During a Chapter 13 bankruptcy proceeding, a trustee collects a portion of a debtor’s wages for distribution to creditors according to a court-approved payment plan. At any time, a debtor may convert his Chapter 13 proceeding into a Chapter 7 proceeding, during which the debtor’s wages are not collected. What happens to wages collected, referred to as “postpetition wages,” that remain undistributed to creditors when this conversion takes place? Federal courts have disagreed on the appropriate course of action; however, the recent Supreme Court decision in Harris v. Viegelahn resolves any confusion.
Harris, the debtor, filed for Chapter 13 bankruptcy. As part of his court-approved plan, a portion of Harris’ wages were withheld from his paychecks, transferred to the Chapter 13 trustee, and distributed to Harris’ creditors. Harris converted his Chapter 13 bankruptcy to a Chapter 7, a nonwaivable right conferred to debtors by the Bankruptcy Code. Following this conversion the trustee distributed the postpetition wages that had accrued in the Chapter 13 estate to Harris’ counsel, creditors, and herself in the form of her own fee. Harris moved the Bankruptcy Court to order return of the postpetition wages, arguing the trustee lacked authority to distribute the postpetition wages after conversion took place.
The Bankruptcy Court granted Harris’ motion and the District Court affirmed; however the Fifth Circuit Court of Appeals reversed, holding a former Chapter 13 trustee must distribute the postpetition wages to creditors because, for reasons of equity and policy, creditors’ claims to postpetition wages are superior to a debtor’s claim to them. On review, the United States Supreme Court held the Bankruptcy Code contemplates return of the postpetition wages throughout the Code. For example, the Chapter 7 estate consists of property under control of the debtor at the time of filing of the original Chapter 13 petition unless the conversion is made in bad faith, in which case property at the time of conversion becomes part of the Chapter 7 estate. Consequently, the Court found the trustee did not possess the right to distribute the wages and ordered they must be refunded to Harris.
The Harris v. Viegelahn decision clarifies that any undistributed postpetition wages must be returned to the debtor, which may leave creditors wondering how they can protect themselves when involved in a Chapter 13 proceeding. To ensure they receive distributions, creditors can request the court-approved plan include a distribution schedule that provides for regular, frequent distribution of funds by the trustee, thereby preventing a build-up of funds that would be refunded to the debtor should he or she choose to convert to a Chapter 7 bankruptcy. If you have any questions regarding this case, please contact one of our Creditor’s Rights and Bankruptcy attorneys.