SCOTUS: At Conversion, Undistributed Funds Go to the Debtor (Harris v. Viegelahn)

When someone converts from a Chapter 13 bankruptcy case to a Chapter 7 case when the Chapter 13 Trustee is in possession of funds that haven’t been distributed to creditors, what happens to that money? Does it go to the debtor (as the 3rd Circuit held), or does it go to the creditors (as the 5th Circuit held)? That was the issue decided today by the Supreme Court in Harris v. Viegelahn.

Charles Harris filed a Chapter 13 case in February 2010, largely to get caught up on arrears on the mortgage to his house. Unfortunately, Mr. Harris continued to fall behind on his mortgage payments during his Chapter 13 plan, and in November 2010, the mortgage holder received permission to proceed with the foreclosure. Mr. Harris then exercised his right to voluntarily convert his case to Chapter 7. After the conversion, the Chapter 13 trustee (Viegelahn) distributed $5,519 of accumulated funds to Mr. Harris’s lawyer, herself, and to unsecured creditors. The Bankruptcy Court ordered the trustee to return the funds, but the Fifth Circuit revered, holding that “considerations of policy and equity” dictated that the funds go to the creditors.

Writing for a unanimous court, Justice Ginsberg looked to the reasoning in the 2012 3rd Circuit case of In re Michael, which had gone in the opposite direction on the same issue. The Court held that, pursuant to Section 348(e) of the Code, the Chapter 13 trustee had been stripped of authority to distribute assets at the moment of conversion. Additionally, no provision of the Code provides that any property (including post-petition assets) as belonging to creditors. Thirdly, the Court rejected the 5th Circuit’s concern that such a hold would result in a windfall for the debtor; the money being returned to the debtor was money that the debtor would have kept had he filed a Chapter 7 case.

Local practice here in the Northern District of California was already in keeping with the law as laid out here, but it is nice to see the Supreme Court holding unanimously in favor of the debtor in a consumer case like this. A PDF of the opinion can be found here.

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