11 U.S.C. Section 706 - Conversion from Chapter 7

What Is Section 706?

Section 706 governs conversion from Chapter 7 to one of the reorganization chapters (Chapter 11, Chapter 12, or Chapter 13). The provision gives a debtor a one-time absolute right to convert out of Chapter 7, allows other parties to seek conversion for cause, and conditions conversion on the debtor being eligible to be a debtor under the target chapter.

Conversion is a different remedy from dismissal. A converted case continues, with the same petition date controlling exemption and avoidance computations, but moves into the procedural framework of the new chapter. Property of the estate, the trustee, plan procedures, and discharge rules all shift to those of the target chapter.

Section 706(a): The Debtor's One-Time Absolute Right

Section 706(a) provides that the debtor "may convert a case under this chapter to a case under chapter 11, 12, or 13 of this title at any time, if the case has not been converted under section 1112, 1208, or 1307 of this title." On its face, the statutory language describes an unrestricted entitlement. Section 706(c) reinforces this by providing that the court may not convert to Chapter 12 or 13 unless the debtor requests or consents.

The "one-time" character of the right derives from the proviso that the case must not have already been converted from another chapter. A debtor who originally filed Chapter 13, converted to Chapter 7, and now wishes to return to Chapter 13 has exhausted the (a) right and must proceed by motion for cause under the limitations discussed below.

The legislative history of Section 706(a) describes the conversion right as "absolute" and intended to give debtors broad flexibility to choose the chapter that fits their situation. Until 2007, most courts read the statute this way: if the case had not previously been converted and the debtor met the eligibility requirements of the target chapter, conversion was a matter of right not subject to substantive challenge.

The Marrama Bad-Faith Limitation

In Marrama v. Citizens Bank of Massachusetts, 549 U.S. 365 (2007), the Supreme Court substantially qualified the absolute-right reading. The Court held that a Chapter 7 debtor who has engaged in bad-faith conduct that would constitute cause for immediate reconversion or dismissal under Section 1307(c) is not entitled to convert under Section 706(a). The Court reasoned that the statute should not be interpreted to require a "futile gesture" of allowing conversion that would immediately be undone.

Marrama is most often applied to debtors who concealed assets, made fraudulent transfers, or otherwise abused the bankruptcy process before seeking conversion. It is a substantive bar, not a procedural one: even a debtor whose case has not previously been converted and who meets the target chapter's eligibility requirements may be denied Section 706(a) conversion if bad faith is shown. Courts vary in how strictly they apply the Marrama gloss, with some treating it as a narrow exception for egregious cases and others applying it more broadly.

Section 706(b): Cause-Based Conversion by Other Parties

Section 706(b) provides that, on request of a party in interest and after notice and a hearing, the court may convert a Chapter 7 case to a case under Chapter 11 "at any time." The provision is limited to conversion to Chapter 11 and does not authorize conversion to Chapter 12 or 13 without the debtor's consent (Section 706(c)).

Cause for involuntary conversion is not defined in the statute. Courts have identified factors such as the existence of substantial unencumbered assets that could be administered more effectively in a reorganization, the prospect of a meaningful reorganization, the size and complexity of the case, and the wishes of the principal creditor constituencies. Section 706(b) is most often invoked by trustees or major creditors who perceive that the going-concern value of the debtor's business exceeds its liquidation value.

Section 706(d): Eligibility Requirement

Section 706(d) imposes the threshold requirement that conversion is permitted only if the debtor "may be a debtor under such chapter." This means the debtor must satisfy the eligibility requirements of the target chapter under Section 109.

Practical eligibility issues include: Chapter 13's debt limits (currently the unified secured-and-unsecured limit established by recent amendments, subject to periodic recalculation); Chapter 13's requirement that the debtor have regular income; Chapter 12's requirement that the debtor be a family farmer or family fisherman within the statutory definitions; and Chapter 11's requirement that, for small business cases proceeding under Subchapter V, the debtor satisfy the eligibility threshold of Section 1182. A Chapter 7 debtor whose debts exceed the Chapter 13 limit cannot convert to Chapter 13 even under Section 706(a).

Procedural Consequences of Conversion

Conversion under Section 706 does not change the date of the filing, the commencement of the case, or the order for relief, except as provided in Section 348. Property of the estate is generally redefined as of the conversion date for the post-conversion chapter, with limitations to prevent harvesting of post-petition appreciation. The Chapter 7 trustee is replaced by the trustee of the target chapter (in Chapter 11, often a debtor-in-possession). Schedules and statements must be updated, fees adjusted, and a new Section 341 meeting typically held under the target chapter's procedures.

Related Bankruptcy Code Sections

This section operates in concert with several other provisions of the Bankruptcy Code:

• Section 109 - Who may be a debtor (target-chapter eligibility)
• Section 348 - Effect of conversion
• Section 349 - Effect of dismissal
• Section 707(b) - Means-test dismissal of Chapter 7
• Section 1112 - Conversion or dismissal of Chapter 11
• Section 1208 - Conversion or dismissal of Chapter 12
• Section 1307 - Conversion or dismissal of Chapter 13

Understanding how these sections interact is important for debtors, creditors, trustees, and counsel evaluating mid-case strategy.