Refunds by Creditors After Chapter 13 Discharge Go to Creditors, Not the Debtor

If a chapter 13 case is dismissed before confirmation, Section 1326(a)(2) requires the trustee to return undistributed funds to the debtor after payment of allowed administration claims. Further feathering the debtor’s nest, the Supreme Court ruled in Harris v. Viegelahn, 135 S. Ct. 1829 (2015), that undistributed post-petition wages in the hands of a chapter 13 trustee must be paid to the debtor on conversion to chapter 7.

So, by statute and Supreme Court authority, a chapter 13 debtor comes out on top on conversion to chapter 7 and after dismissal before confirmation. But what if creditors return distributions to the chapter 13 trustee after the debtor completes plan payments? Does a logical extension of Harris mean that refunded distributions go to the debtor and not to other creditors?

At least when the debtor has confirmed a so-called pot plan not paying creditors in full, Bankruptcy Judge Rebecca B. Connelly of Harrisonburg, Va., decided that refunded distributions go to other creditors.

The court had confirmed a chapter 13 plan where the debtor paid $275 a month, or $16,500 in total over the 60-month plan. Unsecured creditors were to receive pro rata distributions after payment in full on administrative and secured claims. The plan estimated that unsecured creditors would recover 4%.

When the debtor completed her plan payments, unsecured creditors had recovered about 4.7%.

After discharge, the debtor applied for a total and permanent disability discharge for her student loans, which, of course, were not discharged by the plan. When the government approved the disability discharge, two student loan lenders returned about $3,600 to the trustee that they had received in distributions under the plan.

The bankruptcy court reopened the case to decide who should receive the refunded $3,600. In her March 15 opinion, Judge Connelly ruled that the plan required distributing the refund to other unsecured creditors.

Judge Connelly’s analysis began and ended with the statute and the terms of the plan.

The confirmed plan binds the debtor, and Section 1326(a)(2) requires the trustee to make distributions to creditors with allowed claims in accordance with the plan. The refund by the student loan lenders “simply places the plan payments back into the hands of the trustee to disburse according to the terms and provisions of the confirmed plan,” Judge Connelly said.

The fact that the debtor had completed her plan payments and received a discharge did not change the equation, Judge Connelly said. Returning the $3,600 to the debtor would have had the effect of modifying the plan and reducing the debtor’s payment obligation from $16,000 to about $12,900.

The debtor was not empowered to modify the plan, Judge Connelly said, because Section 1329 only permits modifying a plan before the completion of plan payments. Furthermore, a decrease in creditors’ claims is not grounds for modifying a plan, she said.

The debtor might have argued that redistribution after discharge had the effect of giving the plan a duration of more than five years, in contravention of Section 1322(d). However, we don’t find the logic overwhelming, because the trustee would have redistributed unclaimed funds during the life of the plan, as Judge Connelly noted.