In re Karlinger-Smith: Debtors Protected from Conversion by Good Faith Efforts to Repay

Case AnalysisNadine Ona

In re Karlinger-Smith, 544 B.R. 126 (Bankr. W.D. Tex. Jan. 21, 2016)
Opinion Issued: Jan. 21, 2016. Westlaw Link
Written By: Nadine Ona, Staff Member

Debtors attempted to start a business, but ultimately failed to sustain it. The debtors engaged in a number of good faith efforts to repay their creditors, including hiring a credit counseling group, agreeing to settlement offers, and sacrificing their disposable income. After making payments on the business debts, the only business debt left to negotiate was with a bank. The credit-counseling group attempted to negotiate a settlement with the bank, but ultimately failed to do so.  The credit-company then stopped working for the debtor and returned any payments collected back to the debtors. The bank sued the debtors in order to collect its debt. In response, the debtors filed for Chapter 7 relief. The trustee then sought conversion to Chapter 11 because of the substantial disposable income the debtors had.

The bankruptcy court determined the proper standard to evaluate if a case should be converted from Chapter 7 to 11 was to determine “what [would] most inure to the benefit of all parties in interest.” The court noted that if conversion were granted and all of the debtors’ disposable income were directed to creditors against their will, then not only would there be a lack of benefit to the debtors, but also a lack of incentive for them to continue working productively. The court also noted the potential litigation fees on both sides arising from conversion would be disproportionate to any derived benefit. Additionally, the court noted that not only did the debtors “responsibly, diligently, and successfully” pay off most of their debt even before filing for bankruptcy, but they also made many personal sacrifices, continued to pay their taxes, and satisfied all of their other creditors. Finally, the court noted that the motion to convert was by the trustee, not the creditor who filed pre-petition suit. Thus, the court denied the trustee’s motion to convert.

Ultimately, this case demonstrates that as long as debtors make good faith efforts to repay their debts, the courts may protect them from involuntary conversion.