Believing that Supreme Court authority on preferences didn’t govern, the First Circuit Bankruptcy Appellate Panel ruled that funds allegedly withdrawn from a retirement account before the filing date were not exempt even though the debtor never cashed the check.
The facts were simple. A woman filed a chapter 7 petition and scheduled her 401(k) account with $50,000 as exempt under Section 522(d)(12). She did not disclose, however, that she “borrowed” $18,000 from her retirement account three weeks before filing. On the filing date, she had not cashed the $18,000 check.
At the Section 341 meeting, the trustee learned about the “loan” when he inquired about loan repayments to the retirement account. At the trustee’s request, she turned the check over to her attorney. The debtor did not amend her schedules to claim an exemption over the $18,000. Evidently, the check was not negotiated.
The trustee mounted a turnover action, contending that the $18,000 was estate property and was not exempt. The bankruptcy judge denied the motion.
The transcript of the hearing implies that the bankruptcy judge invoked Barnhill v. Johnson, 503 U.S. 393, 112 S. Ct. 1386, 118 L. Ed. 2d 39 (1992), for the notion that a transfer for bankruptcy purposes does not occur until an ordinary check is honored by the drawee bank. She said that the funds therefore remained in the retirement account because the check was not cashed and thus retained the exemption.
In a May 21 opinion by Bankruptcy Judge Pete G. Cary of Portland, Maine, the BAP reversed the bankruptcy court, holding that the $18,000 was estate property and was not exempt.
Judge Cary first dealt with the question of whether the $18,000 was estate property, because a retirement account is held in trust and is protected from attachment by creditors under ERISA. Ordinarily, funds in a retirement account are not brought into the estate because Section 541(c)(2) provides that 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.”
Judge Cary followed a line of cases holding that distributions from retirement accounts lose their protection by Section 541(c)(2) and can become estate property. Nonetheless, a distribution from a retirement account can retain the exemption if deposited into another retirement account within 60 days.
Therefore, Judge Cary next grappled with the more complex question of whether the $18,000 retained its exempt status.
Under Fifth Circuit authority, Judge Cary said that funds must be in an exempt account to be exempt under Section 522(d)(12), the federal exemption for qualified retirement accounts. He followed cases holding that “distributed funds do not retain their exempt character if not placed in another account that is exempt from taxation.”
Because the debtor had not redeposited the $18,000 in another retirement account within 60 days, the trustee argued that the money lost its exempt status.
To counter the trustee’s contention, the debtor argued that the $18,000 never left the retirement account because the check was never cashed. In substance, the debtor was relying on Barnhill.
Barnhill was a preference case. To decide whether a transfer occurred within the 90-day preference period, the Supreme Court held that a transfer occurs when an ordinary check is honored, not when delivered to the transferee.
Countering Barnhill, Judge Cary cited a district court from Michigan and a New Jersey bankruptcy court for saying that a distribution of retirement funds does not require cashing the check. In part, he rested his conclusion on the idea that a transfer had occurred because the trustee for the retirement account had approved the loan.
Judge Cary reversed and remanded, apparently requiring the bankruptcy court to compel a turnover to the trustee combined with a declaration that the $18,000 was not exempt.
Observations
Whether one agrees with the BAP or not depends on one’s interpretation of Barnhill. Did the Supreme Court decide when a transfer occurs only for preferences? Does Barnhill also determine the date of a fraudulent transfer? When the question involves an ordinary check, does Barnhill prescribe the time of transfer for all bankruptcy purposes?
If Barnhill fixes the time of a transfer generally for bankruptcy, then the $18,000 actually remained in the retirement account and should be exempt. But are there separate rules defining the time of transfer of retirement funds? And if so, what’s the statutory basis?
The BAP’s decision in favor of the trustee seems aligned with the notion that the approval of the loan and the delivery of the check was tantamount to an assignment of funds to the debtor. However, footnote 6 in the Barnhill majority opinion cites the Uniform Commercial Code to say that the delivery of a check is not an assignment of funds in the account. Barnhill, 503 U.S. at 398.
The debtor in the BAP was not an attractive litigant. Coughing up the $18,000 may have been light punishment for what seemed to be an attempt to conceal the funds. She could have lost her discharge.
And maybe that would have been the better result: losing her discharge but retaining the $18,000 as part of an exempt retirement account. After all, the Supreme Court in Law v. Siegel, 571 U.S. 415 (2014), decided that an egregious fraudster was entitled to retain the exemption in his home.
Believing that Supreme Court authority on preferences didn’t govern, the First Circuit Bankruptcy Appellate Panel ruled that funds allegedly withdrawn from a retirement account before the filing date were not exempt even though the debtor never cashed the check.
The facts were simple. A woman filed a chapter 7 petition and scheduled her 401(k) account with $50,000 as exempt under Section 522(d)(12). She did not disclose, however, that she “borrowed” $18,000 from her retirement account three weeks before filing. On the filing date, she had not cashed the $18,000 check.
At the Section 341 meeting, the trustee learned about the “loan” when he inquired about loan repayments to the retirement account. At the trustee’s request, she turned the check over to her attorney. The debtor did not amend her schedules to claim an exemption over the $18,000. Evidently, the check was not negotiated.
The trustee mounted a turnover action, contending that the $18,000 was estate property and was not exempt. The bankruptcy judge denied the motion.
The transcript of the hearing implies that the bankruptcy judge invoked Barnhill v. Johnson, 503 U.S. 393, 112 S. Ct. 1386, 118 L. Ed. 2d 39 (1992), for the notion that a transfer for bankruptcy purposes does not occur until an ordinary check is honored by the drawee bank. She said that the funds therefore remained in the retirement account because the check was not cashed and thus retained the exemption.
In a May 21 opinion by Bankruptcy Judge Pete G. Cary of Portland, Maine, the BAP reversed the bankruptcy court, holding that the $18,000 was estate property and was not exempt.