May It Please the Court If I Had Been at Oral Argument in Rousey v. Jacoway Part II

Journal Issue

Mar 2005

Column Name

Feature

Bankruptcy Code

522

Topic Tags

Consumer Bankruptcy

Bankruptcy Taxation

Labor/Employment

Journal HTML Content

Last month, we looked at the history of
Rousey v. Jacoway and began to consider the arguments of the
debtors, the trustee and the amicus in light of the Third Circuit's
decision in Clark v. O'Neill (In re Clark), 711 F.2d 21
(3d Cir. 1983).<a href="#1" name="1a">1</a>

The trustee did not press the question suggested by Clark that
Bankruptcy Code §522(d)(10)(E) exempts only a "right to payment"
and not the underlying source of the payments, such as individual
retirement accounts (IRAs). The text of the statute strongly suggests
this possibility.<a href="#2" name="2a">2</a>
But if this section exempts only a right to payment, then debtors must
turn to other exemptions (or exclusions) to protect the corpus of their
retirement funds. Because the Court did not address this issue, I
interject at occasional points into the oral argument to suggest why the
Court should consider this possibility.

<h4>Oral Argument<a href="#3" name="3a">3</a></h4>

Justice O'Connor: Aren't most of the pension
profit-sharing, stock bonus plans, and annuities similar to the IRAs in
terms of allowing withdrawal on the payment of a penalty? So the effect
of this rule of the Eighth Circuit is that they would all fail to
qualify under the bankruptcy, isn't it?

Prof. Pryor: Not exactly, Justice O'Connor. Part 2 of Title I
of ERISA (which prohibits alienation of pension plan benefits)
specifically excludes IRAs. ERISA §201(6). Since IRAs enjoy their
tax-advantaged status by virtue of IRC §408, the anti-alienation
requirements of IRC §401(a)(13) do not apply to them. Thus, nothing
in the Internal Revenue Code prohibits voluntary or involuntary
withdrawals from IRAs at any time. Pension plans come in two basic
types: defined-benefit plans and defined-contribution (also known as
individual account) plans. ERISA §§3(34) and (35).
Defined-benefit plans are the traditional sort of pension plans, but
defined-contribution plans (frequently profit-sharing plans) have become
more common, especially since the revision of the IRC in 1986.

Participants may make withdrawals from traditional
defined-benefit retirement plans only by terminating employment
through retirement, separation from service, disability or other very
limited situations. IRC §§411-(a) and (b)(1)-(2). Participants
may make withdrawals from defined-contribution plans for the same
sorts of reasons, plus, if the plans so provide, hardship (and even then
only of their elective contributions). IRC §401(k)(2)(B). Safe
harbors for "hardship" distributions are found at Treas. Reg.
1.401(k)-1(d)(3).<a href="#4" name="4a">4</a>
Disregard of these limitations could disqualify the plan. IRC
§§401(a) and (k)(1).

Loans from defined-benefit plans are not generally allowed. Loans
from defined-contribution plans that permit them will be treated as
taxable distributions to the participant under IRC §72(p)(1) unless
they meet all of the criteria for exception under IRC
§72(p)(2).<a href="#5" name="5a">5</a>

Justice Breyer: The statute uses the word "payment." So
suppose you simply have an IRA plan but you don't take money out of it.
Then is it exempt from bankruptcy?

Prof. Pryor: Many state statutes exempt IRAs.<a href="#6" name="6a">6</a> However, if Code
§522(d)(10)(E) is construed to exempt only a "right to payment,"
then nothing under federal bankruptcy law would exempt an underlying IRA
from the bankruptcy estate.<a href="#7" name="7a">7</a>

Justice Breyer: It sounds as if a person were to withdraw
from an IRA before he's 59 and pay the 10 percent income tax penalty
under §72(t), then the amount that he took out would not be a
payment "on account of" age, but one that he took out after he's 59 and
didn't pay what the penalty would be.

Prof. Pryor: The trustee, debtors and amicus focused
their attention on the construction of two internal phrases in
§522(d)(10)(E): whether IRAs were "similar" to the four enumerated
plans and whether withdrawals from IRAs were necessarily "on account of"
one of the five permitted purposes. Because their briefs considered
these two issues in depth, I prefer to focus my remarks on the unasked
question: Are IRAs included within preliminary "right to payment"
language?

