Kenneth Brown v. Christopher Barclay

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.