For some people, bankruptcy is an unforgiving process. There are strict rules about what can and cannot be included in a petition, and there are strict written and unwritten rules about what you do after you have filed. It seems unfair, for example, that the government can take your tax return after you have filed (under certain circumstances; see our April 6, 2015, post for details).

For the debtor in the case we have been discussing, it seemed unfair that that the bankruptcy trustee would not reimburse money the man had paid toward his Chapter 13 repayment plan after he had converted his bankruptcy to a Chapter 7 liquidation. In his case, and now all similar cases going forward, the law was actually on his side.

The U.S. Supreme Court ruled that the money was his. And, the court reinforced the basic tenet of bankruptcy, that it offers debtors a fresh start.

The trustee maintained that it was her responsibility to “wind up” the Chapter 13 bankruptcy by distributing the funds to the creditors. The court disagreed, pointing out that, in a conversion, the rules require a Chapter 13 trustee to turn the file and assets to the new Chapter 7 trustee and file a report with the U.S. bankruptcy trustee. That’s it.

The trustee had objected to the idea of reimbursing the debtor because the refund would be a windfall, a reward of sorts for a man who could not pay his creditors. The court disagreed here as well. First, the refund represents a very small portion of his wages, and, moreover, the money would have been his if he had skipped Chapter 13 and filed for Chapter 7 right away. Finally, the court said, the only reason there was so much money in the account was that the trustee had not disbursed the funds to the creditors for months.

The court also made a procedural recommendation for Chapter 13 trustees and creditors. This situation would have been avoided, again, if the trustee had paid out the money in a timely fashion. Moving forward, creditors and Chapter 13 trustees should add a provision in the repayment plan that requires the trustee to make regular payments to the creditors.

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