If a chapter 13 case has been dismissed before confirmation, the Tenth Circuit Bankruptcy Appellate Panel seems inclined to allow judgment creditors to garnish funds that the trustee would otherwise return to the debtor.
The nonprecedential opinion on April 27 by Bankruptcy Judge Michael E. Romero includes an in-depth survey of the split on Section 1326(a)(2) and questions like the right of a chapter 13 trustee to collect a fee when dismissal occurs before confirmation. The opinion examines decisions going both ways on the right of creditors to garnish funds held by the trustee on dismissal of a chapter 13 case.
$29,000 Held by the Trustee on Dismissal
In the case before the BAP, the debtor had filed three successive chapter 13 petitions. The previous two had been dismissed quickly.
In the third and last case, the debtor filed to prevent state court clerks from collecting some $30,000 in judgments made in sanction for frivolous and vexatious litigation.
Eventually, the bankruptcy court refused to confirm the debtor’s chapter 13 plan. Together with denial of confirmation, the bankruptcy court dismissed the chapter 13 case. On dismissal, the chapter 13 trustee was holding about $29,000, after deducting the trustee’s fees.
The debtor’s former wife and the state court clerks filed motions for authority to garnish the funds being held by the trustee that would otherwise be distributed to the debtor under Section 1326(a)(2). The wife contended that her domestic support obligations were prior to the clerks’ judgments.
Section 1326(a)(2) and the Barton Doctrine
Section 1326(a)(1) requires a chapter 13 debtor to commence making payments to the trustee within 30 days of filing.
Subsection (a)(2) provides that payments made by the debtor “shall be retained by the trustee until confirmation or denial of confirmation. . . . If a plan is not confirmed, the trustee shall return any such payments not previously paid . . . to creditors . . . , after deducting any unpaid claim allowed under section 503(b).”
The bankruptcy court denied the motions, finding that the burden and inconvenience imposed by the garnishments on the trustee would not permit an exception to the Barton doctrine. The bankruptcy judge also decided that the plain language of Section 1326(a)(2) precluded diverting the funds away from the debtor in garnishment. The bankruptcy judge stayed his order pending appeal.
First pronounced by the Supreme Court in 1881 in Barton v. Barbour, 104 U.S. 126 (1881), the Supreme Court made a “general rule” that receivers could not be sued without permission from the appointing court. Id. at 128. The doctrine was expanded to cover bankruptcy trustees after adoption of the Bankruptcy Act of 1898. Later still, Barton was broadened to protect court-appointed officials and fiduciaries, such as trustees’ and debtors’ counsel, real estate brokers, accountants, and counsel for creditors’ committees.
As Judge Romero said in his opinion, Barton was further extended to cover trustees after dismissal.
Barton Applies to the Garnishments
The BAP agreed with the bankruptcy court that Barton applied, meaning that the creditors could not garnish funds held by the trustee without the bankruptcy court’s permission. As Judge Romero said, however, the holding “speaks only to whether pre-suit leave is required, not whether such leave should or should not be granted.”
Next, Judge Romero analyzed caselaw laying out factors to consider when deciding whether actions should be permitted despite Barton. For the BAP, he ruled that the “mere possibility of inconvenience cannot serve as a blanket protection for trustees from a legal process to which any other person may ordinarily be subjected.”
On de novo review, the BAP agreed that Barton required court approval before initiating garnishment. On the other hand, the panel ruled that the bankruptcy court had “abused its discretion by denying Barton leave based upon unsupported allegations of potential inconvenience to the Trustee without weighing the other important factors bearing upon such a decision.”
Section 1326(a)(2)
Regardless of Barton, the bankruptcy court had also decided that Section 1362(a)(2) barred the proposed garnishment.
As Judge Romero explained, there are two lines of cases interpreting Section 1362(a)(2). The courts taking a “plain meaning” approach conclude generally that a chapter 13 trustee must return everything to the debtor. For example, he cited an unpublished Alabama decision holding that the section preempts state law garnishments.
The other line of cases, Judge Romero said, take “a more practical approach” and view the section in a broader context. Those courts as a general matter would permit a trustee to deduct his or her fee before returning the remainder to the debtor, after payment of outstanding administrative claims.
More on point factually, Judge Romero discussed “debtor-of-a-debtor” cases that “approve of post-dismissal garnishments” by “taking a more nuanced and functional approach to applying the statute.”
