Many bankruptcy practitioners today are faced with the often confusing and unenviable dilemma of advising their clients as to the exemptions of private disability insurance. The reality is that thousands of dollars can often be at stake with private disability insurance, depending on the timing and motivation involved in a bankruptcy filing. Bankruptcy scholars have researched the applicability of exempting privately purchased disability insurance policies and have looked to the source of disability payments through 11 U.S.C.§522(d)(10)(c) and (e) to determine if government benefits are involved vs. rights to payment that arise from the debtor’s employment. Others have considered the distinction between temporary and permanent benefits in deciding which exemption is applicable. Perhaps the most notable distinction between the various exemptions listed in §522(d)(10) is that of full and partial exemptions. As outlined below, the applicability of exempting private disability insurance policies is certainly up for debate.
When a debtor files for bankruptcy protection, an estate is created that includes “all legal or equitable interests of the debtor in property as of the commencement of the case.” 11 U.S.C. §541(a)(1). Federal bankruptcy law allows a debtor to exempt some of his or her property—mainly basic necessities—from the bankruptcy estate. The exemptions can afford the debtor some economic and social stability, which is important to the fresh-start guaranteed by bankruptcy. Williams v. U.S. Fid. & Guar. Co., 236 U.S. 549, 554-55, 35 S.Ct. 289, 59 L.Ed. 713 (1915). Any person who files a petition under federal bankruptcy law may exempt the following property from property of the estate in a bankruptcy proceeding:
11 U.S.C. §522(d)(10) the debtor’s right to receive:
(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; and
(e) payment under a stock bonus, pension, profit sharing, 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.
The benefits listed in §522(d)(10)(a)-(c)) are fully exempt from the bankruptcy estate without regard to their amount. In contrast, the payments listed in 11 U.S.C. §522(d)(10)(d)-(e) are “partially exempt” in the sense that debtors are entitled to exempt these payments only to the extent that the payments are reasonably necessary for the support of the debtor and his dependents. A debtor may, of course, be entitled to exempt the full amount of a payment classified under §522(d)(10)(d)-(e) if the payment does not exceed the amount reasonably necessary for support.
The task is to decide whether payments made under a privately purchased disability insurance policy should be classified as fully exempt disability benefit(s) under 11 U.S.C. §522(d)(10)(c) or partially exempt “payment(s) under a…contract on account of” disability under 11 U.S.C. §522(d)(10)(e). Only two courts, both outside of the authors’ circuit, have discussed the treatment of disability payments under state exemption schemes molded on the federal code. In re Bari, 43 B.R. 253, 255 (Bankr. D. Minn. 1984)(classifying payments under disability insurance policy as partially exempt under Minnesota exemption 204 modeled on 11 U.S.C. §522(d)(10)(E)); Sanders v. Sanders, 711 A. 2d 124, 128 (Maine 1998)(classifying payments under disability insurance policy as partially exempt under Maine exemption modeled on 11 U.S.C. §522(d)(10)(E)).
There are two strains of thinking on the issue. Both sides believe that §522(d)(10) classifies types of disability benefits or payments as fully or partially exempt on the basis of their source, but each side argues for a different result. The respective arguments are based on the fact that the payments come from a privately purchased insurance policy rather than from the government or an employer. One analysis claims that the use of the word “benefit” in 11 U.S.C. §522(d)(10)(c) establishes that the “disability, illness or unemployment” benefits referred to therein are government benefits. That side therefore argues that the disability payments must fall under 11 U.S.C. §522(d)(10)(e) because they do not come from the government. The most obvious problem with this argument is that the word “benefit” is not restricted to government benefits. Black’s Law Dictionary defines “benefit” in part as “financial assistance that is received from an employer, insurance, or a public program (such as social security) in time of sickness, disability, or unemployment.” Black’s Law Dictionary 151 (7th ed. 1999).
The other strain of thinking is the claim that the §522(d)(10)(e) exemption covers only rights to payment that arise from the debtor’s employment. There is no case law interpreting 11 U.S.C. §522(d)(10)(e) to be limited solely to plans or contracts provided by or through the debtor’s employer.
The failure of both of these arguments means that we cannot always look to the source of the payments to tell the difference between the “disability benefits” fully exempted by §522(d)(10)(c) and the “payments under a contract on account of disability” partially-exemptible approach. A second potential way to distinguish between the two disability exemptions is on the basis of the duration of the payments rather than their source. A treatise states that 11 U.S.C. §522(d)(10)(c), covers “temporary contractual benefits.” whereas 11 U.S.C. §522(d)(10)(e) covers “permanent employment-related benefits.” 2 Norton, supra, 46:17. A Maine state court has recited this distinction in classifying certain disability insurance payments as partially exempt under a state provision modeled on 11 U.S.C. §522(d)(10)(e). Sanders, 711 A.2d at 128.Whatever the merits of this approach as a general matter, we do not find it helpful here because the payments provided by disability insurance are not readily classified as either permanent or temporary.
