ by
shielding from creditors his postpetition earnings and
acquisitions.”).
An issue that arises is how to define the contents of the
estate that is converted from Chapter 13 to Chapter 7. One
option would be to apply Chapter 7’s rule that all assets
acquired after the filing of the initial petition are retained by
the debtor and do not become part of the bankruptcy estate.
This approach would bar creditors from obtaining assets that
were acquired by the debtor after the Chapter 13 petition was
filed. In essence, this approach would put the debtor where
he would have been, had he filed in Chapter 7 initially.
Applying Chapter 7’s rule upon conversion would therefore
allow the debtor to keep assets that were acquired after the
initial voluntary Chapter 13 petition was filed.
8 IN RE BROWN
Another approach would be to apply Chapter 13’s rule
that assets acquired after the petition is filed become part of
the estate. Thus, assets acquired after the Chapter 13 petition
was filed would, upon conversion to Chapter 7, become part
of the converted estate. This approach would give a debtor’s
creditors, upon conversion to Chapter 7, access to all such
assets. Such an approach would put the debtor in a worse
position than if the petition had been filed in Chapter 7
initially.
Congress tried to resolve the issue in § 348(f)(1)(A),
which effectively adopted the Chapter 7 approach, by
defining the converted estate to exclude assets acquired after
the initial filing. This provision limits the converted estate in
two ways. First, to avoid penalizing the debtor who initially
engaged in voluntary bankruptcy under Chapter 13, Congress
restricted the assets of the converted estate to property “as of
the date of filing of the [voluntary] petition.” 11 U.S.C.
§ 348(f)(1)(A). This means that, after conversion to Chapter
7, creditors are barred from recovering property that was
acquired by the debtor after filing the Chapter 13 petition.
See, e.g., Harris, 135 S. Ct. at 1837 (holding that wages
acquired by the debtor after filing for Chapter 13 bankruptcy
and not distributed at the time of conversion, are not property
of the converted estate under section 348(f)(1)(A)).
Second, and of immediate concern here, Congress, in
§ 348(f)(1)(A), limited the property of the converted estate to
include only property that “remains in the possession of or is
under the control of the debtor on the date of conversion.”
This was necessary in order to take into account the debtor’s
ability to spend funds on ordinary living expenses during the
Chapter 13 proceeding. See 11 U.S.C. §§ 1303, 1306(b); In
re Pisculli, 426 B.R. 52, 66 (E.D.N.Y. 2010) (“[T]he rights
IN RE BROWN 9
conferred by sections 1303 and 1306(b) . . . provide the
Chapter 13 debtor with the implicit right to use property of
the estate for ordinary and necessary living expenses,
provided such use is not in bad faith.”). This second
limitation prevents creditors from seeking to recover funds
that were lawfully spent during the Chapter 13 proceeding
and therefore no longer property of the estate. See 140 Cong.
Rec. H10752-01 at *H10771 (1994).
This second limitation on the property of the converted
estate has given rise to problems for the bankruptcy courts,
when, as here, there have been unlawful expenditures during
Chapter 13. See In re Salazar, 465 B.R. 875, 878–79 (B.A.P.
9th Cir. 2010) (“Courts have struggled in applying
§ 348(f)(1)(A).”) The primary issue that arises is whether
creditors may go after funds that are no longer in the
possession or control of the debtor, because they were
transferred out of the Chapter 13 estate without proper
authorization.
Salazar was the first BAP case to grapple with
§ 348(f)(1)(A). In Salazar, the issue was what to do with
assets that, during the Chapter 13 proceeding, came in and
then went out for appropriate, but unauthorized, expenses.
The debtors had received a tax refund after they filed for
Chapter 13 bankruptcy. Id. at 882. The debtors proceeded to
spend those funds “in the normal course of living.” Id. After
conversion to Chapter 7, the trustee sought recovery of the
tax refunds that were acquired by the debtors post-petition.
The trustee argued that the tax refund should be included in
the property of the converted estate, because in the trustee’s
view, the tax refunds should have been categorized as
property of the Chapter 13 estate. Id. at 877. But the BAP
reasoned that, because the debtor spent the tax refunds on
10 IN RE BROWN
ordinary living expenses, those funds should be excluded
from the converted estate. Id. at 882. Other bankruptcy
courts have agreed that § 348(f)(1)(A) bars creditors from
recovering funds from the converted estate that were spent on
ordinary living expenses during Chapter 13, even if those
expenses were unauthorized. See, e.g., In re Laflamme,
397 B.R. 194, 205–06 (Bankr. D.N.H. 2008).
Conversely, courts have generally allowed creditors to
recover funds where the debtor has fraudulently transferred
those funds out of the Chapter 13 estate to avoid creditors
without authorization. For example, in Pisculli, the debtor
transferred to his wife and brother-in-law funds obtained from
a truck sale that should have been used to repay the debtor’s
creditors, and did so without notifying the Chapter 13 trustee.
