Following the Fifth and Seventh Circuits, Thomas L. Ambro wrote an opinion for the Third Circuit holding that “a retirement plan governed by [the Employee Retirement Income Security Act] that is not tax-qualified is still protected by ERISA’s anti-alienation bar” and does not become estate property.

In his October 24 opinion, Judge Ambro declined to make federal common law in derogation of Section 541(c)(2), which says, “A restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law is enforceable in a case under this title.”

The Governing Statutes

Before delving into the facts of the case, Judge Ambro laid out the governing statutes.

ERISA, he said, establishes the standards of conduct for those who administer retirement plans. In addition, retirement plans are given favorable tax treatment for compliance with rules promulgated under the Internal Revenue Code.

Judge Ambro rephrased Section 541(c)(2) to mean “that bankruptcy respects rules protecting trust assets from a beneficiary’s creditors. If a creditor cannot access the trust outside bankruptcy, the assets remain out of its reach in bankruptcy.” He cited the Supreme Court in Patterson v. Shumate, 504 U.S. 753 (1992), for holding that a trust established under ERISA is “a trust that is enforceable under applicable nonbankruptcy law” that takes trust property outside of the bankruptcy estate.

Violations of ERISA and the IRS Code

In his chapter 7 petition, the debtor disclosed ERISA trusts with $1.6 million in assets and claimed them to be excluded from the bankruptcy estate under Section 541(c)(2). The chapter 7 trustee filed a complaint alleging that operations of the trust violated both ERISA and the IRS Code and thus brought the trust assets into the estate.

Judge Ambro characterized Bankruptcy Judge Kathryn C. Ferguson as having “dismissed [the trustee’s complaint] because ‘a plain meaning reading of § 541(c)(2)’ excluded the Retirement Plans from the bankruptcy estate even if they were operated contrary to ERISA and the IRC.”

The district court affirmed on the same grounds, prompting the trustee’s appeal to the Third Circuit in hopes of creating a circuit split.

The Question on Appeal

The trustee wanted the appeals court to reverse based on Patterson. The trustee read Patterson to mean that a retirement plan is ERISA-qualified only if it is tax-qualified and follows ERISA’s rules.

Judge Ambro conceded there is a split, with two circuit courts on one side and a few bankruptcy courts on the other. He framed the question on appeal as “whether, assuming (as [the trustee] alleges) that the Retirement Plans did not comply with ERISA and the IRC, the former nonetheless provides an ‘enforceable’ bar to alienation of [the debtor’s] interest in the Plans.”

Judge Ambro Refuses to Go Beyond the Statutes

Judge Ambro said that the trustee “provides no statutory support for [his] proposition. And we see none in ERISA’s text.” He agreed with decisions from the Seventh and Fifth Circuits. See In re Baker, 114 F.3d 636, 640 (7th Cir. 1997); and Traina v. Sewell (In re Sewell), 180 F.3d 707, 711 (5th Cir. 1999).

Judge Ambro described the Seventh Circuit opinion by Frank H. Easterbrook as having held that “plans governed by ERISA are excluded from the bankruptcy estate under § 541(c)(2) because of the statute’s anti-alienation command,” and that violations of ERISA did not make ERISA inapplicable, because what matters is the application of ERISA rather than the observation of its rules.

Judge Ambro cited bankruptcy court opinions from Maryland, Michigan and Florida that have held that violations of ERISA or IRS rules would bring trust assets into the bankruptcy estate. The most recent of these contrary opinions was issued in 2000. He said that the three opinions point “to no statute or authority suggesting that ERISA’s anti-alienation bar fails to protect from misbehaving plan administrators.”

Citing Law v. Siegel, 571 U.S. 415 (2014), Judge Ambro said that an appeal to equity must fail, because the Supreme Court held “that equity cannot be used to override bankruptcy’s detailed scheme delineating the property of the bankruptcy estate.”

Judge Ambro affirmed the lower courts, holding that “interests in trusts are not part of the bankruptcy estate if applicable law prohibits their alienation.” There being no language in ERISA or the IRS Code “that disables those protections if a retirement plan violates ERISA’s rules or is not tax-qualified,” he said that Section 541(c)(2) excludes retirement plans from the bankruptcy estate, “even if their operation did not comply with ERISA and the [IRS Code].”