Bankruptcy Leftovers Go to Debtor, SCOTUS Says

     (CN) – Chapter 13 bankruptcy trustees must refund debtors any undistributed funds when a debtor converts the case to Chapter 7, a unanimous U.S. Supreme Court held on Monday.
     When Charles Harris converted his case to Chapter 7, a federal judge in Texas found that he was entitled to retrieve funds that the Chapter 13 trustee that had not yet distributed to Harris’ creditors at the time of conversion.
     Mary Viegelahn, the trustee in his Chapter 13 case, had more than $5,500 of Harris’ payments at the time of the case’s conversion in late 2011. She gave the bulk of the other funds to six unsecured creditors, taking $267.79 as commission and distributing $397.68 to an unsecured creditor that Harris owed $900 for a television.
     The 5th Circuit disagreed with the Texas court, however, noting in a July 2014 reversal that Harris’ debt stemmed from his home-mortgage loan held by Chase and concluding that Viegelahn had an obligation to distribute the funds despite Harris’ conversion to Chapter 7.
     After agreeing to hear the case this past December, a unanimous Supreme Court on Monday resolved a question that has divided bankruptcy courts for 30 years by holding that debtors who convert their cases from Chapter 13 to Chapter 7 are entitled to a refund of any undistributed funds garnished from wages from the date of the Chapter 13 filing.
     Writing for the court, Justice Ruth Bader Ginsburg held that when Congress revised bankruptcy laws in 1994 it allowed that when debtors convert their case from Chapter 13 their post-petition earnings and acquisitions do not become part of the Chapter 7 estate – except in cases of bad faith.
     “By excluding post-petition wages from the converted Chapter 7 estate, the bankruptcy law amendment removes those earnings from the pool of assets that may be liquidated and distributed to creditors,” Ginsburg wrote. “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 post-petition wages, a plan to place those wages in creditors’ hands another way.”
     Keeping and distributing the garnished wages – as Viegelahn had done – is the penalty for a bad-faith conversion, and nothing about Harris’ decision indicated anything other than a desire for a fresh start, the court held.
     The court rejected Viegelahn’s arguments that bankruptcy code required her to disperse the funds to Harris’ creditors or, in the alternative, tasked her with the duty to “wind up” the affairs of the Chapter 13 estate.
     “Federal Rules of Bankruptcy Procedure specify what a terminated Chapter 13 trustee must do post-conversion: (1) she must turn over records and assets to the Chapter 7 trustee, and (2) she must file a report with the United States bankruptcy trustee,” Ginsburg wrote. “Continuing to distribute funds to creditors pursuant to the defunct Chapter 13 plan is not an authorized ‘wind-up’ task.”
     The high court also dismissed the Fifth Circuit’s concern that Harris would receive a “windfall” by reclaiming the garnished wages from the Chapter 13 estate.
     “Chapter 13 is a voluntary proceeding in which debtors endeavor to discharge their obligations using post-petition earnings that are off-limits to creditors in a Chapter 7 proceeding,” Ginsburg wrote. “We do not regard as a ‘windfall’ a debtor’s receipt of a fraction of the wages he earned and would have kept had he filed under Chapter 7 in the first place.”
     The court concluded by noting that if Viegelahn had made regular disbursements to Harris’ creditors prior to his conversion to Chapter 7, his refund would have been a lot smaller and possibly nonexistent.
     “Creditors may gain protection against the risk of excess accumulations in the hands of Chapter 13 trustees by seeking to include in a Chapter 13 plan a schedule for regular disbursement of funds the trustee collects,” Ginsburg wrote.

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