426 B.R. at 57. The court reasoned that, because those
proceeds had not been spent on ordinary living expenses, they
should be included in the converted estate. Id. at 66. The
court explained that, where the debtor surreptitiously
transferred funds out of the estate during Chapter 13, “the
debtor should not be allowed to escape the consequence [of
that action]. . . simply because the proceeding has been
converted to a Chapter 7 case.” Id. at 65.
Such a result is even more compelling where, as here,
conversion to Chapter 7 has been imposed as a sanction for
fraudulent transfers. In such cases, courts have observed that
a literal application of § 348(f)(1)(A) to treat assets
transferred in bad faith without authorization as outside the
estate could lead to an absurd result, one rewarding bad faith.
As the court in Wyss v. Fobber explained, exclusion of the
fraudulently transferred funds from the converted estate
would mean that “the very act which generally would form
the basis for the denial or revocation of discharge, i.e.,
IN RE BROWN 11
disposition of property of the estate, would insulate the debtor
from liability” in the Chapter 7 proceeding. 256 B.R. 268,
276 (Bankr. E.D. Tenn. 2000); see also In re Grein, 435 B.R.
695, 699 (Bankr. D. Colo. 2010) (including property in the
converted estate, “in order to avoid an absurd result”).
While the result that fraudulently transferred funds should
be recoverable by creditors as part of the converted estate
under section 348(f)(1)(A)—especially when conversion was
imposed as a sanction for those fraudulent transfers—seems
obvious, the text of the statute is much less so. Perhaps for
this reason, in this case, the Bankruptcy Court and members
of the BAP articulated three different theories to explain how
to reach that result. The BAP majority applied the test from
Salazar and concluded that because the funds were not spent
in good faith on ordinary living expenses, they remained part
of the converted estate. Separately concurring, Judge Spraker
explained that, in his view, the funds were not part of the
converted estate, but the right to recover those funds had
accrued to the Chapter 13 trustee before conversion. He
concluded that the right to recover was unaffected by
conversion to Chapter 7. The Bankruptcy Court had taken a
slightly different view, stating that because debtor Jason’s
estate had a claim against his brothers, that claim was part of
the Chapter 13 estate and became property of the estate.
Although they disagreed on the specific rationale, the BAP
majority, Judge Spraker, and the Bankruptcy Court all agreed
that the fraudulently transferred funds must be considered
property of the estate after conversion to Chapter 7.
None of these rationales, however, directly address
Appellant’s main contention. That contention is that the
definition of the post conversion estate in § 348(f)(1)(A),
property that “remains in the possession of or is under the
12 IN RE BROWN
control of the debtor,” does not include funds transferred out
of the estate, albeit fraudulently. Although the BAP
majority’s approach, to include the fraudulent expenditures as
part of the converted estate because they were not spent on
ordinary living expenses, seems sensible, the statute does not
say that. It provides only that funds remaining within the
possession or control of the debtor are part of the converted
estate. Appellant further argues that the BAP should have
discussed the Supreme Court’s decision in Law v. Siegel,
571 U.S. 415 (2014). There, the Court was considering a
bankruptcy court’s equitable powers under 11 U.S.C.
§ 105(a). The Court held that a bankruptcy court cannot use
such equitable powers where doing so would “contravene
specific statutory provisions” exempting certain property
from the reach of creditors. Siegel, 571 U.S. at 421.
Appellant argues that the Bankruptcy Court and BAP
committed a similar error by using their equitable authority
to override an express provision of the Bankruptcy Code.
Appellant contends that the BAP majority did not even
attempt to explain how its result could be reconciled with the
text of § 348, and that they are in fact irreconcilable.
Appellant further contends that Judge Spraker’s view is
incompatible with the text of §348. Judge Spraker’s
conclusion that the Chapter 13 trustee’s claim to avoid the
fraudulently transferred funds was unaffected by conversion,
Appellant argues, would make § 348(f)(1)(A)’s separate
definition of the converted estate superfluous.
The question we must answer here is whether the
statutory provision, § 348(f)(1)(A), that defines property of
the estate at the time of conversion, includes funds that were
fraudulently transferred out of the voluntary estate in order to
avoid creditors. We do not agree with Appellant that the
IN RE BROWN 13
express provision of the Code provides a clear answer with
respect to the issue of fraudulent transfers. To interpret what
we view as ambiguous text, we begin by looking to the
structure, object, and policies of the Bankruptcy Code. See
Hawkins, 769 F.3d at 666.
The Code reflects a firm policy of not rewarding fraud or
bad-faith debtors—which it realizes in numerous provisions,
including the structural relationship between Chapter 13 and
Chapter 7. In both Chapter 13 and Chapter 7 proceedings,
unauthorized transfers of estate property by the debtor can be
recovered by the trustee. See 11 U.S.C. § 549(a). Under
both, a delay of discharge may be obtained where a debtor
fraudulently transfers funds. See 11 U.S.C. § 523(a)(2)(A).
And the Code permits the bankruptcy court to order
conversion to Chapter 7 when the debtor fraudulently
transfers funds during a voluntary bankruptcy proceeding.
