Laying the groundwork for the Supreme Court to grant certiorari and resolve a circuit split, the Ninth Circuit ruled that voluntary contributions to a retirement plan are not counted as disposable income in chapter 13.

Over a dissent, the majority in the circuit’s November 22 opinion will permit chapter 13 debtors to make retirement contributions up to the limit in the IRS Code, regardless of whether the debtor had been making contributions before bankruptcy.

In other words, debtors in the Ninth Circuit may provide for retirement while they’re in chapter 13, rather than diverting retirement contributions to creditors.

The Debtor’s Budget for Retirement Contributions

The debtor in chapter 13 had no dependents and was earning $102,000 a year as an above median income debtor. She had $8,500 in unpaid taxes and $56,000 in unsecured debt. Originally in her means test, the debtor listed monthly deductions of $484 for contributions to her retirement account and $263 toward repayment of loans from the retirement account. With negative disposable income, the original plan would have had nothing for unsecured creditors.

The chapter 13 trustee objected to the plan. The bankruptcy court sustained the objection, following Parks v. Drummond (In re Parks), 475 B.R. 703 (B.A.P. 9th Cir. 2012), where the Ninth Circuit Bankruptcy Appellate Panel held that voluntary contributions to retirement plans are disposable income in chapter 13 that go to creditors.

The debtor amended her plan to spend only $281 a month toward amortizing retirement plan loans. The amended plan had a 30% recovery for unsecured creditors.

The bankruptcy court confirmed the amended plan, and the debtor appealed. When the district court affirmed, the debtor appealed to the circuit. The National Consumer Bankruptcy Rights Center and the National Association of Consumer Bankruptcy Attorneys submitted an amicus brief on behalf of the debtor.

The Advent of the ‘Hanging Paragraph’

After adoption of the Bankruptcy Code in 1978, Circuit Judge Sidney R. Thomas said in his opinion for the majority that Section 541 “excluded contributions to employer-managed retirement plans from the definition of ‘property of the estate.’” However, he went on to say that “courts routinely held that voluntary retirement contributions [after filing] were disposable income for the purposes of Chapter 13” and were therefore directed to creditors.

Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act in 2005 and, as Judge Thomas said, included “incentives” to file in chapter 13. The BAPCPA amendments include the so-called hanging paragraph in Section 541(b)(7). The subsection excludes employee benefit and deferred benefit plans from the estate, thus excluding 401(k)s from the estate that the debtor owns on filing. But does it also shield salary that the debtor will receive after filing but intends to contribute to a 401(k)?

The hanging paragraph may have been intended to clarify the meaning as to contributions after filing, but lousy drafting made matters worse, especially the inexplicable use of the words “except that.” The hanging paragraph at the end of Section 541(b)(7) reads:

except that such amount under this subparagraph shall not constitute disposable income, as defined in section 1325(b)(2).

As Judge Thomas said, the hanging paragraph has been the “subject of varied bankruptcy court interpretations.”

Why Contributions Go to Retirement Plans, Not to Creditors

Judge Thomas wasted no time in stating the holding. He said that the words in the hanging paragraph “are plain enough. . . . [T] he statutory text unambiguously excludes voluntary contributions from a debtor’s disposable income in a Chapter 13 case.” From the “plain language” of the hanging paragraph, he went on to expand the holding by saying that “debtors can exclude any amount of their voluntary retirement contributions to employer-managed plans from their disposable income calculation under Chapter 13.”

Judge Thomas said he was not alone. “[M]ost of the bankruptcy courts that have considered this issue have also concluded that voluntary retirement contributions do not constitute disposable income.” For him, the “most prominent case” on his side is Baxter v. Johnson (In re Johnson), 346 B.R. 256, 263 (Bankr. S.D. Ga. 2006).

Opposed to his conclusion and Johnson’s, Judge Thomas identified three other interpretations of the hanging paragraph: (1) In the BAP’s Parks decision, voluntary contributions are disposable income; (2) as exemplified by the Sixth Circuit in Davis v. Helbling (In re Davis), 960 F.3d 346 (6th Cir. 2020), voluntary contributions are excluded from disposable income, but only to the extent the debtor was making contributions before bankruptcy; and (3) as found in In re Anh-Thu Thi Vu, 15-41405, 2015 WL 6684227, at *3–4 (Bankr. W.D. Wash. June 16, 2015), the six month average contributions before bankruptcy are excluded from disposable income. Judge Thomas did “not find these constructions consistent with the statute.” To read ABI’s report on Davis, click here.

Judge Thomas said that Parks “does not give the hanging paragraph any meaning.” [Emphasis in original.] Without the hanging paragraph, the remainder of the subsection already excludes prior contributions from the estate. As for the Davis approach, he said there “is no foundation in the Code to limit a debtor’s disposable income to the debtor’s prepetition contribution amount.” Similarly, he said that Anh-Thu Thi Vu “lacks textual support in the Bankruptcy Code [and] conflates the concepts of ‘current income’ and ‘disposable income.’”

When there is abuse, the bankruptcy court has tools, Judge Thomas said. In an abusive case, the court could deny confirmation of a plan filed in bad faith.

Judge Thomas reversed and remanded, saying “that voluntary contributions to employer-managed retirement plans do not constitute disposable income in a Chapter 13 bankruptcy.”

The Dissent

Circuit Judge Consuelo M. Callahan dissented. She saw the majority’s decision as being “contrary to the general purpose of the underlying statute.” She saw BAPCPA as meaning that “any income a debtor with above average income does not need to survive during those three to five years should be allocated as disposable income.”

Judge Callahan identified four different interpretations of the hanging paragraph, which, she said, is “truly ambiguous.” To support her conclusion, Judge Callahan quoted five pages from the BAP opinion in Parks and five pages from Davis.

Judge Callahan dissented “from the majority’s conclusion that voluntary contributions to employer-managed retirement plans do not constitute disposable income in a Chapter 13 bankruptcy.” For her part, she would have adopted a “workable solution” by allowing a deduction for “the debtor’s contributions for six months prior to bankruptcy.”

Judge Callahan said that her approach “does the least amount of harm until such time as Congress decides to clarify the statute or change the law.”

Observation

Former Bankruptcy Judge Keith Lundin, the author of a leading treatise on chapter 13, told ABI:

The Ninth Circuit majority asked (and answered) the hard question: Given that prepetition retirement contributions already “withheld” or already “received” by an employer are not property of the bankruptcy estate and would never be projected disposable income, what purpose remains for the precise language of the hanging phrase at the end of section 541(b)(7)(A)(i) and (B)(i) except to remove postpetition retirement contributions from the projected disposable income test calculation?

Some courts have required monitoring the debtor, so money earmarked for retirement plans will be redirected to creditors if the debtor stops making contributions.

The divided panel in the Ninth Circuit creates a stark split of circuits. We will report if the Court grants a petition for certiorari.