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The Debtor, not the Trustee, is Entitled to Funds Being Held by a Trustee Following Dismissal of a Chapter 13 Bankruptcy Case

Filing for Chapter 13 bankruptcy as a consumer is a voluntary decision. Once a Chapter 13 case has been filed, it is also up to the debtors to dismiss the case if they so choose.

What happens if, after a Chapter 13 case has been filed and a plan confirmed, a debtor decides to dismiss the case but the Chapter 13 trustee is holding funds that would have otherwise been distributed to creditors?

This is the situation at issue in a recent case in the United States Bankruptcy Court for the Western District of Michigan.1 After considering the competing arguments put forth by the debtor and the trustee, the Court ruled that the post-confirmation plan payments in the possession of the trustee when the case dismissal order was entered must be returned to the debtor.

Case Background

After the Chapter 13 bankruptcy was filed, the Court confirmed the debtor’s plan and the Debtor made plan payments for almost three years. The debtor then filed a motion seeking to voluntarily dismiss the case, and the Court entered a dismissal order.

At the time of dismissal, the trustee was holding $525.40 derived from the debtor’s post-petition wages. The trustee then distributed these funds to the debtor’s creditors in accordance with the plan.

The debtor’s attorney subsequently filed a fee application seeking payment of fees and expenses incurred during the case, and also a motion seeking an order requiring the trustee to recover the funds that had been distributed to creditors post-dismissal, and to send such recovered funds to the attorney (with the debtor’s permission) in partial satisfaction of the fee application. Although the trustee did recover the distributed funds, she objected to the argument that the debtor is entitled to the return of the funds.

The Parties’ Arguments and Court’s Analysis

The debtor’s primary argument was that Bankruptcy Code Section 349, which governs dismissal of a case, provides that dismissal “revests the property of the estate in which such property was vested immediately before the commencement of the case.” However, the Court noted that the funds at issue were not in existence before the commencement of the case. They were post-petition wages that came into existence after the case was filed.

The trustee relied upon Bankruptcy Code Section 1326 which, the trustee argued, requires that after a plan is confirmed a trustee must distribute funds in accordance with the plan, notwithstanding dismissal of a case. The Court noted, however, that this Bankruptcy Code section addresses payments made “pending confirmation” of a plan, not payments received after a plan has been confirmed.

The Court found neither the debtor’s nor the trustee’s arguments to be on point, and so it looked elsewhere for guidance. The Court began its analysis by looking at federal policies related to Chapter 13 bankruptcy, and the fact that a Chapter 13 case must be entirely voluntary. When a case is dismissed the objective is to unwind a case as if it never happened. The Court stated that this policy “counsels in favor of returning the funds to the Debtor.”

The Court went further, however, and determined that because the Bankruptcy Code does not directly answer the question at issue, the decision of how the funds should be treated requires looking at Michigan state law. In other words, because there is no controlling federal law, state law then applies.

In this case, the Court found Michigan law that relates to how funds are to be treated in a “frustrated escrow arrangement” to be instructive. In an escrow situation, where the condition precedent to a payment being made to a third party is not satisfied, the escrowed property is returned to the original transferor. The Court reasoned that a trustee in a Chapter 13 case is analogous to an escrow agent, and so when the case was dismissed and the plan no longer was effective, then the funds should have been returned to the debtor (the original transferor.) Accordingly, the Court ruled in favor of the debtor and ordered the trustee to return the funds to the debtor.

1 In re Gonzales, Case No. DL (4-04778 (W.D. Banker. Dec. 18, 2017)

Categories: Chapter 13, Did you Know?

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