Post-Confirmation Funds Returned to Debtor after Conversion to Chapter 7

Posted by NCBRC - April 15, 2013

What happens to funds paid into a confirmed chapter 13 plan that are still in the trustee’s possession when the bankruptcy is converted to chapter 7? That is the question recently answered by the district court for the Western District of Texas. The trustee had distributed the funds to creditors post-conversion and upon motion by the debtor, the bankruptcy ordered turnover to the debtor. Relying in large part on the Third Circuit case of In re Michael, 699 F.3d 305 (2012) in which NACBA participated as amicus, the district court affirmed. Veigelahn v. Harris (In re Harris), No. 12-540 (W.D. Tex. March 22, 2013).

Key to the decision was section 348(f) which provides that when a case is converted in good faith from chapter 13 to chapter 7 the property of the estate is determined as of the original petition date.  Because the funds at issue had been garnished from debtor’s wages post-confirmation, they were not part of the debtor’s estate upon the original filing of the chapter 13 petition and, therefore, under section 348 would not be part of the chapter 7 estate upon conversion.

The trustee distinguished Stamm v. Morton (In re Stamm), 222 F.3d 216 (5th Cir. 2000), in which funds collected prior to confirmation of the chapter 13 plan were returned to the debtor upon conversion. Here, the trustee argued, the funds were collected post-confirmation thereby giving the creditors a vested interest in them even though the case was later converted. The trustee relied on section 1326(a)(2) which provides that “[i]f a plan is confirmed, the trustee shall distribute any such payment in accordance with the plan as soon as is practicable. If a plan is not confirmed, the trustee shall return any such payments not previously paid and not yet due and owing to creditors  . . . to the debtor.” The trustee argued that because Congress specifically provided for the return of funds collected pursuant to a plan that was not confirmed it could be inferred that different treatment should be accorded funds collected after confirmation.

Acknowledging the superficial appeal of the trustee’s position, the court found that  the Code sections at issue created an ambiguity that necessitated looking beyond the text. The court found that the legislative history indicated Congress’s intention to encourage debtors to file chapter 13 wherever possible without the inhibiting fear of penalty in the event that the chapter 13 failed and the debtor had to resort to chapter 7.  H.R. Rep. No. 95-595 (1977), reprinted in 1978 U.S.C.C.A.N. 5963, 5966, 1977 WL 9628. In enacting section 348(f) Congress specifically addressed and sought to minimize the potential loss of property that a debtor could face upon conversion from chapter 13 to chapter 7 that would not have been at risk had the debtor filed directly in chapter 7.

The court also rejected the trustee’s argument that there is an inherent unfairness in returning the funds to the debtor upon conversion reasoning that the creditors lost nothing while reaping the benefits of payments made in accordance with the plan up to the time of conversion. Quoting Michael, the court found that the duties of the trustee delineated in section 1326 did not vest any rights in the creditors:

When the debtor transfers funds to the Chapter 13 trustee . . . under a confirmed plan . . . the funds become part of the estate, and the debtor retains a vested interest in them. Though creditors have a right to those payments based on the confirmed plan, the debtor does not lose his vested interest until the trustee affirmatively transfers the funds to creditors. Also, § 1326(a)(2) and (c) only address the obligation of  the trustee to distribute payments in accordance with a confirmed plan; they do not vest creditors with any property rights.

Michael,699 F.3d at 313.

Furthermore, section 348(f)(2) protects creditors from unfair manipulation by debtors by including a provision that in the event of a bad faith conversion the estate would consist of property as of the conversion date rather than as of the petition date. As the court in Michael pointed out, the specific expansion of the chapter 7 estate in the event of bad faith, indicates that when the conversion is in good faith, the chapter 7 estate would be as of the petition date.

This is a case that illustrates the power of NACBA’s members to create good law around the country by getting involved in select cases on appeal.

Harris opinion


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