Dazed and Confused: Circuit Splits Regarding Retirement Contributions in Chapter 13 Cases

By Hon. Paul R. Hage and Kelley M. Donnelly

This article examines § 541(b)(7) of the Bankruptcy Code, a provision that has been characterized as “awkward,” a “gordian knot” and “inelegantly drafted.” It is a provision of great importance to chapter 13 debtors and of great consternation to bankruptcy judges tasked with interpreting its meaning.1

Some courts have interpreted § 541(b)(7) to exclude voluntary retirement contributions from “disposable income,” thereby permitting debtors to continue funding their retirement plans throughout the pendency of their chapter 13 case. Other interpretations have led to the opposite result, and others have tried to find a “middle ground” to allow some debtors to continue making some contribution to their retirement plan. As a result of a recent opinion by the Ninth Circuit Court of Appeals,2 we now have a circuit split on the issue.

Background

In exchange for a discharge of their debts, chapter 13 debtors “must agree to [a] court-approved plan under which they pay creditors out of their future income” over a period of three to five years.3 As part of this bargain, only debtors who apply all of their “projected disposable income” to make payments to unsecured creditors during the applicable commitment period are entitled to a discharge of debts upon plan completion.4 Section 1325 calculates a debtor’s disposable income by looking at the debtor’s current monthly income (CMI) and subtracting amounts “reasonably necessary to be expended ... for the maintenance or support of the debtor.”5 “Current income” is defined as “the average monthly income from all sources that the debtor receives ... during the six-month period” before the petition date.6

Section 541 and Its Varying Interpretations

Prior to the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), there was an “overwhelming consensus” among courts that voluntary retirement contributions constituted disposable income.7 Therefore, a debtor could not contribute to a retirement plan during the pendency of his or her chapter 13 case because it would mean that he or she was not contributing all disposable income to the plan for payment to creditors. Saving for one’s retirement would need to wait until after the completion of the chapter 13 plan.

BAPCPA brought about two relevant changes to the Bankruptcy Code. First, § 1322(f) provides that any amounts required to repay a loan from a retirement account shall not constitute “disposable income” under § 1325.8 Second, § 541(b)(7) provides that property of the estate does not include “any amount ... withheld by an employer from the wages of employees for payment as contributions to [a 401(k) retirement plan] ... except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).”9 (The italicized clause is frequently referred to as the “hanging paragraph.”) This provision has led to disagreements among courts nationwide as they attempt to grapple with the question of whether proposed voluntary retirement contributions are considered disposable income such that they must be paid to creditors.10

The majority view — commonly referred to as the “Johnson approach” — reads the hanging paragraph to “place ... retirement contributions outside the purview of a Chapter 13 plan.”11 Courts adopting this approach have held that the plain language of the hanging paragraph allows a chapter 13 debtor to make voluntary post-petition contributions to a retirement plan regardless of whether the debtor was making such contributions at the time of filing, subject only to the good-faith requirement imposed on all chapter 13 plans in § 1325(a)(3).

On the opposite end of the spectrum is the decision reached in In re Prigge.12 The Prigge approach effectively precluded post-petition contributions to a retirement plan during the applicable commitment period. Courts adopting this approach generally conclude that § 541(b)(7) deals only with contributions made to a retirement plan prior to the petition date. Therefore, proposed post-petition contributions are not excluded from the definition of “disposable income,” and such amounts must be paid to creditors. Some of the courts adopting this approach have posited that the hanging paragraph’s purpose is simply to clarify that post-petition dividends, capital gains and withdrawals from the pre-petition retirement accounts referenced in § 541(b)(7) are not “disposable income” for purposes of § 1325(b)(2).13

A middle ground between the Prigge and Johnson approaches was articulated by the Bankruptcy Appellate Panel of the Sixth Circuit in In re Seafort.14 This approach, aptly named the Seafort BAP approach, “construes the hanging paragraph to exclude the debtor’s pre-petition contribution amount — rather than merely her accumulated savings — from her disposable income.”15 Therefore, if the debtor was making contributions at the time of filing the chapter 13 petition, the debtor may continue to make contributions in that same amount post-petition, but not more.

