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Converting to Chapter 7 bankruptcy from Chpater 13

Some Texas residents may know that the United States Supreme Court ruled in May that funds that were not distributed to creditors while a debtor was in Chapter 13 bankruptcy must be returned to the debtor by the trustee if the bankruptcy is converted to Chapter 7. This ruling clarifies what has become a difference of opinion among bankruptcy courts.

The ruling was based on a Texas case where a man converted his Chapter 13 bankruptcy case to Chapter 7 in 2011. The trustee involved in the Chapter 13 bankruptcy held about $5,500 when the bankruptcy conversion took place. Instead of providing the funds to the debtor, she paid off unsecured debts to creditors with the funds, took a commission of $267.79 and paid another unsecured debt of $397.68. The debtor took the case to court saying that he was owed the funds held by the trustee at the conversion time.

The bankruptcy court agreed and said the money should be returned to the debtor. The case was appealed, and the 5th Circuit overturned the lower court's ruling, holding that the trustee was obligated to pay the funds to the creditors. The Supreme Court has now ruled that the debtor had the right to recover undistributed funds once the conversion from Chapter 13 bankruptcy occurred.

Writing for the unanimous court, Justice Ginsburg said that a Chapter 13 trustee who distributes funds to creditors after the conversion to Chapter 7 occurs is going against the 1994 revisions to bankruptcy law, and that the concern of the 5th Circuit that returning the funds to the debtor represented a "windfall" was misguided.

The differences between Chapter 7 and Chapter 13 are significant, and each has its own eligibility requirements. An attorney who has experience with these matters can explain them to a client who is seeking a way to obtain debt relief.

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