In re Michael

• Decision Date: 26 October 2012
• Docket Number: No. 11–1992.,11–1992.
• Parties: In re Barry L. MICHAEL, Debtor. Charles J. DeHart, III, Trustee, Appellant.
• Court: U.S. Court of Appeals — Third Circuit

699 F.3d 305

In re Barry L. MICHAEL, Debtor. Charles J. DeHart, III, Trustee, Appellant.

No. 11–1992.

United States Court of Appeals,Third Circuit.

Argued May 7, 2012.

Opinion filed: Oct. 26, 2012.

James K. Jones, Esquire (Argued), Agatha R. McHale, Esquire, Charles J. DeHart, III, Esquire, Standing Chapter 13 Trustee Office, Hummelstown, PA, for Appellant.

Richard J. Bedford, Esquire (Argued), Ronda J. Winnecourt, Esquire, Office of the Chapter 13 Trustee, Pittsburgh, PA, for Amicus Appellant.

John J. DiBernardino, Esquire (Argued), Lehighton, PA, for Debtor–Appellee.

Irv Ackelsberg, Esquire (Argued), Langer, Grogan & Diver, Philadelphia, PA, for Amicus Appellee.

Before: SLOVITER, AMBRO,^* and ROTH, Circuit Judges.

OPINION OF THE COURT

AMBRO, Circuit Judge.

This appeal raises a question of first impression involving the interpretation of Chapter 13 of the Bankruptcy Code, 11 U.S.C. §§ 101 et seq., in the common circumstance of a debtor converting his or her case from a Chapter 13 adjustment of debts under a reorganization plan to a Chapter 7 liquidation of assets and distribution to creditors.¹ If at the time of conversion the Chapter 13 trustee is holding funds acquired post-petition by the debtor for eventual distribution to creditors under a confirmed Chapter 13 reorganization plan, must the trustee return the funds to the debtor or distribute them to creditors under the provisions of the plan? The District Court affirmed the Bankruptcy Court's holding that those funds are to be returned to the debtor at the time of conversion. We agree and thus affirm the District Court's decision.

I. Facts and Procedural History

Appellee Barry Michael filed a voluntary petition under Chapter 13 of the Bankruptcy Code in September 2005. In June 2006, the Bankruptcy Court confirmed his Chapter 13 reorganization plan (the “Plan”). The Plan provided that Michael would pay approximately $277 per month to the Chapter 13 trustee, Appellant Charles J. DeHart, III (the “Trustee”), for 53 months, and the Trustee would direct the monies received to creditors holding secured and priority claims. Among these creditors was GMAC Mortgage, which held a mortgage on Michael's residence. Michael agreed also to make regular mortgage payments to GMAC outside of the Plan. The Plan further provided that, to the extent funds were available, creditors holding unsecured claims would be paid pro rata. To complete his bargain and fund the Plan, Michael allowed his wages to be attached and paid directly to the Trustee.

Michael, however, was unable to make mortgage payments to GMAC outside of the Plan, and in August 2006 the Bankruptcy Court granted GMAC relief from the automatic stay to allow it to foreclose on Michael's residence. Because Michael did not move to amend the Plan or modify the wage attachment order, the Trustee continued to receive automatic payments from Michael's employer. When the Trustee attempted to forward the funds to GMAC as provided by the Plan, GMAC refused to accept the payments (ostensibly because it wanted to foreclose—pun intended—an estoppel and/or waiver defense to its mortgage foreclosure). The funds continued to accumulate in the Trustee's account until Michael moved to convert his case to Chapter 7 in October 2009.

Several days after the conversion, Michael filed a motion seeking an order compelling the return to him by the Trustee of the accumulated funds, which amounted to $9,181.62. The Trustee objected, arguing that the funds should be distributed pro rata to unsecured creditors as provided by the Plan.

Both the Bankruptcy and District Courts noted that the Bankruptcy Code does not provide a clear answer on whether undistributed plan payments held by a Chapter 13 trustee should be returned to the debtor or distributed to creditors under a plan when a Chapter 13 case is converted to Chapter 7. Each court assessed the main arguments advanced by the parties and discussed by other (mainly bankruptcy) courts regarding statutory language, legislative intent, and the goals of the Code. They both concluded that the funds must be returned to Michael. The Trustee filed a timely notice of appeal. ²

II. Discussion

We have a pure question of law—what does the Bankruptcy Code require a Chapter 13 trustee to do with undistributed funds received pursuant to a confirmed Chapter 13 plan when that Chapter 13 case is converted to Chapter 7? Not only does the Code provide no clear answer to this question, in reading it one finds an internal tension, as separate provisions seemingly lead to divergent results.

