Obligation to Return Funds to Debtor upon Dismissal Preempts State Levy Law

Posted by NCBRC - December 4, 2018

The chapter 13 trustee had no choice but to return post-petition funds to the debtor upon pre-confirmation dismissal of his bankruptcy despite state law permitting the Division of Child Support to levy against any person holding the debtor’s funds. Commonwealth of Va., Dept. of Soc’l Serv. v. Webb, No. 17-2328 (4th Cir. Nov. 19, 2018).

Chapter 13 debtor, Barry Webb, paid $3,000 to the chapter 13 trustee while his bankruptcy was pending confirmation. After he was unable to establish a confirmable plan, his bankruptcy was dismissed and the Virginia Department of Social Services, Division of Child Support, presented the trustee with an Order to Withhold the funds for payment to the Division. The bankruptcy court found that the Code required the trustee to return the funds to the debtor. The district court affirmed.

On appeal, the Fourth Circuit was called upon to interpret section 1326(a)(2), which provides: “If a plan is not confirmed, the trustee shall return any [post-petition] payments not previously paid and not yet due and owing to creditors pursuant to paragraph (3) to the debtor, after deducting any unpaid claim allowed under section 503(b).” The Division sought the funds under a state law permitting it to recover child support debt by levying against any “person, firm, corporation, association, political subdivision or department.”

In affirming the courts below, the circuit court found that section 1326(a)(2)’s mandatory language was clear and dispositive. Where neither of the two exceptions were applicable, the trustee had no choice but to return any funds in his possession to the debtor. Permitting the Division to assert a claim for those funds prior to their return would simply create a “race to the trustee” situation among creditors. Though Congress made exceptions for child support payments in other sections of the Code, it did not do so here. Contrary to the Division’s argument, returning the funds to Mr. Webb would harmonize with Congress’s apparent intent to return an unconfirmed case to status quo ante to the extent possible. While the dismissal of the case lifted the automatic stay, it did not change the trustee’s duty to return the funds to the debtor as required by section 1326(a). The court found that to the extent the Code conflicted with state law permitting levy, federal law prevailed.

Webb 4th Cir Nov 2018

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