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Debtors Converting from Chapter 13 to Chapter 7 Get Their Wages Back

If the U.S. Supreme Court was reluctant this year to decide whether a debtor in bankruptcy can sue a creditor for violating the Fair Debt Collections Practices Act, it was in a different mood when it heard and decided Harris v. Veigelahn. The case concerned a debtor whose accumulated chapter 13 payments were distributed to his creditors after he converted his case to chapter 7. The Supreme Court unanimously held that accumulated post-petition wages paid to the trustee in chapter 13 revert to the debtor’s possession upon a valid conversion of the case to chapter 7.

The facts in Harris aren’t atypical of a chapter 13 bankruptcy. Charles Harris III owed debts to two unsecured creditors: $3,700 to his mortgage lender, Chase Manhattan; and an unspecified amount to an electronics store. His repayment plan required him to repay both creditors in full, and then he would pay his unsecured creditors. Harris, however, could not make all the payments to Chase, so it foreclosed on his home. Meanwhile, he continued making the payments to the trustee, Veigelahn, who distributed some of the money to the electronics store and saved the rest for the unsecured creditors.

Harris converted his case to chapter 7, and Veigelahn distributed the accumulated wages to the unsecured creditors, herself, and Harris’ bankruptcy lawyer. Harris filed suit demanding the money back, but the bankruptcy court and the federal courts didn’t agree as to whom the money belonged. The Bankruptcy Code was silent on the matter, and other federal circuits had arrived at conflicting conclusions.

The Supreme Court reasoned that because Congress intended post-petition wages to be exempt from a chapter 7 case, it could not have also intended that the creditors be able to obtain those wages another way—a converted chapter 13 case. The converted case ought to proceed no differently than if it had been filed in chapter 7 to begin with. The Court also took a literal interpretation of the provision in the Bankruptcy Code stating that the chapter 13 trustee’s “services” terminate upon conversion. The Court asserted that distributing assets to creditors was one such service.

After dismissing the trustee’s arguments, the Court casually noted that for Harris to receive his wages back was a “fortuity” of the trustee’s decision to allow the wages to accumulate. Other debtors might not be so lucky.

It’s not too infrequent for debtors to convert their chapter 13 cases to chapter 7, and Harris’ decision to do so, outside of his Supreme Court case, appears to have been the right move given that he couldn’t keep his house anyway. That having been said, the ruling in Harris should not encourage debtors to convert their cases flippantly. The Court emphasized that the conversion must be done in good faith, otherwise the debtors might not see their wages returned to them.

The text of Harris v. Veigelahn can be found on the Supreme Court’s Web site (pdf).

For answers to more questions about bankruptcy, the automatic stay, effective strategies for dealing with foreclosure, and protecting your assets in bankruptcy please feel free to contact experienced Chapter 13 Bankruptcy Lawyer Brooklyn NY Bruce Weiner for a free initial consultation.

Rosenberg, Musso & Weiner, L.L.P
26 Court St # 2211
Brooklyn, NY 11242, USA

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