Funds Held By Trustee at Time of Conversion Belong to Creditors

The United States Court of Appeals for the Fifth Circuit recently weighed in on whether the funds held by a Chapter 13 trustee at the time the case is converted to Chapter 7 are given back to the debtor or paid out to the creditors.

In Viegelahn v. Harris, III, ___F.3d ___(Case No.  13-50374 5th Cir. July 7, 2014), Debtor’s proposed Chapter 13 plan was approved and out of each plan payment, $352 was to go to Chase Bank for his mortgage arrears and the rest to another secured creditor. Debtor was also to make a separate payment to Chase outside the plan. Debtor got behind on his mortgage, Chase moved to lift the automatic stay which was granted and foreclosed on Debtor’s house. Debtor continued to make the monthly plan payments including that portion approved for Chase. The trustee placed a hold on the payments to Chase after foreclosure and continue to accumulate the funds that originally where to go to Chase. Debtor did not modify the plan and eventually, the case was converted to Chapter 7. At that time, the trustee held $5,519.22 in his possession and distributed the funds to pay debtor’s counsel, the other secured creditor, six unsecured creditors and a portion to himself. Trustee then filed a final report and accounting for the Chapter 13 case. The debtor objected and argued that the funds should be returned to him and the trustee disagreed. The district court found in favor of the debtor and an appeal was taken.

Reversing the district court’s finding that the funds should be returned to the debtor, the Fifth Circuit held that payments in the possession of the Chapter 13 trustee at the time the case was converted from Chapter 13 to Chapter 7 must be distributed to creditors who have a superior claim to the funds. Under equitable and policy considerations, the Fifth Circuit held that returning undistributed funds to the debtor is not justified by policy of encouraging debtors to proceed through Chapter 13 rather than Chapter 7. Fairness also dictates distribution of funds to creditors. The attached wages given up are quid pro quo during the pendency of the reorganization in return for being permitted to stave off creditors. Viegelahn v. Harris, III, ___F.3d ___(Case No.  13-50374 5th Cir. July 7, 2014).

The Fifth Circuit provides an exhaustive view of cases that have gone the other way such as the Third Circuit’s opinion in In re Micahel, 699 F.3d 305 (3rd Cir. 2012) (holding funds must be returned to debtor) and distinguished and limited its prior opinion In re Stamm, 222 F.3d 216 (5th Cir. 2000) (holding that when a Chapter 13 case is converted before confirmation of a plan, the wages paid to a Chapter 13 trustee pursuant to a proposed plan do not become part of the Chapter 7 estate upon conversion). I commend the reading of the opinion which is at https://www.ca5.uscourts.gov/opinions%5Cpub%5C13/13-50374-CV0.pdf because the exhaustive treatment of the prior cases and statutory arguments.

The opinions of this blog are solely the author’s and any comments, replies or suggestions should be sent to john@jrjoneslaw.com.

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