Voluntarily dismissing a bankruptcy

Whether or not you can easily dismiss your case depends on which chapter of bankruptcy you have filed and the specific facts of your financial situation. In some cases, dismissing a bankruptcy case is relatively simple. The problem is that if you actually want to dismiss your case, you might fall into the category of cases which are not easily dismissed.

Why Would it Be Difficult to Dismiss a Bankruptcy?

Nearly all bankruptcy cases are commenced by the debtor filing a bankruptcy petition with the court. It is possible for the creditors to force someone into a Chapter 7 or 11 bankruptcy involuntarily. However, these involuntary bankruptcies are extremely rare, and only account for 0.05% of all bankruptcy cases, and between 50% to 75% of these cases are dismissed. Additionally, involuntary bankruptcy cases can back-fire on the creditors since the requirements are very strict and failure to meet these requirements can result in severe penalties against the creditors.

So if filing a bankruptcy is voluntary, then why would the debtor not be able to change their mind and just as easily dismiss the case?

Take this example:
We took on a case that was filed by an inexperienced attorney who shall remain nameless. This attorney’s clients lived in a home with no equity, but they also had a rental home with a substantial amount of equity. Their original attorney (not us) claimed the $175,000 California homestead exemption on their personal residence and the rental property despite the fact that you must reside in the property in which you claim a homestead exemption and married couples are only entitled to one homestead exemption that cannot be split. The trustee objected to both of the exemptions and sought turnover of both properties. That is when we substituted into the case and took over representing the Debtors and, by converting their case to one under Chapter 13, our clients were able to save both properties.

Ideally, these debtors would have voluntarily dismissed their case, rearranged their financial and asset situation, and then re-file at a point in time where they would not stand to lose their properties (this process is often referred to as “exemption or pre-bankruptcy planning”). This would have resulted in no loss of property, no payment to creditors, and it would have been a simple open-and-shut case. However, a motion to dismiss in their situation would require a showing that dismissal is in “the best interests of creditors”. Clearly, this could not be shown as a sale of one or both of the properties would have resulted in a substantial payment to creditors. So the only thing that could be done is to try and mitigate the damage caused by our clients’ former attorney which we were able to do by converting their case to one under Chapter 13.

Although the primary purpose of bankruptcy is to allow debtors to obtain a discharge and/or reorganize debts, there are some facets of bankruptcy law that are aimed toward balancing the equities, sometimes in favor of creditors. If there was an absolute right to dismissal, then in any case where there was some flaw with the filing or some other reason that the debtor would prefer for the case to end (for instance, when the case will result benefit to creditors at the debtor’s detriment), then these situations could be easily avoided by simply dismissing the case and then figuring out a different course of action to take.

Chapter 13 Bankruptcy Dismissal

Unlike Chapters 7 and 11, a Chapter 13 case is purely voluntary and a person cannot be forced into it nor can they be forced to remain in it. One reason for this is that Chapter 13 bankruptcy is defined by the monthly payments derived from a person’s income. Since the 13th Amendment prohibits involuntary servitude (aka, slavery), then forcing someone to work in order to make those payments would constitute a violation of this right. When the Bankruptcy Reform Act of 1978 was making its way through Congress, it was noted:

“[t]hough it has never been tested in the wage earner context, it has been suggested that a mandatory chapter 13 plan, by forcing an individual to work for creditors, would violate this prohibition [against involuntary servitude].”

H.R.Rep. 585, 95th Cong., 1st Sess. 120 (1977)

In general, the process for dismissing a Chapter 13 case is extremely simple and only involves filing a two-page motion for voluntary dismissal which is usually granted almost immediately.

However, this right to dismiss is not absolute. Dismissal of a Chapter 13 case can be denied when the case was originally filed as a Chapter 7 case and then converted to Chapter 13, or where the dismissal is sought in “bad faith”.

Conversion from Chapter 7 or 11 to Chapter 13 is also relatively simple and only requires filing a different 2-page form. If there was an absolute right to dismissal of a Chapter 13 case, this would allow people to side-step the difficulties of dismissing a Chapter 7 or 11 case by filing a simple motion to convert to Chapter 13, and then turning around and filing a simple request for voluntary dismissal of that Chapter 13 case.

In short, there is a good faith right to dismiss a Chapter 13 case when that case is initially filed under Chapter 13. However, when a case is converted to Chapter 13, the right is not absolute and that person can be forced back into Chapter 7 or 11.

The Best Interests of Creditors

In order to dismiss a Chapter 7 or 11 case, you must file a motion explaining how dismissal would be in the best interests of creditors. Since in most cases, especially Chapter 7 cases, creditors receive no payment or other benefit, then dismissal without a discharge would almost always be in their best interests. However, if you are in one of those situations where creditors stand to receive a benefit in your case, then the “best interests of creditors” test weighs against dismissal and it is likely that your case cannot be voluntarily dismissed quite so easily.

Automatic Dismissal?

Although voluntarily dismissing your case requires taking the affirmative step of filing a motion requesting this, there are instances in which dismissal may occur involuntarily and automatically. The two most common are by failing to file required documents or failing to appear at your 341(a) Meeting of Creditors.

However, one must tread lightly here. Even if a debtor fails to do one or both of these, the case might not be automatically dismissed if a party were to raise the issue and then that person can be forced to file these documents and appear for an examination or give testimony. This situation typically arises when a creditor is aware of the existence of assets that the Chapter 7 trustee could sell and pay dividends to creditors. Additionally, attempting to pull this trick can be seen as bad faith and could potentially result in denial of discharge, meaning that not only will you be forced to lose your property, but you will also not receive a discharge of any debts that are not paid by your loss of that property.

How to Avoid Being Forced to Stay in Bankruptcy

The way to avoid being in a situation where you are forced to stay in bankruptcy against your will is to seek the counsel of experienced bankruptcy attorneys who will know how a case will play out before it is filed.  In most situations where a person would lose property or suffer other adverse consequences if they were to urgently file their case, this can be avoided by pre-bankruptcy planning to delay their case in order to maximize their success in a bankruptcy case that is filed later on down the line.  Pre-bankruptcy planning includes filing at the most optimal time and minimizing risk of loss of property, something which an experienced bankruptcy attorney can assist with.