Similarly, a fourth approach, referred to as the CMI approach, permits a debtor to exclude the six-month average of voluntary retirement contributions made prior to the petition date from the calculation of disposable income, reasoning that looking to the six months before the petition date makes sense because the calculation of projected disposable income focuses on that same period.16 In cases where consistent retirement contributions were made by a debtor in the six months prior to the bankruptcy filing, the outcome of the Seafort BAP and CMI approaches will be the same.

The Sixth Circuit Cases

The first appellate court to tackle this issue was the Sixth Circuit Court of Appeals, which weighed in on the meaning of the “hanging paragraph” in a trio of opinions. First, in In re Seafort,17 the debtors were both participants in their respective employers’ 401(k) retirement plans pre-petition. The debtors were not making contributions to their plans at that time. However, each was repaying a 401(k) loan.

The debtors proposed to repay their 401(k) loans in full before completion of their chapter 13 plans. Upon completion of such payments, the debtors proposed to continue making the same payments to their 401(k) plans as voluntary contributions. The chapter 13 trustee objected, asserting that because the debtors were not making 401(k) contributions as of the commencement of their bankruptcy cases, the debtors could not make the voluntary contributions post-confirmation and, instead, such funds needed to be contributed to creditors.

The Sixth Circuit held that income made available once a debtors’ 401(k) loan payments were repaid was disposable income that needed to be distributed to creditors and could not be used to make voluntary retirement contributions.18 The court found relevant the fact that Congress expressly excluded 401(k) loan repayments from disposable income within chapter 13 itself (in § 1322(f)), whereas the hanging paragraph was added on to the end of § 541(b)(7).

The court stated, “The easy inference is that Congress did not intend to treat voluntary 401(k) contributions like 401(k) loan repayments, because it did not similarly exclude them from ‘disposable income’ within Chapter 13 itself.”19 The court was also persuaded by the fact that voluntary retirement contributions are expressly not considered “reasonable and necessary expenses” in the means test used for determining eligibility for chapter 7 relief, which test is expressly incorporated into the disposable income calculation by § 1325(b)(2).20 The Sixth Circuit expressly rejected the Johnson approach and adopted the Prigge approach:

Ultimately then, we find that the Prigge/McCullers interpretation is the most persuasive because it gives effect to every word in the statute. Although “awkward” perhaps, we conclude, based on the language and structure of Chapter 13, incorporating § 541, that Congress intended to exclude from disposable income and projected disposable income available for unsecured creditors only voluntary retirement contributions already in existence at the time the petition is filed.21

Eight years later, in In re Davis,22 the Sixth Circuit reversed course and rejected the Prigge approach in favor of a middle-ground approach akin to the Seafort-BAP and CMI approaches. Since long before her bankruptcy filing, the debtor in Davis had made voluntary contributions of $220 per month to her 401(k) retirement plan. The debtor proposed to continue making such payments post-petition, excluding such amounts from the calculation of her disposable income. The chapter 13 trustee objected to confirmation of her plan, relying largely on Seafort.

When the case eventually reached the Sixth Circuit, the court held that a debtor may exclude from her disposable income the monthly 401(k) contribution amount that she withheld from her wages prior to her bankruptcy filing.23 The court looked to the canons of statutory construction to give proper meaning to the “hanging paragraph.” Relying on the canon that provides that whenever Congress amends a statutory provision, a significant change in language is presumed to entail a change in the law, the court reasoned that the hanging paragraph should be interpreted in a manner that modifies the pre-BAPCPA practice.

