Blumsack v. Harrington (In re Blumsack)

Summarized by Solymar Castillo-Morales , Goldman Antonetti & Cordova PSC
1 year 11 months ago

Case Type:

Consumer

Case Status:

Affirmed

Citation:

BAP NO. 23-003 (1st Circuit, Mar 05,2024) Published

Tag(s):

Ruling:

The Court of Appeals affirmed the dismissal of the case but do so on different grounds from those articulated by the Bankruptcy Court. The dual requirements of § 1307(c)(5) were satisfied. The Court affirmed that no abuse of discretion existed in the bankruptcy court’s decision to deny the debtor’s request for additional time to propose a modified plan. The Court also disagree with the Bankruptcy Court's reasoning for dismissal on § 105 and the oaths of office taken under 28 U.S.C. § 453 and 5 U.S.C. § 3331.

Procedural context:

Following a motion to dismiss filed by the US Trustee, an evidentiary hearing and post hearing briefs, the Bankruptcy Court denied confirmation of the proposed plan and dismissed the chapter 13 case of a debtor employed by a cannabis dispensary. The court found that the debtor had violated the CSA in the course of his employment. In evaluating whether the debtor’s violations of the CSA established a lack of good faith, the court observed that the term “good faith” is not defined in the Bankruptcy Code and the concept should be evaluated based on the “totality of the circumstances[.]” In denying confirmation, the bankruptcy court explained: "The Debtor’s Chapter 13 plan as currently proposed is to be funded by the wages derived from . . . illegal activities, which would require the Chapter 13 trustee to knowingly administer wages derived from an active participant in a criminal enterprise. . . . [T]he Court cannot find, under an objective standard, that the case was filed in good faith or that the plan was proposed in good faith as required by §§ 1325(a)(7) and (a)(3), since, from the inception of this case, the Debtor has engaged in and benefited from, and intends to continue [to] engage in and benefit from, activities that violate federal criminal law. The bankruptcy court also determined that there was cause to dismiss the case under § 1307(c) for two reasons. First, the debtor’s lack of good faith constituted cause. Second, there was cause under § 1307(c)(5) because confirmation had been denied, and the debtor was not entitled to the opportunity to file a modified plan. The court reasoned that: "While the Debtor now says that he can propose a plan that is funded solely by the wages from the Debtor’s spouse (which are not derived from engagement in federal crimes), the Debtor does not suggest that he will cease engaging in activities that violate federal criminal laws. Based on the circumstances here, the Court will not grant the Debtor additional time to file another plan or a modification of the plan, as such amendment or modification would be futile. Even if the plan were amended as proposed, the Court finds that the Debtor objectively lacks good faith in seeking the benefits and protections of federal bankruptcy laws while continuously and contemporaneously undertaking (and earning income from) actions that violate federal criminal laws." The court asserted that “irrespective of any segregation of funds,” a debtor’s continued employment in the marijuana industry during the pendency of a bankruptcy case would inevitably” require the court and the chapter 13 trustee to support the debtor’s criminal enterprise. Observing that neither party had requested conversion, the court ruled dismissal was appropriate. The bankruptcy court further declared that “it would be an abuse of process to permit the Debtor to obtain the protections and benefits of the federal bankruptcy laws while continuing to commit federal crimes,” rendering dismissal appropriate under § 105(a). Also indicated that it would be inconsistent with the judicial oaths of office taken under 28 U.S.C. § 453 and 5 U.S.C. § 3331 to permit the debtor to obtain the benefits of bankruptcy while engaging in federal crimes. The debtor appealed. While affirming under different grounds, the U.S. Court of Appeals for the First Circuit declared that the “totality of the circumstances” is the standard to be applied when adjudicating good faith under § 1325. Clarified that, although the bankruptcy court recited that the totality of the circumstances test governs the good faith inquiry, the court’s ruling under § 1325(a)(7) was grounded in a single consideration—the debtor’s ongoing violation of the CSA. If a fee-only plan is not per se proposed in bad faith, then it is hard to see how the legal status of the debtor’s employment, standing alone, is enough to doom the debtor on the petition date. Second, to the extent that bright-line rules can be drawn regarding good faith under § 1325, those rules must be meaningfully connected to the debtor’s conduct in connection with the bankruptcy case. The good faith provisions of § 1325 are tethered to the debtor’s actions in filing a petition and proposing a plan. The bankruptcy court’s conclusion that ongoing violation of the CSA renders an individual categorically unable to file a chapter 13 petition in good faith is, in its view, unmoored from the bankruptcy-specific context in which the good faith inquiry must occur. In adopting a categorical rule that a debtor employed in the marijuana industry lacks good faith for purposes of § 1325(a)(7), the bankruptcy court established a bar to eligibility. That is a subject addressed not by § 1325, but rather in § 109. The Court explained that. if Congress had assigned a bankruptcy-specific remedy for violations of the CSA, then the bankruptcy courts would be duty bound to follow that directive. In the absence of such direction, the blunt remedy of dismissal was not warranted under § 105 and the oaths. The Court agreed with the bankruptcy court’s conclusion that the debtor lacked good faith in proposing the Plan and the denial of confirmation on that basis under § 1325(a)(3). The debtor proposed to fund the Plan with the income he derived from his employment at the dispensary; he did not offer his spouse’s income or assets unrelated to marijuana activities until after the Trustee filed the Motion to Dismiss. When given the opportunity at the evidentiary hearing, the debtor did not establish that he segregated his marijuana income from his spouse’s income or other assets unrelated to his employment. The Plan he proposed would have placed the chapter 13 trustee in the untenable position of knowingly administering assets derived from an activity illegal under federal criminal law. Bankruptcy relief is generally unavailable where the trustee “will necessarily be required to possess and administer assets which are either illegal under the CSA or constitute proceeds of activity criminalized by the CSA. Where the debtor proposed to fund his reorganization with the proceeds of illegal activity, the degree of connection between that criminal activity and the debtor’s reorganization efforts crossed a line into bad faith territory. On these facts, the Court agreed with the bankruptcy court that the Plan did not satisfy § 1325(a)(3). Given the conclusion that the denial of confirmation was proper, it follows that the first requirement of § 1307(c)(5) was met as to the second requirement of § 1307(c)(5), the court concluded that no abuse of discretion existed in denying an extension to file another plan, since upon the motion to dismiss and at the evidentiary hearing the debtor could, but failed to produce sufficient evidence regarding the availability of non- cannabis related funds.

