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Bankruptcy Debtors Can Take the Money and Run after Conversion

August 5, 2015

Chapter 13 cases have a low rate of completion for many reasons. Most statistics show that less than half of all Chapter 13 cases filed receive a Chapter 13 discharge. Some Chapter 13 cases are voluntarily dismissed because the reason for filing has been resolved; other cases are converted because the debtor cannot keep up plan payments.

The United States Supreme Court was recently asked an important question in the case of Harris v. Viegelahn, No. 14-400 (5/18/15): what happens to money the trustee is holding when a Chapter 13 case is converted to Chapter 7? The unanimous opinion of the Court was that the money is returned to the debtor.

Section 348(f) of the Bankruptcy Code states that absent bad faith, when a Chapter 13 case is converted to Chapter 7, “property of the estate” is that property which was originally part of the Chapter 13 estate which remained “in the possession . . . or control” of the debtor. Section 348(e) states that the Chapter 13 trustee’s services are terminated upon conversion.

The Supreme Court interpreted these statutes and found that that money paid to the Chapter 13 trustee after the bankruptcy case was filed, but not distributed as of the date of the conversion to Chapter 7, was not part of the debtor’s new Chapter 7 case. Therefore, the money must be returned to the debtor. The Court further decided that paying money to creditors was a “service” provided by the trustee and therefore something that could not be done after conversion. The Court found that the estate’s creditors had no claim on the funds until they were paid to the creditors.

In deciding that this money should return to the debtor, the Supreme Court rejected the Fifth Circuit’s policy argument that this would result in a “windfall” for the debtor. The Court reasoned that these funds would have belonged to the debtor if he had initially filed under Chapter 7. The Court suggested that creditors avoid situations where the trustee “sits” on debtor funds and “seek to include in a Chapter 13 plan a schedule for regular disbursement of funds the trustee collects.”

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