Justice Stevens: It seems to me the easiest black-letter
rule is no penalty tax or some penalty tax. I mean, if withdrawals from
IRAs were totally free, like withdrawals from an ordinary bank account,
then the trustee would be dead right. But the fact that Congress put in
a 10 percent income tax penalty for most withdrawals from IRAs before 59
seems to put it into the category of things that you're not supposed to
have an absolute right to get.

Prof. Pryor: The Eighth Circuit held that payments from the
IRAs were not "on account of illness, disability, death, age or length
of service" because the Rouseys had "unfettered discretion to withdraw
from the corpus at any time subject only to modest early withdrawal tax
penalties." Rousey v. Jacoway (In re Rousey), 347 F.3d
689, 693 (8th Cir. 2003) (internal quotation marks omitted). As I
mentioned above, the parties have sufficiently briefed this issue, so
I'll pass on it. I am concerned, however, that the Court consider
whether only a right to payment from an IRA, as distinct from an IRA
itself, is exempt.

Justice Souter: If, as the trustee asserts, the criterion
of exemptibility should be the total freedom of withdrawal for any
purpose, then why don't we face the daunting question of predicting the
future? Because the question then is going to be, "well, what purposes
are sufficiently close to old age to allow for a continued exemption,
and how free may the purposes be before a plan falls into the IRA
category?" The kind of the paradigm example plans vary enormously
depending on the terms in which employers set them up. So if we say that
the dividing line is going to be between plans under which withdrawal
can be for any purpose versus plans in which withdrawal is going to be
somehow limited, then we're going to have to litigate an awful lot of
plans, aren't we?

Prof. Pryor: The prospect of such daunting predictions of the
future are a good reason to believe that Congress never intended
§522(d)(10)(E) to be used to exempt the corpus of retirement
savings. What would be necessary for a debtor's future support
depends on variables such as the current age and health of the debtor,
other sources of retirement income, the age of the debtor at retirement,
the prospects of the debtor's future health and the ability of the
debtor to make future contributions to retirement accounts. Such a
"muddle" would require the testimony of experts according to Delaney
v. Obuchowski (In re Delaney), 268 B.R. 57, 62 (D. Vt. 2001).

Justice O'Connor: Isn't it simpler to just recognize that
these plans are covered despite the right to withdraw and then rely on
the provision in the statute that only permits the deduction to the
extent reasonably necessary for the support? I mean, that seems to me a
fall-back position that's provided for in the statute.

Prof. Pryor: It's a "fall-back position," but only to the
extent that the bankruptcy court is measuring the exemptibility of a
right to payment. Congress placed no limit on the exemption of
the amount of a debtor's right to payment from a large number of sources
such as social security, unemployment compensation, public assistance,
veterans' benefits and disability benefits. Code
§522(d)(10)(A)-(C). On the other hand, Congress imposed on alimony
and support payments (§522(d)(10)(D)) and on wrongful death and
life insurance benefits (§522(d)(11)(B) and (C)) the same "extent
reasonably necessary for support" standard as it did for the payments
exempted under §522(d)(10)(E). Congress's rationale for "necessary
for support" cap on certain payments would appear to be the assumption
that the unlimited rights to payment are not the sort likely ever to be
excessive and thus the bankruptcy court doesn't need to take the time to
evaluate them: "Congress simply assumed that the [amount of a public]
benefit would be necessary." In re Dale, 252 B.R. 430, 436
(Bankr. W.D. Mich. 2000), aff'd., Dale v. Puerner (In re
Dale), 264 B.R. 875 (W.D. Mich. 2001), rev'd. per curiam, 43
Fed. Appx. 911 (6th Cir. 2002).<a href="#8" name="8a">8</a> Other streams of payment, however, could
be much more than necessary for the debtor's support and therefore come
in for judicial scrutiny.

Justice Breyer: I'm reading the statute. If I were voting
on it and saw the reference to IRC §408 in §522(d)(10)(E)(iii)
and realized that it refers to an "individual retirement account," I
would have thought that they'd be included. Now, is there any indication
that when Congress passed this they didn't think IRAs would be? Any
reference in the terrible words "legislative history" that might shed
light on it?

