On an issue where the courts are split, a district judge in Virginia upheld the bankruptcy court’s ruling that a chapter 13 trustee must return undistributed funds to the debtor, rather than honor a garnishment under state law, if the case was dismissed before a plan was confirmed.
Owing a state agency more than $74,000 for child support arrears, a man filed a chapter 13 petition. After filing, he sent about $3,000 to the trustee. With the debtor unable to craft a confirmable plan, the bankruptcy court dismissed the case.
After dismissal and while the trustee was still holding the $3,000, the state agency served a garnishment order on the trustee. The debtor objected, contending he was entitled to a return of the funds under Section 1326(a)(2).
When the trustee sought instructions, the bankruptcy court decided that the money should go to the debtor. The state agency appealed and obtained a stay pending appeal.
In an opinion on Oct. 19, District Judge Norman K. Moon of Lynchburg, Va., agreed with the bankruptcy judge.
Judge Moon framed the question as being whether the court should follow Section 1326(a)(2) or honor an otherwise valid levy under state law.
Eliminating exceptions that do not apply when a chapter 13 case is dismissed before confirmation, Judge Moon quoted Section 1326(a)(2) to say that the trustee must “return any such payments . . . to the debtor . . . .” That language, he said, “is determinative.”
To the state agency’s argument that the termination of the automatic stay on dismissal allows a levy on the debtor’s property, Judge Moon said that Section 362 “does not contradict or muddle Section 1326(a)(2)’s statement about who gets the funds.”
Next, the state argued that the trustee was obliged to comply with state law under 28 U.S.C. § 959(b). The state’s argument failed under the Constitution’s Supremacy Clause, Judge Moon said, because state law contradicts the mandate of Section 1326(a)(2).
Finally, Judge Moon justified his conclusion by referring to policy as reflected in Harris v. Viegelahn, 135 S. Ct. 1829, 1835 (2015), where the Supreme Court said that a debtor should not be penalized for pursuing chapter 13 voluntarily.