Both the Bankruptcy and District Courts began their analyses, as do we, with the Bankruptcy Reform Act of 1994's amendments to the Bankruptcy Code. Included in those amendments was § 348(f), on which this appeal ultimately turns. That section provides that on conversion of a case from Chapter 13 to another Chapter, “property of the estate in the converted case shall consist of property of the estate, as of the date of filing of the petition, that remains in the possession of or is under the control of the debtor on the date of conversion.” 11 U.S.C. § 348(f)(1)(A) (emphasis added). In the case of a bad faith conversion, “the property of the estate in the converted case shall consist of the property of the estate as of the date of conversion.” Id. § 348(f)(2) (emphasis added).

Prior to the addition of § 348(f), courts considering the disposition of funds held by a Chapter 13 trustee at the time of conversion reached three different results: the funds were (i) property of the new Chapter 7 estate, (ii) property of the debtor, or (iii) property of creditors under a confirmed Chapter 13 plan. See, e.g., In re Boggs, 137 B.R. 408, 411 (Bankr.W.D.Wash.1992) (concluding that the debtor is entitled to undistributed funds held by the Chapter 13 trustee on conversion to Chapter 7); Waugh v. Saldamarco (In re Waugh), 82 B.R. 394, 400 (Bankr.W.D.Pa.1988) (holding that the Chapter 13 trustee must pay out undistributed funds to the creditors as provided by the Chapter 13 plan on conversion); In re Tracy, 28 B.R. 189, 190 (Bankr.D.Me.1983) (holding that the Chapter 13 trustee must turn over undistributed funds to the Chapter 7 trustee on conversion). Courts of Appeals primarily debated whether the funds became property of the Chapter 7 estate. Compare Calder v. Job (In re Calder), 973 F.2d 862, 865–66 (10th Cir.1992) (holding that post-petition funds that were part of the Chapter 13 estate became property of the Chapter 7 estate on conversion to Chapter 7), Matter of Lybrook, 951 F.2d 136, 138 (7th Cir.1991) (same); and Armstrong v. Lindberg (In re Lindberg), 735 F.2d 1087, 1089–90 (8th Cir.1984) (same), with Bobroff v. Cont'l Bank (In re Bobroff), 766 F.2d 797, 803–04 (3d Cir.1985) (holding that a post-petition tort claim did not become property of the Chapter 7 estate on conversion).

Section 348(f) removed the first result, but did not resolve explicitly whether the Chapter 13 trustee should give the funds to the debtor or distribute them to creditorsunder the confirmed Chapter 13 plan. As developed below, § 348(f)'s language and legislative history express Congress's preference as to what property belongs to a debtor after conversion, and ultimately direct our decision.

To understand the full import of § 348(f), we provide a brief overview of a Chapter 13 case. The filing of a Chapter 13 petition creates an estate consisting of all of the debtor's legal and equitable interests in property. 11 U.S.C. §§ 301(a), 541(a).³ “[I]n addition to the property specified in section 541” that exists at the filing of the Chapter 13 petition, the estate includes “all property of the kind specified in [ section 541] that the debtor acquires after the commencement of the case but before the case is closed, dismissed, or converted to a case under chapter 7, 11, or 12 of this title, whichever occurs first....” Id. § 1306(a). This includes “earnings from services performed by the debtor after the commencement of the case but before the case is closed, dismissed, or converted....” Id. § 1306(b). As is the case here, these earnings ordinarily fund the Chapter 13 plan. See, e.g., 8 Collier on Bankruptcy ¶ 1322.01 (Alan N. Resnick & Henry J. Sommer eds., 16th ed. 2012) (“Chapter 13 was designed to facilitate adjustments of the debts of individuals with regular income through flexible repayment plans funded primarily from future income.”).

A debtor must begin making payments to the Chapter 13 trustee “not later than 30 days after the date of the filing of the plan or the order for relief [defined below], whichever is earlier....” 11 U.S.C. § 1326(a)(1). The trustee must retain these payments “until confirmation or denial of confirmation [of a plan].... If a plan is not confirmed, the trustee shall return any such payments not previously paid ... to the debtor, after deducting any unpaid claim allowed under section 503(b).” Id. § 1326(a)(2).

Confirmation of a reorganization plan under Chapter 13 affects the estate, debtor, creditors, and Chapter 13 trustee. The confirmed plan vests all of the property of the estate in the debtor, id. § 1327(b); binds the debtor and its creditors, id. § 1327(a); and obligates the trustee to distribute the debtor's payments under the plan to creditors, id. § 1326(a)(2), (c).⁴ At any time during the Chapter 13 proceeding, the debtor has a near absolute right to convert his case. Id. § 1307(a) ( “The debtor may convert a case under this chapter to a case under chapter 7 of this title at any time. Any waiver of the right to convert under this subsection is unenforceable.”). Regardless when conversion takes place, it “does not effect a change in the date of the filing of the petition.” Id. § 348(a).

Conversion also “terminates the services” of the Chapter 13 trustee. Id. § 348(e). Though his services are ended after conversion, the trustee is required to account for the funds that came into his possession by filing a...