Undistributed Funds Returned to Debtor upon Dismissal

Posted by NCBRC - May 12, 2014

When a chapter 13 case is dismissed, funds held by the trustee must be returned to the debtor. So said the district court in Williams v. Marshall (In re Williams), No. 13-2326 (N.D. Ill. Apr. 11, 2014).

The debtors voluntarily dismissed their chapter 13 case after they had paid approximately $155,000.00 into the plan, $136,000.00 of which had been distributed to creditors. The debtors filed an adversary proceeding seeking to recover the approximately $17,000.00 still held by the trustee. The bankruptcy court granted judgment in favor of the debtors. Williams v. Marshall (In re Williams), 488 B.R. 380 (Bankr. N.D. Ill. 2013).

Affirming on appeal, the district court discussed the interplay between sections 1326 and 349(b)(3). Section 1326 provides, “A payment made under paragraph (1)(A) shall be retained by the trustee until confirmation or denial of confirmation. If a plan is confirmed, the trustee shall distribute any such payment in accordance with the plan as soon as is practicable.” Section 349(b)(3) provides that dismissal of a case, “revests the property of the estate in the entity in which such property was vested immediately before the commencement of the case[.]”

The court, citing In re Tran, 309 B.R. 330, 337 (B.A.P. 9th Cir. 2004), found that the trustee’s reading of section 1326 to require distribution of the funds reads the word “such” out of the statute. Properly read, that section requires only that, once a plan is confirmed, the trustee distribute those funds that were collected prior to confirmation. It does not provide instruction as to the distribution of funds upon dismissal.

The court also rejected the trustee’s argument that section 1326(c), which provides “Except as otherwise provided in the plan or in the order confirming the plan, the trustee shall make payments to creditors under the plan,” creates an obligation to distribute the funds. That section, the court found, merely names the party responsible for disbursing the funds, it does not dictate that a trustee distribute funds in her possession post-dismissal. The court concluded that once a chapter 13 is dismissed the trustee is divested of authority to act with respect to undistributed funds.

Instead, as decided in In re Michael, 699 F.3d 305, 312-13 (3d Cir. 2012), section 349(b) acts to undo the chapter 13 plan and restore all property rights to their position pre-bankruptcy. This applies equally to funds acquired post-petition.

As far as the policy argument that the risk of failure of the plan should fall on the debtors rather than the creditors, the court noted that section 349 permits a court to exercise discretion with respect to a dismissed plan if there is cause to do so. An unusual accumulation of funds in the plan due to delay in distribution, as was the case in In re Darden, 474 B.R. 1, 8 (Bankr. D. Mass. 2012), may constitute such cause. The court also mentioned the possible safeguard suggested by the court in Michael, of including a provision in the plan that undistributed funds at the time of dismissal would be distributed to creditors rather than returned to the debtor. Finally, the court dismissed the “slippery slope” argument that its holding could lead to an attempt by debtors to have all funds, distributed and undistributed, returned to them upon dismissal. It found that it did not see this scenario arising nor did it expect it to.

Williams opinion

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