Some benefits, such as retirement benefits, that will continue until death are clearly permanent. However, benefits with a short, fixed duration, such as unemployment benefits, are clearly temporary. Disability payments fall somewhere in the middle. For example, disability payments could continue until death, or they might end tomorrow if the disability ends. This kind of uncertainty about the length of a disability is not uncommon, and under such circumstances courts have no principled way to decide how permanent or temporary the disability payments will be. Therefore, the conclusion that the distinction between temporary and permanent benefits is not helpful in deciding whether the §522(d)(10)(c) or the §522(d)(10)(e) exemption applies in this case.
Payments under privately-purchased disability insurance policies do not fit neatly within either 11 U.S.C. §522(d)(10)(c) or the 11 U.S.C. §522(d)(10)(e) exemption. In re Thomas, 1990 W.L. 62438 (Bankr. D. Minn. 1990). The legislative history of the federal exemption is not helpful because all payments on account of disability are meant to replace future earnings, and this history sheds no light on Congress’s decision to allow full exemption of some disability payments while allowing only partial exemption of others. In the absence of any indication of specific legislative intent about the treatment of payments under privately purchased disability contracts, we will explore whether full or partial exemptions of these payments is more consistent with the policy behind the bankruptcy exemptions. H.R. Rep. No. 95-595 at 362 (1977).
The most notable distinction between the various exemptions listed in 11 U.S.C. §522(d)(10) is that between full and partial exemptions. Sections 522(d)(10)(a)-(c) list benefits that are fully exempt, while §522(d)(10)(d)-(e) lists benefits or payments that are exempt only to the extent reasonably necessary for the support of the debtor and his dependents. We can imagine only two possible reasons why Congress would make this distinction. One is that the legislature might have believed that certain types of payments (those listed in 11 U.S.C. 522(d)(10)(a)-(c)) ought to be available to debtors even when the payments exceed the amount reasonably necessary for support, but this explanation is inconsistent with the bankruptcy policy of allowing debtors a chance to start over, exempting only the basic means to support that chance. This policy suggests that debtors are never entitled to exempt more than is reasonably necessary for support. The more logical reason for the legislature’s decision to allow full rather than partial exemption for certain types of benefits is this: The legislature believed that the fully exempt benefits (for example, social security, unemployment compensation and veterans’ benefits) listed in 11 U.S.C. §522(d)(10)(a)-(c) could be assumed to be no more than an amount reasonably necessary for the support of the debtor and his dependents. See In re Dale, 252 B.R. 430, 436 (Bankr. W.D. Mich. 2000)(“Congress simply assumed that the benefit(s) would be necessary {for the support of the debtor} without further examination”). This explanation for the structure of the statute shows why the legislature specifically classified the social security, unemployment compensation, public assistance and veterans’ benefits listed in 11 U.S.C. §522(d)(10)(a)-(b) as fully exempt. No one lives lavishly on these benefits. By the same token, workers’ compensation benefits, which are not listed in the statute, should also be classified as fully exempt under 11 U.S.C. §522(d)(10)(c), for these benefits can be assumed to be “not much higher than is necessary to keep the worker from destitution.” In re Cain, 91 B.R. 182,183 (Bankr. N.D. Ga. 1988) (internal quotation marks and citation omitted) (holding that workers’ compensation benefits are fully exempt under 11 U.S.C. §522(d)(10)(c). Accord, In re Evans, 29 B.R. 336, 338-39 (Bankr. D. N.J. 1983): In re LaBelle, 18 B.R. 169,171 (Bankr. D. Maine 1982).
In contrast to the full exemptions in §522(d)(10)(a)-(c), the exemptions in §522(d)(10)(d)-(e) are limited because alimony payments and payments under plans and contracts of the sort listed in 11 U.S.C. §522(d)(10)(e) have the potential in some cases to exceed greatly what is reasonably necessary for support, and they can be “extravagant (witness the divorces of the super-rich) or be supplemented by earnings if the bankrupt debtor also is employed.” Dale, 252 B.R. at 436.Similarly, payments from stock-bonus plans, profit-sharing plans and the like are not inherently limited to amounts reasonably necessary for support of the debtor and his dependents. In re Woodford, 73 B.R. 675, 681-82 (Bankr. N.D.N.Y.1987).Using this approach, the legislature created two categories of disability-related payments: “disability benefits” fully exempted by §522(d)(10)(c), and “payments under a contract on account of disability” partially exempted by § 522(d)(10)(e). The legislature created the two categories because it reasoned that some, but not all, disability payments could be assumed to be limited to amounts reasonably necessary for support. Accordingly, the right to receive payments under a privately-purchased disability insurance contract is fully exempt from the bankruptcy estate under 11 U.S.C. §522(d)(10)(c) only if payments of this type can be assumed to be limited to amounts reasonably necessary for the support of the debtor and his dependents. Under the federal exemptions, a bankruptcy trustee would have the ability to have the court determine what amount of the private disability insurance would be reasonably necessary for the support of the debtor and his dependents.
Determining which, if any, payments under a privately-held disability policy are “reasonably necessary for the support of the debtor and his dependents” is no easy task. Due diligence and meticulous prebankruptcy planning with a client is essential for a successful outcome in a bankruptcy case. Litigation will continue in the bankruptcy arena as each situation must be dealt with on a case-by-case basis. The interplay between benefits that are fully exempt under §522(a)-(c) and those that are exempt under §522(d)(10)(d)-(e) only to the extent reasonably necessary for support will continue to be scrutinized by bankruptcy attorneys for years to come.