Undisbursed Funds Returned to Debtor Upon Conversion

After Harris failed to maintain his mortgage payments in accordance with his chapter 13 plan, the mortgagee foreclosed and the trustee stopped distributing the funds earmarked for that debt. As a result, when Harris converted to chapter 7, the trustee held over $5,500 in accumulated but undistributed funds. Ten days after the conversion, the trustee used the funds to pay attorney and administrative fees and then distributed what was left to the remaining secured and unsecured creditors. The bankruptcy court ordered the trustee to refund the money to the debtor and the district court affirmed. The Fifth Circuit reversed, In re Harris, 757 F. 3d 468 (2014), creating a conflict with the Third Circuit case of In re Michael, 699 F. 3d 305 (2012).
The Supreme Court began its discussion with section 348(f) which provides that, upon conversion, the chapter 7 estate consists of the debtor’s property as of the original chapter 13 petition date unless the case is converted in bad faith. Where this section is intended to shield post-petition assets from chapter 7 creditors, permitting the trustee to distribute those funds via chapter 13 would be contrary to congressional intent. Permitting post-conversion distribution would also declaw section 348(f)(2) under which a debtor converting in bad faith loses the benefit of returning to the original petition date to establish the chapter 7 estate. The Court concluded: “In sum, §348(f) does not say, expressly: On conversion, accumulated wages go to the debtor. But that is the most sensible reading of what Congress did provide.”
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