Facts:

The debtor filed a chapter 13 petition in April 2021. At that time, he was employed as a “budtender” at a cannabis dispensary in Massachusetts (where state law permits the retail sale of marijuana). The debtor’s schedules disclosed his wages from the dispensary and his spouse’s income from her employment as an engineer. The debtor and his spouse commingled their wages in a joint checking account. Also, the debtor stated that the joint checking account was “use[d] for daily living” and admitted that the retirement funds were not the only monies deposited into the joint checking account: he and his wife also deposited their paychecks into that account. As for the savings account, the debtor was unsure whether it was held jointly, and he admitted that he did not know how much money was transferred from the joint checking account to the savings account after the withdrawal from his wife’s retirement account. The United States Trustee (the “Trustee”) filed a motion objecting to confirmation of the Plan and seeking dismissal of the case. The Trustee alleged that the debtor, by virtue of his employment, was engaged in criminal activity proscribed by the Controlled Substances Act (“CSA”) of 1970, 21 U.S.C. § 812. In the Trustee’s view, the debtor’s violations of the CSA precluded a determination that the Plan (or any plan) could satisfy the good faith requirements of § 1325(a)(3) and (a)(7). Because the debtor was incapable of confirming any plan, the Trustee asserted, the debtor was ineligible for chapter 13 relief. More generally, the Trustee argued that the bankruptcy court could not condone the debtor’s “ongoing illegal activity by confirming a plan that [was] funded directly or indirectly through income derived from employment at a marijuana enterprise[.]” The Trustee also sought dismissal under § 1307(c), arguing there was “cause” to dismiss where the debtor could “confirm no plan, and continuance of the case would require the trustee to administer assets representing proceeds of an illegal business.” The debtor asserted that “cannabis does not preclude availability of relief in federal courts.” As for the Trustee’s approach to good faith, the debtor argued that the inquiry should turn on the totality of the circumstances, rather than a single factor. In addition, he asserted that the good faith analysis under § 1325(a)(3) centers not on the terms of the plan, but the manner of its proposal. After an evidentiary hearing and post hearing briefs, the Bankruptcy Court denied confirmation of the proposed plan and dismissed the case.

Judge(s):

Godoy, Cary and Fagon

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