As noted, pre-BAPCPA, courts overwhelmingly agreed that post-petition retirement contributions constituted part of a debtor’s disposable income.24 Moreover, noting that “Congress does not enact useless laws,” the court found that the statute should be interpreted in a manner that gives effect to every word used.25 Based on the foregoing, the court concluded that the hanging paragraph “is best read to exclude from disposable income a debtor’s post-petition monthly 401(k) contributions so long as those contributions were regularly withheld form the debtor’s wages prior to her bankruptcy.”26 Thus, notwithstanding the court’s prior endorsement of the Prigge approach in In re Seafort, the Sixth Circuit rejected that approach. The court expressly declined to choose between the Seafort-BAP and CMI approaches because “either would produce the same result” given the facts in that case.27

Finally, the Sixth Circuit in In re Penfound28 applied the rules that it had articulated in In re Davis and held that where a chapter 13 debtor had historically contributed to a retirement plan but was unable to do so in the six months leading up to the bankruptcy filing, the debtor could not shield voluntary post-petition contributions from unsecured creditors by excluding that recurring amount from the calculation of projected disposable income. In doing so, the court once again rejected the Johnson approach, reasoning that such an approach was contrary to its precedent nine years earlier and, in any event, was not persuasive.29

In re Saldana

The Ninth Circuit Court of Appeals most recently examined this issue in In re Saldana,30 which adopted the Johnson approach. It held that a debtor’s voluntary contributions to her retirement plan were not considered disposable income due to the hanging paragraph. Thus, the debtor could confirm her plan, which contemplated that she would fund her retirement post-petition to the detriment of her creditors.

Beginning with the canons of statutory construction, the court determined that the text of § 541(b)(7) was “plain enough” and “excludes voluntary contributions from a debtor’s disposable income in a Chapter 13 case.”31 The court explained that

Congress declared [in § 541(b)(7)] that the referenced funds “shall not constitute disposable income as defined in section 1325(b)(2).” The reference is to the type of contributions referred to in the preceding subsection. That is, “any amount” “withheld by an employer from the wages of employees for payment as contributions” or “received by an employer from employees for payment as contributions” to specified retirement plans. Thus, pursuant to the plain language of the hanging paragraph, debtors can exclude any amount of their voluntary retirement contributions to employer-managed plans from their disposable income calculation under Chapter 13.32

The court reasoned that when Congress revises a statute, “we presume [that] it intends its amendment to have real and substantial effect.”33 Given the “overwhelming consensus” pre-BAPCPA that voluntary retirement contributions were considered disposable income and the subsequent amendments to § 541(b)(7), the court “presume[d that] Congress intended to alter that consensus.”34 The court concluded that its interpretation was also “consistent with Congress’s intent [with BAPCPA] to encourage individual debtors to reorganize under Chapter 13 and make consistent payments to creditors, rather than file a Chapter 7 liquidation.”35

In a lengthy dissent, Hon. Consuelo Callahan found uncompelling the majority’s conclusion that the hanging paragraph was unambiguous. The dissent cited favorably to the analysis set forth in In re Parks,36 a case that followed Prigge’s lead, holding that voluntary retirement contributions, whether pre- or post-filing, constituted disposable income. The dissent observed that if Congress had intended that amounts to fund a chapter 13 debtor’s retirement be excluded from the disposable-income calculation, it would have categorically said that in § 1322, just as it did with loan repayments to a retirement plan in § 1322(f).37

Conclusion

A significant amount of ink has been spilled by courts in dozens of opinions attempting to interpret the hanging paragraph. As discussed herein, four different approaches have emerged from those opinions. Thanks to the Ninth Circuit’s recent opinion in In re Saldana, a circuit split now exists.

Perhaps a petition for certiorari to the U.S. Supreme Court will follow. Guidance from the Supreme Court would greatly benefit both litigants and the courts, who have now struggled with this issue for more than 20 years. Until the highest court weighs in, or Congress decides to untangle the “gordian knot” of § 541(b)(7), bankruptcy courts will be left on their own to decipher the statutory text.

Hon. Paul Hage is a U.S. Bankruptcy Judge for the Eastern District of Michigan in Detroit. He also is a 2017 ABI “40 Under 40” honoree and serves as Secretary on ABI’s Board of Directors. Kelley Donnelly is a career law clerk for the court.