Supreme Court Rules in Favor of Debtor

If you file for Chapter 13 bankruptcy and later convert to Chapter 7 bankruptcy, what are some of the issues with which you’ll have to contend? According to a recent post from SCOTUSblog, the U.S. Supreme Court had to decide the following question: “When a debtor converts a bankruptcy proceeding from Chapter 13 to Chapter 7, what happens to funds that the trustee is holding at that moment, previously collected out of the debtor’s wages but not yet distributed to creditors?”
In short, the Court came down in favor of the debtor. And that decision could have positive implications for consumers in the Chicago area who convert a bankruptcy proceeding from Chapter 13 to Chapter 7. But let’s take a look at the facts of the case and the Court’s reasoning to understand the impact of the case.
Facts of the Case in Harris v. Viegelahn
In Harris v. Viegelahn, the key issue involved the disposition of a debtor’s income after filing for bankruptcy. As a quick reminder, Chapter 13 bankruptcy allows a debtor to retain assets while agreeing to pay creditors with future income (income earned after filing) under the terms of a repayment plan. In contrast, Chapter 7 doesn’t allow a debtor to retain any non-exempt assets since the creditors get paid with the money obtained through asset liquidation, but the debtor does get to retain all future income.
In this case, the debtor filed for Chapter 13 bankruptcy in 2010, at which time he was behind on mortgage payments and at risk of foreclosure. Chapter 13, unlike Chapter 7, can help a debtor to stop a foreclosure and to allow that debtor to get back on track with payments. According to the terms of the debtor’s repayment plan, $534 of his future monthly wages would go to the bankruptcy trustee. From that money, his mortgage lender would received $352 and other creditors would split the remaining $182. In addition, the debtor was required to make his regularly scheduled mortgage payments.
However, the debtor failed to make those regularly scheduled mortgage payments, and the lender foreclosed. As such, the bankruptcy trustee stopped sending the $352 monthly payment to the lender and “held the funds.” Several months went by, and the trustee accumulated $5500. The debtor then converted the bankruptcy to Chapter 7. At that point, the trustee used the $5500 to pay the debtor’s other creditors. The debtor argued that “he should have gotten the money.”
History and Intent of the Bankruptcy Code
Who should have gotten the $5500? Should it have been treated like future earnings in a Chapter 13 proceeding or a Chapter 7 proceeding? The history of the Bankruptcy Code suggests that, in the early years of the law, courts tended to take three different stances on this issue:
  • The money goes to the debtor (as in a Chapter 7 filing)
  • The money goes to the creditors (as in a Chapter 13 filing)
  • The money goes into the debtor’s Chapter 7 estate
The U.S. Supreme Court reasoned that the language of the statute is unclear. It then had to decide whether the conversion to Chapter 7 affected the trustee’s obligations. In short, the Court reasoned that the trustee’s obligations to repay creditors according to the Chapter 13 plan “ceased to apply once the case was converted to Chapter 7.” The Court rejected other arguments from the trustee, too, and ultimately emphasized that there is “no provision in the Bankruptcy Code that classifies any property, including post-petition wages, as belonging to creditors.”
While commentators don’t think the decision will have a substantial impact on bankruptcy law moving forward, the Court’s holding does make clear that debtors in the situation of the petitioner get to keep the money held by the bankruptcy trustee.
Do you have questions about filing for Chapter 13 or Chapter 7 bankruptcy? Contact an experienced Oak Park bankruptcy attorney today.
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