Treatment of Post-Petition Wages In Conversion for Chapter 13 to Chapter 7

Here at Shenwick & Associates, we specialize in bankruptcy and the unusual questions that arise in the course of bankruptcy cases. One of the great aspects of working in such a specialized area of the law is trying to figure out how courts will hold on an issue that isn't clear under current statutes and case law.

Sometimes, even the District Courts and Courts of Appeals disagree on a point of law. When Courts of Appeals disagree, there becomes a "circuit split" on an issue that only the Supreme Court can resolve.

A "circuit split" occurred regarding the question of what happens when a debtor (in good faith) converts a case to Chapter 7 after the confirmation of a Chapter 13 plan. Do the undistributed funds get distributed to creditors, or are they returned to the debtor?

The question turns upon how the courts interpret Section 348 of the Bankruptcy Code, which addresses the effect of conversion on cases. Subsection (f) provides that if the case is converted in good faith, "property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion."

In the case the Supreme Court decided to review, Harris v. Viegelahn, the petitioner was indebted to multiple creditors and $3,700 behind on his monthly payments to Chase, who held the mortgage on his home. He filed for Chapter 13 bankruptcy, and his plan provided that he would resume making monthly mortgage payments to Chase and $530 per month would be withheld from his post-petition wages and remitted to Viegelahn, the Chapter 13 trustee. Viegelahn would make monthly payments to Chase to pay down Harris' mortgage arrears, and distribute remaining funds to Harris' other creditors.

However, Harris again feel behind on his monthly mortgage payments, and Chase foreclosed on his home. After the foreclosure, Viegelahn stopped making the payments earmarked for Chase and funds began to accumulate in his possession. About a year after the foreclosure, Harris converted his case to Chapter 7. Ten days after the conversion, Viegelahn distributed $5,519.22 in Harris' withheld wages to creditors.

Arguing that Viegelahn lacked authority to disburse his post-petition wages to creditors after conversion, Harris sought an order from the Bankruptcy Court directing refund of the accumulated wages Viegelahn paid to his creditors. The Bankruptcy Court granted Harris' motion, and the District Court affirmed. However, the Fifth Circuit reversed, concluding that a former Chapter 13 trustee must distribute a debtor's accumulated post-petition wages to his creditors. The Supreme Court disagreed, concurring with the Third Circuit in In re Michael that a debtor who converts to Chapter 7 is entitled to the return of any post-petition wages not yet distributed by the Chapter 13 trustee

For these and other questions that require our bankruptcy expertise, please contact Jim Shenwick