Imagine that you are a Chapter 13 debtor with a 5-year reorganization plan. In this plan, you commit your future wages to assure payment of the plan payments. However, one year into the plan, you are not able to pay the current mortgage payments. Because of your default, the mortgage lender files a motion for relief asking for court permission to proceed with foreclosure despite the Chapter 13. That motion is granted and you lose your house to foreclosure. Since the reason you filed for Chapter 13 is to save the house, the foreclosure erases the reason for you to continue on Chapter 13. Although you lost your house to foreclosure, you continue on Chapter 13 for another year. Thereafter, you file a motion to convert your Chapter 13 case to Chapter 7 because you still need to discharge $50K of credit card debt. The Chapter 13 trustee then disburses the $4,800 in her account, which is your accumulated wage deduction for the plan to your creditors. You object and ask trustee to refund the $4,800 that she collected from your wages, which were deposited into your checking account. Trustee refuses to refund the $4,800 claiming that the wages she collected are part of your Chapter 13 bankruptcy estate as future wages. Who is correct?

A case with similar facts went all the way to the United States Supreme Court. This case was argued on April 1, 2015 and the Supreme Court decision was published on May 18, 2015. In Harris vs. Viegelahn, Mr. Harris was indebted to multiple creditors and $3,700 behind on his home mortgage payments to Chase, filed a Chapter 13 to handle the pre-filing default. . His court confirmed plan provided for resumption of the Jh mortgage payments, and that the $530 monthly plan payment would be withheld from his future wages and remitted to the Chapter 13 trustee, respondent Viegelahn. Trustee Viegelahn would make monthly payments to Chase to pay down the pre-filing mortgage arrears, and distribute the remaining funds to Harris’ other creditors. When Harris again fell behind on his mortgage payments, Chase foreclosed on his home. Following the foreclosure, Viegelahn continued to receive $530 monthly from Harris’ wages, but stopped making the payments earmarked for Chase. As a result, funds formerly reserved for Chase accumulated in Viegelahn’s possession. About a year after the foreclosure, Harris converted his case to Chapter 7. Ten days after this conversion, Viegelahn distributed $5,519.22 in Harris’ withheld wages mainly to Harris’ creditors. Asserting that Viegelahn lacked authority to disburse his post-petition wages to creditors post-conversion to Chapter 7, 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. The Fifth Circuit reversed, concluding that the former Chapter 13 trustee must distribute a debtor’s accumulated post-petition wages to his creditors.

Harris appealed to the Supreme Court, which REVERSED the Fifth Circuit and held that:

1. Absent a bad faith conversion, §348(f) limits a converted Chapter 7 estate to property belonging to the debtor “as of the date” the original Chapter 13 petition was filed. Because post-petition future wages do not fit that bill, undistributed wages collected by a Chapter 13 trustee, ordinarily DO NOT become part of a converted Chapter 7 estate.
2. By excluding post-petition future wages from the converted Chapter 7 estate, absent a bad faith conversion, §348(f) removes those earnings from the pool of assets that may be liquidated and distributed to creditors. Allowing a terminated Chapter 13 trustee to disburse the very same earnings to the very same creditors is incompatible with that statutory design.
3. This conclusion is reinforced by §348(e), which “terminates the service of the Chapter 13 trustee upon conversion. One service provided by a Chapter 13 trustee is disbursing “payments to creditors.” §1326(c). The moment a case is converted from Chapter 13 to Chapter 7, a Chapter 13 trustee is tripped of authority to provide that “service.”
4. Section 1327(a), which provides that a confirmed Chapter 13 “binds the debtor and each creditor,” and §1326(a)(2), instructs a trustee to distribute “payments in accordance with the plan,” ceased to apply once the case was converted to Chapter 7. §103(i), Sections 1327(a) and 1326(a)(2), therefore, offer no support for Viegelahn’s assertion that the Bankruptcy code requires a terminated Chapter 13 trustee to distribute to creditors post-petition wages remaining in the trustee’s possession. Continuing to distribute funds to creditors pursuant to a defunct Chapter 13 plan, moreover, is not, one of the trustee’s post-conversion responsibilities specified by the Federal rules of Bankruptcy Procedure.

I guess the Chapter 13 trustee will have to refund the $5,519.22 to Mr. Harris immediately since the Supreme Court has decided that he had no authority to disburse the future wages of debtor to his creditors upon conversion of his Chapter 13 case to Chapter 7. This trustee will have pay the $5,519.22 from his own pocket and sue all the creditors who got a portion of the $5,519.22 for a refund. Good luck on that. It’s just not cost effective and a waste of time. Good luck on that. With this Supreme Court decision debtors can now rest assured that upon conversion of their Chapter 13 case to Chapter 7, their future wages belong to them and is out of reach of the Chapter 13 trustee.

 “WHY ARE YOU IN DESPAIR, O MY SOULD? AND WHY HAVE YOU BECOME DISTURBED WITHIN ME? HOPE IN GOD, FOR I SHALL AGAIN PRAISE HIM FOR THE HELP OF HIS PRESENCE.” PSALM 42:5.

Lawrence Bautista Yang is a graduate of Georgetown University Law Center and has been in law practice for thirty years.  He specializes in bankruptcy, business and civil litigation and has handled more than five thousand successful bankruptcy cases in California.  He speaks Mandarin and Fujien and looks forward to discussing your case with you personally.  Please call (626) 284-1142 for an appointment at 1000 S Fremont Ave, MAILSTOP 58, Building A-1 SUITE 1125, Alhambra, CA 91803 OR at 20274 Carrey Road, Walnut, CA 91789.