Trustee must return debtor’s funds after Chapter 13 conversion.

On May 18, 2015 the U.S. Supreme Court ruled that money paid to a Chapter 13 trustee, and still held by the trustee, belongs to the debtor if the case converts to Chapter 7. Harris v. Viegelahn, 575 U.S ______ (2015).  In the case before the Supreme Court, the Chapter 13 trustee was holding over $5,000 which came from the debtor’s wages.  When the debtor was no longer able to make the Chapter 13 plan payments, the case was converted to Chapter 7.  Instead of returning the debtor’s money to him, the trustee paid it to various creditors.  The Fifth Circuit Court of Appeals reversed the bankruptcy court, which had ordered the trustee to refund the wages to the debtor. In re Harris, 757 F.3d 468 (2015).  Two years earlier, the Third Circuit Court of Appeals ruled that funds held by a Chapter 13 trustee had to be returned to the debtor when a case converted to Chapter 7. In re Michael, 699 F.3d 305 (2012).  The Supreme Court agreed to resolve this split in rulings.

Justice Ginsburg wrote the Supreme Court’s decision, which was unanimous.  The ruling describes some of the differences between Chapter 7 and 13, primarily that wages earned after a case is filed are not available to a Chapter 7 trustee or creditors, but a portion of wages are turned over to a Chapter 13 trustee to be paid to creditors.  While most Chapter 13 trustee send payments to creditors every month, sometimes situations arise where money is held for several months, which is what happened in the Harris case.  Some of the main reasons for the Supreme Court’s ruling are that different sections of the bankruptcy law provide that a) a Chapter 13 trustee’s services end when a case is converted; and b) property available to a Chapter 7 trustee after a case is converted is limited to property which existed when the case was filed (unless a case is converted in bad faith).  Essentially, the Supreme Court ruled that the Chapter 13 trustee did not have authority to make any payments after a case is converted.

It may seem like a lot of work to go all the way to the Supreme Court over $5,000.00 (and it is), but this situation happens over and over again in bankruptcy.  Chapter 13 is a voluntary way to repay creditors over 3 to 5 years, but only about one in three Chapter 13 cases are successful, with many of them being converted to Chapter 7.  Most of the time, debtors are unable to continue their payments because they change or lose jobs, have to deal with an illness, or other unexpected financial issues come up during the 3 to 5 years a plan is in effect.  Sometimes, a Chapter 13 trustee will not have any money to refund when a case is converted, but if she does, it only makes sense to return it to the debtor, who earned it in the first place, and who probably needs it more than the creditors.  We applaud the Supreme Court for clarifying a debtors’ right to get a refund of any funds held by a Chapter 13 trustee when a case is converted to Chapter 7.