Prof. Pryor: The House Report notes that the purpose of
§522(d)(10) as a whole was to "exempt certain benefits that are
akin to future earnings of the debtor." H.R. Rep. No. 95-595,
reprinted in 1978 U.S.C.C.A.N. 5963, 6318.<a href="#9" name="9a">9</a> Section 541(a)(6) had broadened
the definition of "property of the estate" to include five aspects of
future income in the debtor's bankruptcy estate: proceeds, product,
offspring, rents and profits. Specifically excluded from the expanded
scope of §541(a), however, were "earnings from services performed
by an individual" after commencement of the case. While the benefits
exempted by §522(d)(10) are not literally "earnings from services,"
they are substitutes for such earnings for the benefit of those
who cannot work due to unemployment, disability or the like. The
exempted benefits are rights to payments that, while not excluded from
the definition of property of the estate like earnings, nonetheless
provide the recipient with the functional equivalent of earnings. The
fact that Congress chose to exempt these rights to payment means that
otherwise they would have been property of the estate.<a href="#10" name="10a">10</a> As Bankruptcy Judge Hughes
put it, "Congress intended §522(d)(10) to ensure that deserving
debtors who are receiving non-wage benefits...receive the same treatment
as debtors who are employed." Dale, 252 B.R. at 436. After all,
contributions to pension plans are commonly understood as deferred
compensation from the period prior to the bankruptcy that are part of
the bankruptcy estate.<a href="#11" name="11a">11</a> See, e.g., In re Edmonds, 273
B.R. 527 (Bankr. E.D. Mich. 2000) (holding that debtor's contingent
interest in year-end profit-sharing payment attributable to pre-petition
earnings was property of the estate). Pre-petition earnings are clearly
property of the estate, so we can see why Congress's description of
these rights to payment as "akin to future earnings" is
consistent with treating the stream of payments—but not the
underlying corpus—as exempt.

Another important element of the legislative history suggests that
Congress did not intend to exempt retirement assets under
§522(d)(10)(E). Congress drew much of the exemption language of
§522(d) from the Uniform Exemptions Act of 1976. H.R. Rep. No.
95-595, reprinted in 1978 U.S.C. C.A.N. 5963, 6317. Section 6 of
the Act provided that:

<blockquote>
(a) An individual is entitled to exemption of the following
property to the extent reasonably necessary for the support of
him and his dependents:
<blockquote>
(5) assets held, payments made, and amounts payable under a stock
bonus, pension, profit-sharing, annuity, or similar plan or contract,
providing benefits by reason of age, illness, disability or length of
service (emphasis added).
</blockquote>
</blockquote>

Congress's change of "property" to the narrower "right to payment,"
and its omission of the words "assets held," strongly suggest
§522(d)(10)(E) should not extend to underlying retirement assets.
See, generally, In re Kochell, 732 F.2d 564 (7th Cir. 1984).

More importantly, Your Honor, is understanding why
§522(d)(10)(E)(iii) refers to IRAs. This subsection serves only to
exclude certain rights to payment that would otherwise be exempt. An
account denominated as an "IRA" may not qualify under IRC §408. For
example, anyone could open more than one account with a bank or
brokerage firm as an IRA, even though he or she had already contributed
the maximum deductible amount to another account.<a href="#12" name="12a">12</a> Congress intended that not
even the stream of payments from such an account should be exempt.

Justice Ginsburg: You don't dispute...that only a small
percentage of people who have IRAs in fact exercise the right to
withdraw, given the penalty?

Prof. Pryor: I cannot express an opinion on this question. The
bankruptcy court in American Honda Fin. Corp. v. Cilek (In re
Cilek), 115 B.R. 974, 988 n.15 (Bankr. W.D. Wis. 1990), found that
1.2 percent of IRAs were withdrawn subject to the 10 percent penalty for
early withdrawal in 1987 and 1.27 percent in 1988. The court's
"finding," however, was based on a telephone call to the national
association of credit unions. Such a fact is well outside the scope of
judicial notice. FRE 201.

Justice Ginsburg: Does your argument draw a ring around
IRAs? It was suggested that if your argument prevails, then these other
plans would be affected as well.

