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Argument preview: Court to take on undistributed funds and bankruptcy conversion

The Court closes out the last day of its March argument session with the second of a pair of bankruptcy cases, Harris v. Viegelahn. This surely is one of the more low-stakes cases of the Term: a dispute involving a little more than $4,000, funds from income petitioner Charles Harris earned after he sought bankruptcy relief under Chapter 13, and turned over to the trustee handling that case (respondent Mary Viegelahn), but before Harris converted his case to Chapter 7 (more below on what those chapters mean). But both sides are represented (presumably pro bono) by lawyers from two well-regarded law firms — Robbins, Russell and Wilmer Hale. So it comes as no surprise that the briefs on both sides are excellent.

The case involves the interplay between the two important forms of bankruptcy relief available to individuals. In a Chapter 7 proceeding, the debtor gets to keep exempt assets (as determined by the statutes that apply in the debtor’s jurisdiction), but has to turn over all remaining assets for liquidation and distribution to creditors. The cutoff is the date of bankruptcy: conceptually the debtor is turning over all assets as of that date; he retains all income earned after that date. In a Chapter 13 proceeding, by contrast, the debtor gets to keep all assets; nothing is turned over for liquidation. Rather, the debtor accepts a payment plan promising to turn over to creditors all of his disposable income for the next three to five years. Each month, the debtor turns over the specified funds out of that month’s paycheck to the trustee (a private individual appointed by the bankruptcy court), who in turn divides up the payments and distributes them to the creditors.

A big reason for choosing Chapter 13 is that traditionally it has been much easier to protect a home in Chapter 13 than in Chapter 7. Among other things, that is because Chapter 13 allows a debtor in default to his mortgage lender on the filing date to cure the default by paying off the arrearages over the life of the plan. Often, however, the payment plan to which the debtor agrees is unduly optimistic. If he can’t make the required payments, he usually gives up and converts the case to Chapter 7; the benefit of conversion is that the debtor no longer has to make payments out of future income. The issue in this case is what happens to money that the debtor earns while in Chapter 13 and turns over to the trustee for distribution, when those funds have not yet been distributed to creditors by the time the case is converted to Chapter 7. The issue might seem narrow – let’s just agree that it is narrow – but it arises frequently and has generated a substantial circuit conflict.

It’s no surprise that both parties present strong plain-language arguments, but to my mind the statute simply does not address the problem directly. The Bankruptcy Code includes a provision that describes what is supposed to happen when a case is converted from Chapter 13 to Chapter 7 (Section 348(f)). Specifically, property of the estate in the converted case consists of “property of the estate, as of the date of filing of the petition, that remains in the possession or is under the control of the debtor on the date of conversion.” To the debtor, that provision plainly excludes all post-petition earnings from the estate, because they were not in the estate “as of the date of filing of the petition.” Under that reading, Section 348(f) takes those funds, which were in the Chapter 13 estate the moment before the conversion, and transfers them out of the case upon the conversion to Chapter 7. Thus, from that perspective, giving the post-petition earnings to the creditors after the date of conversion denies the debtor the benefits (such as they are) of being in Chapter 7 as opposed to Chapter 13.

To the trustee, by contrast, that argument is wholly beside the point. In the view of the trustee, the funds have “left the building,” as it were, when they were paid to the trustee. They are no longer part of the estate even in Chapter 13. Rather, at that point the trustee holds the funds for the benefit of the creditors – effectively an escrow agent. It is the transfer to the trustee that is crucial (under that reading); the transfer to the individual creditors is an unimportant ministerial act.   The trustee also offers a parallel argument about the “bargain” of Chapter 13. If the benefit of Chapter 13 is that the debtor can stave off foreclosure, so long as any disposable income is turned over to the creditors, the debtor – having enjoyed the benefit of Chapter 13 for a period that matches the income that has been turned over to the trustee – should not be able to retrieve the income turned over while the debtor remained protected by Chapter 13.

The short summary does not do justice to the high quality of the briefing. Suffice it to say that the Justices would have no difficulty writing an opinion that ruled for either side. So perhaps the most interesting question that remains is the one that will be answered at the argument: exactly what would the Justices like to do with this problem?

Recommended Citation: Ronald Mann, Argument preview: Court to take on undistributed funds and bankruptcy conversion, SCOTUSblog (Mar. 30, 2015, 6:00 PM),