The Sixth Circuit became the first appeals court to rule on whether a chapter 13 debtor may deduct contributions to a 401(k) plan from “disposable income” and thereby reduce payments to unsecured creditors under a chapter 13 plan.
In a split decision on June 1, the Sixth Circuit held that a debtor who was making contributions to a 401(k) before bankruptcy may continue making contributions in the same amount by deducting the contributions from “disposable income.” The majority saw the 2005 amendments as changing the law, while the dissenter interpreted the amendments as codifying the prevailing decisions handed down before the change in Section 541(b)(7).
Although the majority opinion is pro-debtor and the dissenter could be seen as pro-creditor, both opinions were written by judges appointed by President Trump. Also, they took fundamentally different approaches to the interpretation of a poorly written statute.
The Debtor’s Plan
Long before bankruptcy, the debtor had been making monthly, voluntary contributions of $220 to her 401(k) plan. She proposed a chapter 13 plan calling for her to make monthly payments of $323. Were the plan confirmed, unsecured creditors with claims of about $190,000 would receive a recovery of some 10%.
To confirm the plan, the debtor was required to devote all of her “projected disposable income” to unsecured creditors under Section 1325(b)(1). The chapter 13 trustee objected to confirmation because the debtor was deducting 401(k) contributions from her calculation of “disposable income.”
The bankruptcy judge upheld the objection, feeling bound by dicta in Seafort v. Burden (In re Seafort), 669 F.3d 662 (6th Cir. 2012).
In Seafort, the Sixth Circuit held that a debtor could continue deducting repayments of a loan from a 401(k) account from disposable income until the loan was repaid. Once repaid, the appeals court did not permit further deductions from disposable income for what would become new contributions to the retirement fund.
However, the Sixth Circuit went on to say in dicta in a footnote that a debtor may never deduct contributions to a retirement account, even if the debtor had been making contributions before bankruptcy. Id., 669 F.3d at 674 n.7. The footnote ended by saying, “However, our view is not relevant here, because this issue is not presently before us.”
The debtor amended her plan to include the 401(k) contributions in disposable income. The bankruptcy court confirmed the plan, but the debtor appealed. The bankruptcy court authorized a direct appeal to the circuit, which the appeals court accepted.
On appeal, the debtor was represented pro bono by former Chicago Bankruptcy Judge Eugene R. Wedoff, a recent past president of the American Bankruptcy Institute. He told ABI, “I think the decision is very thoroughly and carefully considered, and I think it will be helpful to any court that is faced with the issue in the future.”
The Perplexing Statute
The appeal turned on Section 541(b)(7), one of the most poorly drafted provisions added in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act, known as BAPCPA.
Section 541(b)(7)(A) provides that property of the estate does not include contributions to 401(k) plans. The end of the subsection includes a so-called hanging paragraph that says, “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).”
There have been four interpretations of the statute, with three results: (1) Retirement contributions can never be deducted from disposable income, even if the debtor was making contributions before bankruptcy; (2) a debtor may continue making contributions, but not more than the debtor was making before bankruptcy; and (3) a debtor may make contributions after bankruptcy up to the maximum allowed by the IRS, even if the debtor was making none before bankruptcy.
The Majority Opinion
In the majority opinion, Circuit Judge Joan Larsen reported how courts overwhelmingly held before BAPCPA that retirement plan contributions were included in disposable income. After BAPCPA, she said that “most” courts believe that contributions are not part of disposable income.
However, Judge Larsen said that Seafort, handed down after BAPCPA, “squarely” rejected the holding by some courts that contributions are never included in disposable income, whether or not the debtor was making contributions before bankruptcy.
Judge Larsen devoted the remainder of her opinion to deciding whether she should follow the dicta in Seafort. To that end, she carefully laid out the four interpretations of the statute after BAPCPA and asked whether “such amount” in the hanging paragraph includes continued contributions to retirement accounts.
There are two prevalent interpretations of the hanging paragraph, “either of which will do some violence to the text,” Judge Larsen said. She quoted Prof. David Gray Carlson as asking which is “the lesser of evils.”
To resolve the question, Judge Larsen invoked three canons of construction to rule in favor of the debtor. First, she said that the reenactment canon indicates that Congress intended to alter existing law, where courts were not allowing debtors to deduct contributions from disposable income.
Next, Judge Larsen said that the presumption against ineffectiveness advises against an interpretation where the hanging paragraph would not change law. Third, she said that the canon against surplusage favors a construction where the hanging paragraph and Section 1325(b)(2) have “independent effect.”
Applying the canons, Judge Larsen held that “the hanging paragraph is best read to exclude from disposable income the monthly 401(k)-contribution amount that [the debtor’s] employer withheld from her wages prior to her bankruptcy.” That way, she said, the amendment “actually amends the statute” and “also gives meaningful effect . . . to Congress’s instruction in § 541(b)(7) that 401(k) contributions ‘shall not constitute disposable income.’”
Among other authorities, Judge Larsen quoted the Collier treatise for saying that the hanging paragraph amendment “removes any doubt” that withholdings by employers are excluded from disposable income.
Although declining to follow Seafort’s dicta, Judge Larsen did not disturb the holding that a debtor may not begin making contributions after paying off a loan from a retirement account.
Judge Larsen said her holding was “narrow” and “may necessitate a more searching good-faith analysis.”
A district court in Louisiana last year upheld the bankruptcy court and allowed contributions up to the IRS limits. See Miner v. Johns, 589 B.R. 51 (W.D. La. May 23, 2018). To read ABI’s report on Miner, click here.
The Dissent
Circuit Judge Chad A. Readler “respectfully” dissented. To him, Seafort “all but held” that a debtor cannot make contributions after bankruptcy, even if he or she was making them beforehand.
Judge Readler saw BAPCPA as drawing a “simple bright-line rule: a debtor’s pre-filing 401(k) contributions are protected from creditors; those sought to be made during the post-filing Chapter 13 reorganization period are not.”
Rather than changing law, Judge Readler interpreted BAPCPA as “codifying these predominant judicial interpretations” that require the inclusion of contributions in disposable income. He saw his reading of the statute as being in accord with the perceived policy in BAPCPA that a debtor must pay as much as possible toward the claims of unsecured creditors.
To that end, he saw the majority as creating “a massive loophole permitting a Chapter 13 debtor nonetheless to dramatically undermine creditors by dedicating her post-petition income to a 401(k), for her own future use.”
The Sixth Circuit became the first appeals court to rule on whether a chapter 13 debtor may deduct contributions to a 401(k) plan from “disposable income” and thereby reduce payments to unsecured creditors under a chapter 13 plan.
In a split decision on June 1, the Sixth Circuit held that a debtor who was making contributions to a 401(k) before bankruptcy may continue making contributions in the same amount by deducting the contributions from “disposable income.” The majority saw the 2005 amendments as changing the law, while the dissenter interpreted the amendments as codifying the prevailing decisions handed down before the change in Section 541(b)(7).
Although the majority opinion is pro-debtor and the dissenter could be seen as pro-creditor, both opinions were written by judges appointed by President Trump. Also, they took fundamentally different approaches to the interpretation of a poorly written statute.