VictoryIn a victory for bankruptcy filers, yesterday, the U.S. Supreme Court resolved a split among the Courts of Appeal in Harris v. Viegelahn, 575 U.S. __ (2015). The ruling affects people who file for Chapter 13 bankruptcy and then, before completing the Chapter 13 plan, convert the case to a Chapter 7 bankruptcy. The Supreme Court said that if the bankruptcy trustee has plan funds on the date of conversion that he or she has not yet distributed to creditors, the money belongs to the debtor.  (Learn more about converting a Chapter 13 case to a 7.)

The Facts in the Harris Case

Mr. Harris filed for Chapter 13 bankruptcy. The court confirmed his plan and he began making $530 payments to the trustee, Mr. Viegelahn.  Mr. Viegelahn distributed those payments as follows: A chunk to Chase Manhattan Bank (Mr. Harris’ mortgage servicer) to repay Mr. Harris’ mortgage arrears and the rest to Mr. Harris’ other creditors. (Learn how the Chapter 13 repayment plan works.)

Mr. Harris fell behind in his regular mortgage payments (which he made outside of his bankruptcy) and lost his home in foreclosure.  Mr. Harris continued to make his $530 monthly payments to the trustee. A year later, Mr. Harris converted his case to a Chapter 7 bankruptcy. At that time, Mr. Viegelahn had about $5,500 in undistributed funds – he had stopped paying Chase after the foreclosure, but hadn’t distributed that money to other creditors.

Ten days after Mr. Harris converted his case to Chapter 7, Mr. Viegelahn distributed the $5,000 to Mr. Harris’ creditors. Mr. Harris cried foul, and sued to get the $5,500 back.

The Split Among the Courts of Appeal

Prior to the Harris v. Viegelahn opinion, courts handled the above situation in one of two ways.

Debtor gets the money. Some courts ruled that when a debtor converts from Chapter 13 to 7, any funds that the trustee holds and has not yet distributed, belong to the debtor.

Trustee gets the money. Other courts (including the 5th Circuit where the Harris case arose) ruled that any funds the trustee holds belong to the trustee and the creditors. The trustee, therefore, can use the money to repay creditors and his or her own commission.

The U.S. Supreme Court’s Decision

The Supreme Court sided with the first group of courts, ruling that any undistributed funds on the date of conversion to Chapter 7 belong to the debtor. This is good news for Mr. Harris and other people who convert their Chapter 13 cases to Chapter 7.

In reaching its decision, the Court relied on the following:

The Chapter 7 bankruptcy estate does not include post-petition earnings. When a debtor converts a Chapter 13 bankruptcy case to a Chapter 7, the Chapter 7 bankruptcy estate (the money and property that now are under the control of the bankruptcy court) consists of the property and assets the debtor had as of the date of the original Chapter 13 filing. In Chapter 7, money earned or property acquired (with a few exceptions) after filing the bankruptcy, belong to the debtor.  (In contrast, in Chapter 13, money and property acquired during the plan period belong to the bankruptcy estate.)

The money that the trustee held consisted of Harris’ post-petition wages (money Harris  earned after filing the Chapter 13), which were not part of the Chapter 7 bankruptcy estate and therefore not subject to the control of the bankruptcy court.

The Chapter 13 trustee had no authority to distribute the funds. Once the Chapter 13 bankruptcy is over and the plan defunct, the bankruptcy trustee no longer has authority to distribute funds.

The trustee can take steps to prevent this from happening. The trustee and creditors can prevent this scenario from happening by seeking to have plan payments distributed on a regular basis. If the trustee had done this in the Harris case, he wouldn’t have had $5,000 in undistributed plan funds sitting around on the date of conversion.