Prof. Pryor: That's correct; only a variety of rights to
payment are protected by §522(d)(10), not the corpus of retirement
funds. Congress has protected certain forms of retirement savings by
excluding them from the bankruptcy estate. Code §541(c)(2). See
Patterson v. Shumate, 504 U.S. 753 (1992). Justice Blackmun's
opinion in Patterson at one point suggests that a debtor's
interest in "these plans" (including government and church plans, for
which ERISA does not mandate an anti-alienation provision, as well as
IRAs, which are not covered by ERISA) "could be exempted under
§522(d)(10)(E)." Patterson, 504 U.S. at 763. But he
immediately hastened to add that "[w]e express no opinion on the
separate question whether §522(d)(10)(E) applies only to
distributions from a pension plan that a debtor has an immediate
and present right to receive, or to the entire undistributed corpus of a
pension trust." Id. at n.5 (emphasis added). The Patterson

opinion thus left open the question currently before the
Court.<a href="#13" name="13a">13</a>

One might question why the Code leads to such disparate results
without concluding that Congress could not have intended such an
outcome. Beginning long before and continuing for several years after
enactment of ERISA in 1974, most pension participants were covered by
defined-benefit pension plans. Highly mobile workers were not fond of
defined-benefit plans, and since 1987 defined-contribution plans have
flourished at the expense of their more traditional
cousin.<a href="#14" name="14a">14</a> But in
1978, when Congress was drafting the Code, IRAs had existed for only
five years, and they certainly had not become the all-purpose
repositories for roll-overs from defined-contribution plans. It seems
certain that Congress simply did not anticipate that vast amounts of
Americans' retirement savings would be held in a form that was not
excluded from bankruptcy estates under §541(c)(2). This unfortunate
lack of foresight explains why Congress fully protected the
then-familiar form of retirement savings and left the now-ubiquitous IRA
subject to the limited "right to payment" exemption of
§522(d)(10)(E). And one can certainly hope that Congress will act
in the near future to bring the protection afforded ERISA-qualified
plans and IRAs into conformity with each other.

<hr>
<h3>Footnotes</h3>

<a name="1">1</a> See Pryor, C.
Scott, "May It Please the Court: Some Answers to Questions Not Raised in

Rousey v. Jacoway (Part 1),: ABI Journal, February 2005 at
40. <a href="#1a">Return to article</a>

<a name="2">2</a> Bankruptcy Code
§522(d) reads as follows:

<blockquote>
(d) The following property may be exempted under subsection (b)(1) of
this section...

<blockquote>
(10) The debtor's right to receive—

<blockquote>
(A) a social security benefit, unemployment compensation or a local
public assistance benefit; 
(B) a veterans' benefit; 
(C) a disability, illness or unemployment benefit; 
(D) alimony, support or separate maintenance, to the extent reasonably
necessary for the support of the debtor and any dependent of the
debtor; 
(E) a payment under a stock bonus, pension, profitsharing, annuity or
similar plan or contract on account of illness, disability, death, age
or length of service, to the extent reasonably necessary for the support
of the debtor and any dependent of the debtor, unless—

<blockquote>
(i) such plan or contract was established by or under the auspices of an
insider that employed the debtor at the time the debtor's rights under
such plan or contract arose; 
(ii) such payment is on account of age or length of service;
and

(iii) such plan or contract does not qualify under §401(a), 403(a),
403(b) or 408 of the IRC of 1986 (emphasis added). <a href="#2a">Return
to article</a>
</blockquote>
</blockquote>
</blockquote>
</blockquote>

<a name="3">3</a> I will not "answer" all
of the questions put to counsel at the oral argument. I have also taken
the liberty of editing and reordering some of the Justices' questions in
the interests of clarity. <a href="#3a">Return to article</a>

<a name="4">4</a> Treas. Reg.
§1.401(k)-1(d)(3)(i):

<blockquote>
(3) Rules applicable to hardship distributions—(i)
Distribution must be on account of hardship. A distribution...is
made on account of hardship only if the distribution both is made on
account of an immediate and heavy financial need of the employee and is
necessary to satisfy the financial need...[and] must be made in
accordance with nondiscriminatory and objective standards set forth in
the plans.
</blockquote>

"Immediate and heavy financial needs" include certain medical expenses,
the down payment on the purchase of a home and certain educational
expenses. See, generally, Treas. Reg.
§§1.401(k)-1(d)(3)(iii)-(iv). <a href="#4a">Return to
article</a>

<a name="5">5</a> See, generally,

Treas. Reg. 1.72(p)-1 for more details. <a href="#5a">Return to
article</a>

<a name="6">6</a> See Pryor, C.
Scott, "Rock, Scissors, Paper: ERISA, The Bankruptcy Code and State
Exemption Laws for Individual Retirement Accounts," 77 American
Bankruptcy Law Review 65, 123-27 (2003) (listing state statutory
exemptions for IRAs). <a href="#6a">Return to article</a>

