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Do Debtors or Creditors Get Undisbursed Chapter 13 Plan Payments Upon Conversion? -- A New Circuit Split

posted by Pamela Foohey

Chapter 13 trustees handle millions of dollars in plan payments every year. At some point in likely a sizable portion of cases, the trustee accumulates these payments instead of distributing the funds to creditors. What happens if a debtor's case is converted while the trustee has this accumulated money in its account? In 2012, the 3rd Circuit, in a majority opinion, held that the trustee must return the funds to the debtor (see decision here). Yesterday the 5th Circuit held that the trustee must distribute the funds to creditors (see decision here), thus creating a split on an issue that, as the Fifth Circuit stated, "has divided courts for thirty years," though only had previously produced one appellate court decision squarely on point.

With only one-third of Chapter 13 cases making it to discharge, the issue potentially affects a good number of debtors and involves a significant amount of money in total. Each individual debtor may (or may not) be entitled to a large sum of money in his or her estimation. In the 3rd Circuit case, the Chapter 13 trustee had accumulated over $9,000 in undistributed payments. In the 5th Circuit case, the trustee was holding about $5,500 in undistributed payments. And to the extent there isn't at least a local rule to rely on, Chapter 13 trustee probably would like clearer guidance on the issue.  

My initial reaction is that the accumulated payments should go to creditors. That's the bargain the debtor signed up for. The debtor makes payments under the plan and, in return, keeps her house and car and continues to benefit from the automatic stay. But the text of the Code provides little guidance, and I think there are good policy arguments on both sides, as well as a bit of legislative history that perhaps might tilt the balance toward the debtor. For now, as the 3rd Circuit noted, if creditors want to make sure that undistributed payments go to them upon conversion, they should request that such language be added to the plan. Seems like a rather easy fix? And now maybe we have another bankruptcy issue for the Supreme Court to consider? Stay tuned to see if a writ of certiorari is filed.


My issue with Chapter 13 is the amount of interest that has to be paid to the trustee on top of the payment of debt. Additionally, there is no incentive to creditors to help write down portions of the debt after the plan is in effect. If only a third of debtors survive there apparently are defects in the Chapter that should be revisited by Congress. Debtors who file Chapter 13 or Chapter 11 are trying to be morally responsible. The courts and creditors make it an extremely difficult process rather than assist the Debtors in achieving an amicable goal. Creditors that force bankruptcy, deny plans, and/or are generally hateful and egregious have no reason to gripe when the Debtor is forced to convert to a Chapter 7 and they get nothing because the Chapter 7 trustee and his attorneys (administration) are paid first... And in most cases are not above fee cranking to leave the estate empty.

Recently, the accumulation of funds in the hands of the trustees has been the result of poorly documented mortgage claims and the challenge to the allowance of many of them. The trustee will generally hold the funds until the claim dispute is resolved, and then, if the claim is allowed, the funds will go to that creditor. If the claim is disallowed, the funds will be allocated, pursuant to the plan, to other creditors. Your comment is spot on, when you observe that chapter 13 trustees would like some guidance on this issue. After all, in the Nash decision from the 9th Circuit, the trustee was personally surcharged for making payments to creditors upon the dismissal of the case.

“This Godlike act” must be scrapped, for ultimately "accumulated payments should go to creditors. That's the bargain the debtor signed up for." Ms.Foohey, bankruptcy law is a collective decision of people, congress crafted it and made it clear that people need to be given a chance. And that definitely entails: someone has to take the loss. If you disburse the collected money to creditors upon conversion, then people would be thwarted in attempting to give 13 a try. The fact that there is no fear incent people to reorganize. Statutorily also, it is clear Congress desired this result, otherwise it would not have amended 348(f) in 1994. This provision is given a liberal reading, for bankruptcy aim is to rehabilitate the debtor and not throw him in deeper morass.

Distribution to creditors? Quo warranto?

Because the order of conversion terminates the Ch13 trustee's service as trustee when it appoints the Ch7 trustee, the Ch13 trustee no longer has authority to distribute the funds to creditors. His only remaining duties are to account for and turn over all property of the estate remaining in his possession to the successor trustee and to file his final report.
But then section 348 as a curious effect: In virtually all cases, the accumulated funds on-hand represent post-petition wages of the debtor.* These were clearly property of the estate in the Ch13 case, but now they are equally clearly NOT property of the estate in the converted case because 348 limits the converted case estate to the assets of the debtor as of the original order for relief (less anything disposed of since). So all the newly-appointed Ch7 trustee can do is hand over the funds back to the debtor. It is a seemingly bizarre outcome, but the only one possible under the plain language of 348.

This is at least what routinely happens in the Southern District of Alabama.

[*Obviously, if the funds are of some other origin, 348 might not alter their status as property of the estate, such as the case with rents generated by real property or proceeds of a pre-petition insurance policy, etc.]

Chapter 13 should not be a savings account for the debtor and collected funds should be distributed to unsecured creditors who have filed proofs of claim. If the funds are returned to the debtor then the debtor should report that as income on their tax forms and/or if they convert to a Chapter 7 then those funds should belong to the bankruptcy estate, thus an asset case. Having two different opinions makes no sense and I agree that Chapter 13 Trustees need a uniform standard. Otherwise, more of the estate will be consumed by attorney fees.

I filed chapter 13. My repayment amount is 35k because I owned property however I don't owe 35k to creditors. My attorney claims I'm only paying back 17% of my debts? How can that be and where's all my money going! This guy won't call me back. Help!i

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