See 11 U.S.C. § 1307(c). Appellant concedes that had this
case remained in Chapter 13, the trustee could have recovered
those funds. And if the case had been filed initially in
Chapter 7, the trustee could have also recovered the funds.
There is thus no basis in the structure, policy, or purpose
of the Bankruptcy Code for treating the fraudulent transfers
as beyond the reach of the creditors merely because the estate
was converted. The only argument otherwise is that Congress
used language that seemingly requires actual possession or
control, despite the injustice of the result. For the reasons
that follow, we disagree with that statutory interpretation.
To assist us in our interpretation of the text, we look to
other situations in which courts examining statutes requiring
possession have recognized that an interpretation requiring
actual physical possession could lead to unfair or untoward
14 IN RE BROWN
results. In such situations, which arise principally in criminal
contexts, courts have adopted a broader interpretation of
“possession.” Examples are statutes penalizing the
possession of contraband and statutes penalizing laundering
of money that has been in the defendant’s possession. Courts
have utilized the concept of “constructive” control or
possession, whereby an individual is deemed to possess items
even when the individual does not actually have immediate
physical possession of the item. See, e.g., United States v.
Vasquez, 654 F.3d 880, 885–86 (9th Cir. 2011).
The possession of a controlled substance is a crime under
our drug laws. See, e.g., 21 U.S.C. § 841(a)(1) (“[I]t shall be
unlawful for any person knowingly or intentionally to . . .
possess . . . a controlled substance”). When defendants
charged with violating this and similar statutes have argued
that actual physical possession of the contraband is required,
courts have rejected the argument, explaining that a
demonstration of constructive possession or control of the
contraband is sufficient. See, e.g., United States v. Disla,
805 F.2d 1340, 1350 (9th Cir. 1986) (observing that “[w]e
have upheld many convictions [under § 841(a)(1)] under the
theory of constructive possession”); United States v. Ruiz,
462 F.3d 1082, 1088 (9th Cir. 2006) (“[W]e have defined
possession as having actual or constructive control.”).
With respect to money laundering, the criminal statute
penalizes the transfer of unlawfully obtained proceeds.
18 U.S.C. § 1957(f)(2) (defining “criminally derived
property” as “any property constituting, or derived from,
proceeds obtained from a criminal offense”). Courts have
held that to show that a defendant “obtained” proceeds, there
must be a demonstration of possession or control. See United
States v. Piervinazi, 23 F.3d 670, 677 (2d Cir. 1994).
IN RE BROWN 15
Defendants charged under this statute have argued that if a
defendant merely directed a transfer of proceeds without ever
placing the funds in the defendant’s own account, that
defendant “neither possessed nor controlled the[] funds” and
therefore could not be the subject of the money laundering
charges. United States v. Smith, 44 F.3d 1259, 1265–66 (4th
Cir. 1995). But courts have concluded that constructive
control of fraudulently obtained funds is sufficient and may
be inferred where transfers are made pursuant to a scheme of
fraud that the defendant participated in or directed. See id. at
1266; United States v. Prince, 214 F.3d 740, 748 (6th Cir.
2000) (holding that the defendant “did not need to have
physical possession of the money before it could be
considered proceeds”); United States v. Howard, 271 F. Supp.
2d 79, 83 n.4 (D.D.C. 2002) (explaining that “the defendant
need not be in actual possession of the proceeds of the funds
derived from the specified unlawful activity; constructive
control of the funds is sufficient”). Accordingly, proceeds
from money laundering may be within the defendant’s
constructive control or possession, even though the funds
were never placed in the defendant’s account. Smith, 44 F.3d
at 1266.
The situation in this case is parallel. The debtor Jason
transferred the funds out of his actual possession to a close
family member, in an effort to avoid payments to his creditors
that would have otherwise been required under the
Bankruptcy Code. In analogous criminal contexts, courts
have consistently rejected efforts to evade the operation of the
law by disguising ownership of fraudulently obtained funds
or contraband. See, e.g., Henderson v. United States, 135 S.
Ct. 1780, 1785 (2015) (explaining that a defendant “cannot
evade the strictures of [the statute] by arranging a sham
16 IN RE BROWN
transfer that leaves him in effective control of” the
contraband). We apply the same approach here.
It is undisputed that the debtor Jason was trying to avoid
the operation of the Bankruptcy Code when he transferred the
funds to close relatives without first notifying either the
Bankruptcy Court or the Chapter 13 trustee. Had there been
a dispute as to his intent, we believe that an unauthorized
transfer would at least give rise to a rebuttable presumption
that funds remained within the debtor’s possession or control.
In this case, however, the Bankruptcy Court found, and it has
never been disputed on appeal, that the debtor transferred the
funds with the fraudulent purpose of avoiding payments to
creditors. The brothers may, for example, have intended to
give the money back to the debtor Jason after the bankruptcy
was over. We therefore hold that those funds remained
within his constructive possession or control, and hence
should be considered property of the converted estate under
§ 348(f)(1)(A).
AFFIRMED.