The U.S. Supreme court ruled today (May 18, 2015) that bankruptcy debtors are entitled to the return of any undistributed funds held by a chapter 13 trustee, if the case is converted to chapter 7.

In this case, the debtor Harris filed chapter 13, but even after his plan was confirmed, he because delinquent on his home mortgage again. Because of that, Chase Bank got permission from the bankruptcy court to foreclose. Meanwhile Viegelahn the chapter 13 trustee continued to receive money from Harris intended for Chase, totalling $5500.

Harris converted his case to chapter 7, and the $5500 was paid out to creditors by Viegelahn. Harris sued for the money back and won at the bankruptcy and district court levels, but the 5th Circuit Court of Appeals reversed, and held that the chapter 13 trustee was correct, the money should go to creditors. This conflicted with another circuit court's decision, and U.S. Supreme Court granted certioriari to resolve the conflict.

The Court held that Section 348(f) of the Bankruptcy Code makes one thing clear: that when there is a good-faith conversion from chapter 13 to 7, the chapter 7 trustee is not entitled to any undistributed funds in the hands of the chapter 13 trustee.

The Court stated:

By excluding postpetition wages from the converted Chapter 7 estate, §348(f)(1)(A) removes those earnings from the pool of assets that may be liquidated and distributed to creditors. Allowing a terminated Chapter 13 trustee to disburse the very same earnings to the very same creditors is incompatible with that statutory design. We resist attributing to Congress, after explicitly exempting from Chapter 7’s liquidation-and-distribution process a debtor’s postpetition wages, a plan to place those wages in creditors’ hands another way. Section 348(f)(2)’s exception.

The Court also held that a chapter 13 trustee's authority to distribute funds to creditors ends immediately upon conversion to chapter 7. And because of a provision of Harris' plan, property that did not become part of the chapter 7 estate (his post-petition wages) revested in Harris. So the trustee could do only one thing: return the undistributed funds to Harris.

So you think the Supreme Court was correct in ruling this way? Why or why not? Shouldn't the creditors in the chapter 13 be entitled to what was paid in the chapter 13 case? Please give us your comments or questions below.

J Thomas Black
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Board Certified, Consumer Bankruptcy Law- Texas Board of Legal Specialization
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