<a name="7">7</a> See 4 Collier
on Bankruptcy ¶522.09[11] (2004) ("If the debtor's interest in
the pension plan is included in the estate, the exemptions set out in
§522(d)(10) are limited to the debtor's 'right to receive payment'
under the plan"). <a href="#7a">Return to article</a>

<a name="8">8</a> The Sixth Circuit
Bankruptcy Appellate Panel considering this appeal reversed on the basis
of the decision in In re Brucher, 243 F.3d 242 (6th Cir. 2001),
even though the Brucher court had not considered the argument
raised in Dale. See, also, Sheehan v. Morehead (In re Morehead),
283 F.3d 199, 206 (4th Cir. 2002) (construing identical state statute
and concluding that the legislature "believed that the fully exempt
benefits (for example, social security, unemployment compensation and
veterans' benefits)...could be assumed to be no more than an
amount reasonably necessary for the support of the debtor and his
dependents") (emphasis in original). <a href="#8a">Return to article</a>

<a name="9">9</a> The next sentence of the
House Report makes it clear that it was the "benefits under a
certain stock bonus, pension, profitsharing, annuity or similar plan..."
that were to be exempted under §522(d)(10). H.R.Rep. No. 95-595,
reprinted in 1978 U.S.C.C.A.N. 5963, 6318 (emphasis added). <a href="#9a">Return to article</a>

<a name="10">10</a> See, e.g., Neavear
v. Schweiker (In re Neavear), 674 F.2d 1201, 1206 n.12 (7th Cir.
1982) (social security benefits are property of the estate); Michigan
Employment Sec. Comm'n. v. Jenkins (In re Jenkins), 64 B.R. 195, 198
(Bankr. W.D. Mich. 1986) (unemployment compensation benefits are
property of the estate). <a href="#10a">Return to article</a>

<a name="11">11</a> "Many economists view
pension benefits as deferred wages, in essence an agreement to delay the
receipt of earnings that workers would otherwise demand currently for
services being performed long before retirement." Dilley, Patricia E.,
"Hidden in Plan View: The Pension Shield Against Creditors," 74 Ind.
L.J. 355, 411 (1998-1999). <a href="#11a">Return to article</a>

<a name="12">12</a> While IRC
§408(a)((1) prohibits acceptance of excess contributions to an IRA,
the sanctions for excess contributions run against the taxpayer. Treas.
Reg. 1.408-1(c). See Boggs v. Commissioner, 83 T.C. 132 (1984),
rev'd. on other grounds, 784 F.2d 1166 (4th Cir. 1986). <a href="#12a">Return to article</a>

<a name="13">13</a> Footnote 5 of
Patterson cited two circuit court opinions, both of which held
that §522(d)(10)(E) applied only to the right to payment from
pension plans, not the plans themselves. See Gladwell v. Harline (In
re Harline), 950 F. 2d 669, 675 (10th Cir. 1991) ("§522 deals
with distributions made from a pension plan and distributions
which the debtor has a present and immediate right to receive")
(emphasis in the original), and Velis v. Kardanis, 949 F. 2d 78,
81-82 (citing Clark). The Court's choice of authority, even in

dicta, suggests openness to a plain reading of this statute. <a href="#13a">Return to article</a>

<a name="14">14</a> See, generally,
Borden, Michael J., "PSLRA, SLUSA and Variable Annuities: Overlooked
Side Effects of a Potent Legislative Medicine," 55 Mercer Law
Review, 681, 712 (2004) (listing reasons for shift toward defined
contribution plans). According to Christiane Bird, "defined-contribution
plans [as of Jan. 17, 2002]...have $2 trillion in assets, compared to
$1.8 trillion for defined-benefit plans). This is a vast change from the
mid-1970s, when defined-benefit plan assets stood at about $186 billion
and defined-contribution plan assets at $74 billion." (quoted in
Stabile, Susan J., "Another Look at 401(k) Plan Investments in Employer
Securities," 35 J. Marshall Law Review, 539, 545 n. 27 (2002)).

<a href="#14a">Return to article</a>

Journal Authors

C. Scott Pryor

Journal Date

Tuesday, March 1, 2005 - 12:00

Bankruptcy Rule

2005

none