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Supreme Court okays debtor refund on conversion to Chapter 7

When a Chapter 13 payment plan bogs down due to reduced income or other financial setbacks, the debtors may find it necessary to convert to a Chapter 7 and discontinue the Chapter 13. The debtor in a Chapter 13 proceeding in Arkansas or any other jurisdiction has a right to make that conversion at any time. One problem that may arise, however, is regarding the debtor's monthly payments still held by the Chapter 13 trustee and not distributed to creditors at the time of conversion to Chapter 7. As a general rule, the trustee usually refunds that balance to the debtors after deducting fair sums for administrative expenses.

The trustee usually refunds the money because it was part of the debtor's post-petition net income that he or she would have earned and kept in a Chapter 7. Occasionally, however, a Chapter 13 trustee may have a different perspective, including the intention of distributing the payments to unsecured creditors and not to the debtors as a return of income, and notwithstanding the conversion of the case. The issue was controversial enough to be chosen for consideration by the U.S. Supreme Court.

The Supreme Court just recently cleared up the issue and held unanimously that the Chapter 13 trustee must refund to debtors any undistributed funds at the time of conversion. The trustee had been holding about $5,500 of the debtor's payments. When the case converted, she gave the bulk of the funds to six  unsecured creditors, while taking a $267.79 commission.

The 5th Circuit Court of Appeals agreed with the trustee in holding that she had a duty to distribute the funds to creditors despite the Chapter 7 conversion. The U.S. Supreme Court judges unanimously disagreed with the 5th Circuit and held that any payments not already distributed to creditors at the time of the conversion was the debtor's money. The Court stressed that post-petition earnings are off-base to a Chapter 7 trustee, and the debtor would have kept post-petition earnings had he filed a Chapter 7 in the first place. The ruling applies to bankruptcy proceedings in Arkansas as well as all other jurisdictions.

Source: courthousenews.com, "Bankruptcy Leftovers Go to Debtor, SCOTUS Says", William Dotinga, May 18, 2015

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