Harris v. Viegelahn: New Debtor-Friendly Rule When Chapter 13 Cases are Converted to Chapter 7

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Harris v. Viegelahn, 135 S. Ct. 1829 (2015).
Opinion Issued: May 18, 2015. Westlaw Link
Written by: Alex Weatherbie, Staff Member.

In the instant case, the debtor filed for bankruptcy under Chapter 13 of the Bankruptcy Code. Debtor’s repayment plan required debtor to continue his monthly mortgage payments to Chase Bank and to pay a monthly sum to the Chapter 13 trustee, who allocated those funds to pay down the additional, outstanding mortgage debt owed to Chase.

Shortly thereafter, debtor again fell behind on his mortgage payments, so Chase foreclosed on his home. In the wake of the foreclosure, debtor continued to pay the required monthly sum to the Chapter 13 trustee, but the trustee ceased payments to Chase. As a result, a significant amount of funds accumulated in the possession of the trustee.

Debtor then converted his Chapter 13 case to Chapter 7. The Chapter 13 trustee proceeded to pay the accumulated funds to various other creditors, rather than return the funds to the debtor. Debtor asserted that the Chapter 13 trustee lacked the authority to disburse the postpetition wages after conversion to Chapter 7, and requested the court to order a refund of the disbursed funds.

The 5th Circuit held in In re Harris, 757 F.3d 468 (2014), that disbursal of the funds to creditors was appropriate; in so holding, the 5th Circuit expressly conflicted with the 3rd Circuit in In re Michael, 699 F.3d 305 (2012).

The Supreme Court granted certiorari in Harris v. Viegelahn, 135 S. Ct. 1829 (2015), to resolve the question of whether postpetition wages held by a Chapter 13 trustee must be returned to the debtor when a Chapter 13 case is converted to Chapter 7.

The Court stressed that Chapter 13 is a voluntary alternative to Chapter 7 and allows an individual debtor to repay his or her debts according to a court-approved repayment plan. Whereas Chapter 7 requires liquidation of the debtor’s assets, Chapter 13 allows debtors to keep assets; however, disposable postpetition income is paid to the Chapter 13 trustee who then distributes the funds to creditors. Under Chapter 7, postpetition wages are excluded from the bankruptcy estate.

Individual debtors often cannot successfully comply with Chapter 13 repayment plans. Recognizing this fact, Congress allowed debtors the right to convert a Chapter 13 case to Chapter 7 at any time.  Since Chapter 13 entitles creditors to funds in excess of the amount available in a normal Chapter 7 case, returning postpetition wages to the debtor would place creditors in the same position they would have been in if the debtor filed under Chapter 7 in the first place.

Chapter 13 repayment plans are hard to comply with, so debtors often end up converting from Chapter 13 to Chapter 7. The ubiquity of this occurrence renders Harris an important decision by default. In the wake of this decision, prudent practitioners should be mindful of client funds held by Chapter 13 trustees when converting cases from Chapter 13 to Chapter 7 and should petition the court for reimbursement of funds that were distributed to creditors after conversion. Furthermore, practitioners would be wise to include specific terms governing the regularity of fund disbursal when submitting Chapter 13 repayment plans to the court.