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U.S. Supreme Court to Hear Bankruptcy Conversion Case on Whether Undistributed Funds Should be Refunded to the Debtor or Paid to Creditors – Glass & Goldberg | Financing, Property & Bankruptcy Law
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U.S. Supreme Court to Hear Bankruptcy Conversion Case on Whether Undistributed Funds Should be Refunded to the Debtor or Paid to Creditors

U.S. Supreme Court to Hear Bankruptcy Conversion Case on Whether Undistributed Funds Should be Refunded to the Debtor or Paid to CreditorsOn December 14, 2014, the U.S. Supreme Court agreed to hear the case of Harris v. Viegelahn on the following question that has divided two circuit courts:

Whether, when a debtor in good faith converts a bankruptcy case to Chapter 7 after confirmation of a Chapter 13 plan, undistributed funds held by the Chapter 13 trustee are refunded to the debtor (as the Third Circuit held in In re Michael, 699 F.3d 305 (2012)) or distributed to creditors (as the Fifth Circuit held).

The case before the Supreme Court later this term involves a Chapter 13 bankruptcy debtor who sought to keep his home by making payments during the pendency of the bankruptcy case. Chapter 13 cases differ from Chapter 7 cases in that Chapter 13 cases have a way for debtors to keep their home. Wages earned after they file their bankruptcy petition go to the bankruptcy trustee, who uses those and other funds to pay off creditors, including the mortgagor.

In most Chapter 7 cases, only the property the debtor had at the time of filing goes toward satisfying creditor obligations, not wages earned post-filing. In this case, after the debtor learned he could not successfully complete a Chapter 13 filing since he could not make the monthly mortgage payments going forward, he agreed to let the lender proceed to foreclosure provided he could convert his case to a Chapter 7.

The bankruptcy court let him convert, but when the trustee would not return those wages he earned that were post-petition earnings, the debtor filed suit against the trustee and won before both the bankruptcy court and the District Court before losing on appeal at the Fifth Circuit. Their decision conflicts with a recent decision from the Third Circuit, In re Michael, 699 F.3d 305 (2012).

The Petitioner, Charles E. Harris, III, contends that the bankruptcy code generally favors debtors who file Chapter 13 because it enables them to keep their homes and pay creditors with post-petition earnings, noting that Section 348 of the Bankruptcy Code, which governs the effect of conversion from Chapter 13 to Chapter 7, specifies, “[e]xcept when a debtor has acted bad faith, the post-conversion Chapter 7 estate comprises only the debtor’s petition date property, and none of the post-petition property (including wages) that was in the Chapter 13 estate.”

In addition, Harris argues that trustee Mary K. Viegelahn lost all power over the funds after the conversion to Chapter 7 was ordered because she was relieved of her duties in the case. Section 348(e) provides that conversion “terminates the service” of the Chapter 13 trustee. They also argue that Section 1327(b) states that confirmation of a Chapter 13 plan “vests all of the property of the estate in the debtor” and this conversion occurred post-confirmation.

In response, Respondent Viegelahn argues that the estate held by the trustee is not “some savings account” the debtor has to generate savings, and the trustee has administrative duties to complete and so receives the benefit of the automatic stay. Respondent claims that Section 348(f) does not terminate a Chapter 13 trustee’s responsibility to distribute funds in her possession to creditors and that Section 348(e) does not establish who, between Petitioner and his creditors, has the better claim to monies in possession of a Chapter 13 Trustee at the time of conversion.

This is a case of importance both to bankruptcy debtors and creditors as each have an interest in how it is decided.

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