Bankruptcy Law Blog

Friday, June 26, 2015

Conversion From Chapter 13 to Chapter 7: Who keeps the funds?

I recently decided to convert my consumer bankruptcy case from a Chapter 13 payment plan to a Chapter 7 liquidation. What happens to the unused funds held by the trustee? 

For consumers facing insolvency, there are two options in bankruptcy. The first, known as a Chapter 13 proceeding, allows debtors to enter into a repayment plan with the help of a trustee to oversee the process. In theory, this plan will help protect debtors’ credit, keep most of their secured assets, and experience the satisfaction of debt payoff. The other option, known as a Chapter 7 proceeding, allows debtors facing serious, insurmountable debt the opportunity to break free from the confines of financial pressure and avoid repayment all together through discharge. 

In some cases, debtors start out on the Chapter 13 path, only to quickly realize that a Chapter 7 bankruptcy proceeding is a better option for their situation. However, if a repayment plan has already been set up, the trustee assigned to the case may have a substantial amount of funds held in trust for the repayment of debts. In this case, courts have been unsure whether these funds should be refunded directly to the debtors or reapplied to the Chapter 7 proceedings as an asset. In a recent case known as Harris v. Viegelahn, the U.S. Supreme Court responded to this inquiry, thereby finally putting the issue to rest. 

Court’s Holding in Harris v. Viegelahn

The situation at hand in Harris involved a mere $5,000.00 that was languishing in the trustee’s escrow account after the debtors had opted to convert their case from a Chapter 13 to a Chapter 7 proceeding. At the time, Circuit Courts were split over how the surplus should be distributed. The Fifth Circuit, for example, held that the money should be refunded back to the debtor under the Bankruptcy Code provision that states a Chapter 7 debtor gets to keep all post-filing income. Other courts concluded that the money should go directly to creditors under the Chapter 13 rules requiring post-filing income to funnel to creditors. 

After pointing out the complete lack of clarity on the issue in the language of the Code itself, the Court unanimously decided that the debtor should benefit from the surplus funds in this scenario, and the $5,000.00 at issue in this case should be refunded back to the bankruptcy petitioners. In sum, the Court reasoned that the Chapter 13 rules ceased to apply immediately upon the moment the case is converted to Chapter 7. Since the trust funds do not become an issue until this point, the Chapter 7 rule allowing post-filing income to refund to the debtor should apply – and the trustee must return the money immediately. 

If you are considering Chapter 7 or Chapter 13 bankruptcy, please do not hesitate to contact Padgett & Robertson in Mobile and Baldwin County, Alabama today by calling (251)342-0264. 

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