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Supreme Court rules on bankruptcy conversion issue

A recent Supreme Court decision may be of interest to Virginia residents who are considering filing for bankruptcy as a form of debt relief. In a unanimous decision on May 18, the U.S. Supreme Court ruled that debtors who convert to Chapter 7 should be entitled to keep any funds that have not yet been distributed by the Chapter 13 trustee, absent a showing of bad faith.

The case involved a man who had converted to Chapter 7 bankruptcy at the end of 2011. At the time of the conversion, the trustee in the case still had over $5,500 of the man's Chapter 13 payments that had not yet been distributed to creditors. Rather than return the money to the debtor, the Chapter 13 trustee chose to distribute the funds to several creditors and retain a portion as her fee.

A Texas bankruptcy judge originally ruled that the man was entitled to keep the funds held by the trustee, but the U.S. Court of Appeals for the 5th Circuit disagreed, holding that the trustee's actions had been correct. The Supreme Court has now settled the issue by ruling that retaining undistributed funds after a switch to Chapter 7 should only be done as a penalty for a bad-faith conversion. A person who converts to a Chapter 7 case in good faith should not be penalized because the trustee failed to make regular disbursements to creditors during the Chapter 13 case, according to the decision.

Many people begin their Chapter 13 bankruptcy process with the intention of completing it successfully. However, the monthly payments may become unaffordable for some debtors due to changes in their income or other circumstances. A bankruptcy lawyer may be able to determine if the case is eligible to be converted to Chapter 7.

Source: Courthouse News Service, "Bankruptcy Leftovers Go to Debtor, SCOTUS Says," William Dotinga, May 18, 2015

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