In the debtor-of-a-debtor cases, Judge Romero said that the chapter 13 trustee “is effectively no longer operating as a court-appointed fiduciary” following dismissal and “can no longer be thought of as a representative of the estate exercising control over property of the estate.”
After dismissal, Judge Romero decided that “the legal relationship between the debtor and a trustee following dismissal is akin to a traditional bailment.” A bank, he said, “is not excused from complying” with a garnishment. He therefore saw “no reason why a different rule should apply to trustees merely because they were formerly an estate representative and the property used to be in custodia legis through an estate which no longer exists.”
In terms of the purpose of Section 1326(a)(2), Judge Romero saw the trustee as “in fact . . . returning the property to the debtor, not in the form of a cash payment, but in the form of a debt reduction . . . . The transfer may not be to the debtor, but it is nevertheless made for the debtor’s benefit.”
In short, the BAP ruled that Section 1326(a)(2) by itself did not preclude honoring the garnishments. The panel reversed and remanded for the bankruptcy court to conduct further proceedings on the Barton doctrine.
Observations
In the case before the BAP, the fee of the chapter 13 trustee was about $1,500.
In the case on appeal, the trustee was faced with competing garnishments. Who comes first? The court clerks or the former wife?
To ensure no liability in disbursing the funds, the trustee would become ensnared in further litigation in bankruptcy court or state court to decide who should be paid and how much. The $1,500 fee would quickly become a losing proposition if the trustee were involved in deciding whom to pay.
A bright-line rule calling for payment to the debtor would aid the trustee in preventing the case from becoming a loser.
Jurisdiction is also an issue. Surely, the bankruptcy court at least has “related to” jurisdiction to decide which garnishment comes first. Why should the bankruptcy court rather than state court make such decisions after dismissal?
If the trustee were to return the funds to the debtor, the creditors would be justly concerned that the debtor would squirrel the money away before they could locate and attach the debtor’s bank account. Is it the purpose of the bankruptcy court to assist in the collection of judgments when the distribution is not being made under the Bankruptcy Code?
Courts are always inclined to sort out disputes when the parties and the res are before the court. Sometimes, however, the desire to resolve disputes should take second place behind regard for the court’s limited jurisdiction and the purpose of the forum.
Congress intended to give debtors incentives for attempting chapter 13 arrangements. That’s why Section 1326 gives funds back to the debtor on dismissal before confirmation. If the bankruptcy court becomes a collection agent when chapter 13 fails, is the intent of Congress being fulfilled?
Disallowing garnishments would not mean, by analogy, that a chapter 13 trustee cannot be paid if dismissal precedes confirmation. Trustees rely on 28 U.S.C. § 586(e) as statutory authority for being paid after dismissal. Creditors have no similar statutory authority to demand payments from a chapter 13 trustee on dismissal.
The foregoing factors could be considered in deciding whether Barton precludes honoring a garnishment.
If a chapter 13 case has been dismissed before confirmation, the Tenth Circuit Bankruptcy Appellate Panel seems inclined to allow judgment creditors to garnish funds that the trustee would otherwise return to the debtor.
The nonprecedential opinion on April 27 by Bankruptcy Judge Michael E. Romero includes an in-depth survey of the split on Section 1326(a)(2) and questions like the right of a chapter 13 trustee to collect a fee when dismissal occurs before confirmation. The opinion examines decisions going both ways on the right of creditors to garnish funds held by the trustee on dismissal of a chapter 13 case.
$29,000 Held by the Trustee on Dismissal
In the case before the BAP, the debtor had filed three successive chapter 13 petitions. The previous two had been dismissed quickly.
In the third and last case, the debtor filed to prevent state court clerks from collecting some $30,000 in judgments made in sanction for frivolous and vexatious litigation.
Eventually, the bankruptcy court refused to confirm the debtor’s chapter 13 plan. Together with denial of confirmation, the bankruptcy court dismissed the chapter 13 case. On dismissal, the chapter 13 trustee was holding about $29,000, after deducting the trustee’s fees.
The debtor’s former wife and the state court clerks filed motions for authority to garnish the funds being held by the trustee that would otherwise be distributed to the debtor under Section 1326(a)(2). The wife contended that her domestic support obligations were prior to the clerks’ judgments.