What happens to funds held by a Chapter 13 trustee (the “Trustee”) in the event that a Chapter 13 debtor dismisses her case voluntarily? That’s the question that was addressed by the United States Bankruptcy Court for the Eastern District of Michigan (the “Court”) in a recent opinion.1
In this case, the Chapter 13 debtor (the “Debtor”) owned a residence with significant equity. The Court confirmed a plan pursuant to which the Debtor would retain her residence and make monthly payments to the Trustee in the amount of $8,500.75 for 60 months.
The Debtor made plan payments, but after a period of time defaulted. She resolved the default, and began making payments again, but eventually fell behind, at which time she filed a motion requesting a voluntary dismissal of her case.
The Court entered an order dismissing the case. At that time the Trustee had funds on hand in the amount of approximately $16,000 (the “Funds”). The Trustee subsequently disbursed the Funds to four of the Debtor’s unsecured creditors.
The Debtor then filed a motion to compel the Trustee to recoup the funds and disburse them to the Debtor. Despite the Trustee’s objection to the motion, the Court granted the Debtor’s motion after conducting an analysis of what a Chapter 13 trustee must do with funds following dismissal of a case after confirmation of a plan and based upon a recent U.S. Supreme Court case Harris v. Viegelahn.2
THE COURT’S ANALYSIS
The Debtor and the Trustee based their arguments in favor and in opposition of the motion, respectively, on two different Bankruptcy Code sections - sections 349 and 1326.
The Debtor argued that section 349, titled “Effect of Dismissal,” requires return of the Funds to the Debtor because it provides that dismissal of a case “reverts the property of the estate in the entity in which such property was vested immediately before the commencement of the case under this title.”
The Trustee argued that, under section 1326, once a plan is confirmed funds held by the Trustee are to be distributed in accordance with the plan. Since a plan was confirmed in this case, the Trustee argued that disbursing the Funds was appropriate.
In granting the Debtor’s motion, the Court looked to the U.S. Supreme Court’s recent opinion in Harris v. Viegelahn. While the facts in Harris were different - it involved an analysis of what a Chapter 13 trustee must do with funds on hand that were received from a debtor post-confirmation when the debtor converts the case to Chapter 7 - the Court found the same underlying legal principles to be dispositive of the issue before it.
As explained by the Court, in Harris the Supreme Court “concluded by holding that the Chapter 13 trustee should not have distributed the funds on hand to the debtor’s creditors under the confirmed plan but instead should have returned those funds to the debtor.” The Court ruled in favor of the Debtor, in large part, because it found that once a case is dismissed (or, as in Harris, converted) “no Chapter 13 provision holds sway.” In other words, the Trustee’s reliance on section 1326 was misplaced because once the case was dismissed the Trustee’s role and responsibilities ended. Once the case was no longer pending, the Funds should have been returned to the Debtor.
The Court also raised another point from Harris in its analysis, namely “the Supreme Court’s point-blank rejection of the idea that a debtor’s creditors somehow obtain a vested right in funds held by a Chapter 13 trustee just because a plan has been confirmed.” Since creditors had no vested right in the Funds, such an argument could not be used to justify disbursement of the Funds to them.
In granting the Debtor’s motion, the Court noted that its decision represents a departure in practice in the Eastern District. It explained, however, that “the practice must conform to the law,” and in light of Harris the practice must change.