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Opinion: Tie goes to the debtor in consumer bankruptcy dispute about funds paid to trustee

Harris v. Viegelahn is living proof that the Court takes its responsibility for resolving circuit conflicts seriously. This is a consumer bankruptcy case that involves only $5000 and turns on a remarkably narrow issue of statutory interpretation: 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? With refreshing candor, the Court acknowledges that the statute provides no clear answer to the question, resting its decision to side with the debtor largely on the Court’s intuitions about how the Bankruptcy Code should work.

To understand how the issue arises, consider the facts of the case at hand. Petitioner Charles Harris filed a petition for relief under Chapter 13 in 2010. He was at that time far behind on his mortgage payments. Chapter 13 allows him to cure that arrearage over the course of the plan; the Chapter 13 “bargain” is that the debtor gets to keep assets, but must pay creditors out of future income for three to five years. That contrasts with the Chapter 7 “bargain”; the debtor gets to keep all post-filing income, but must turn over all non-exempt assets to creditors.

In the Chapter 13 proceeding, the bankruptcy court approved a plan requiring that $534 of Harris’s monthly wages be forwarded to the trustee; the mortgage lender (Chase) would get $352 each month to cure the arrearage, and the remaining creditors would share the remaining $182. Harris would make the regularly scheduled monthly mortgage payments outside the plan.

Unfortunately, Harris fell behind on the mortgage. In due course, Chase foreclosed. At that point, the trustee stopped sending payments to Chase, but instead held the funds. After several months (when $5500 had accumulated in the hands of the trustee), Harris converted the case to Chapter 7. The trustee (respondent Mary Viegelahn) promptly distributed the funds to the unpaid creditors. Harris insisted that he should have gotten the money.

A little history puts the interpretation question in context. In the early years after the adoption of the Bankruptcy Code, courts took three views on this problem. Some courts thought the money should go back to the debtor (because a Chapter 7 debtor gets to keep post-filing income). Some courts thought the money should go to the creditors (because in a Chapter 13 post-filing income typically goes to the creditors). A third group held that the funds flowed into the debtor’s Chapter 7 estate. As part of a 1994 statute correcting a number of problems in the Bankruptcy Code, Congress turned to that question. Unfortunately, showing the lack of craft exhibited all too commonly in amendments to the Bankruptcy Code, Congress adopted a provision that indisputably rejects the third alternative (funds go to the Chapter 7 estate) but says nothing at all about how to choose between the first two alternatives (funds go to creditors or to the debtor).

The Court ultimately was persuaded by the idea that the termination of the Chapter 13 plan at the moment of conversion brings the Chapter 13 “bargain” to an immediate conclusion: the debtor is entitled to all post-filing income not yet paid over to creditors. With a level of frankness not typical of the Court’s opinions, Justice Ruth Bader Ginsburg (writing for a unanimous Court) did not insist that the plain language of the Code “compels” this result. Rather, the Court explained that the statute “does not say, expressly: On conversion, accumulated wages go to the debtor. But that is the most sensible reading of what Congress did provide.” A bit more expansively, the Court explained that the Justices “resist attributing to Congress, after explicitly exempting from Chapter 7’s liquidation-and-distributions process a debtor’s postpetition wages, a plan to place those wages in creditors’ hands another way.”

Against that policy backdrop, the Court turned briefly to three statutory arguments. But once the Court has characterized the language as unclear, all that remains is to satisfy the reader that the trustee’s arguments are not compelling enough to force a result in the trustee’s favor, and that task is not a hard one. The Court first points to the strongest argument supporting its result: that the Chapter 13 trustee’s authority to provide services to the estate terminates at the moment of conversion. Because the statute identifies making payments to creditors as one of the core “services,” that immediate termination supports the Court’s conclusion.

The Court next acknowledged the trustee’s argument that the statute directly obligated her “to distribute ‘payment[s] in accordance with the plan,” depriving her of any capacity to return them to the debtor. Not so, the Court explains, because the provisions obligating the trustee “ceased to apply once the case was converted to Chapter 7.”

Finally, the Court rejected the idea that the trustee’s duty to “wind up” the affairs of the estate included a duty to distribute funds to the creditors. The Court pointed to the relevant provisions of the Federal Rules of Bankruptcy Procedure, which identify a number of winding-up tasks but mention no duty to distribute. Thus, the Court reasoned, “[c]ontinuing to distribute funds to creditors pursuant to the defunct Chapter 13 plan is not an authorized ‘wind-up’ task.”

To my mind, the trustee’s strongest argument was the idea that the creditor’s interest in the funds vested when they came into the trust, because the trust exists only for the benefit of the creditors. The Court was unimpressed, dismissing the argument with no explanation beyond a summary quotation from one of the conflicting court of appeals decisions: “[N]o provision in the Bankruptcy Code classifies any property, including post-petition wages, as belonging to creditors.”

It is hard to see any substantial long-term impact flowing from this decision. Even an opinion resting entirely on the Court’s notions of applicable bankruptcy policy comes across as sufficiently narrow to obviate any lasting effect. But it does settle the conflict and of course that task is what justified the Court’s attention.

PLAIN LANGUAGE: Debtors can receive two forms of bankruptcy relief. In Chapter 13, the debtors make payments out of future income, but keep their assets. In Chapter 7, they keep their future income but turn over any non-exempt assets. This case asks what happens to money that the debtor earns while in Chapter 13, if the debtor converts the case to Chapter 7 before the money is sent to the creditors. The Court holds that the debtor gets to keep the money.

Recommended Citation: Ronald Mann, Opinion: Tie goes to the debtor in consumer bankruptcy dispute about funds paid to trustee, SCOTUSblog (May. 18, 2015, 5:28 PM),