With qualifications implying that all chapter 13 debtors may not qualify, Chief Bankruptcy Judge Helen E. Burris of Spartanburg, S.C., sided with the majority and allowed the debtor to continue making voluntary contributions to her retirement account.
Before bankruptcy, the 36-year-old debtor had been making monthly contributions of some $470 to her retirement account, enough to qualify for her employer’s maximum contribution. The debtor had been making the contributions for three years. The balance in her retirement account was $38,000, Judge Burris said in her May 20 opinion.
Originally, the debtor’s chapter 13 plan called for $98,400 in payments over the five-year life of the plan. The chapter 13 trustee objected, leading to a compromise where the debtor upped the payments to $109,000.
A creditor objected to confirmation of the amended plan, contending that the debtor was not devoting all her disposable income to the plan and that the plan was not filed in good faith, given ongoing contributions to the retirement plan.
To the extent the statute provides an answer, several sections are pertinent. To confirm the plan, the debtor is required to devote all of her “projected disposable income” to unsecured creditors under Section 1325(b)(1).
Section 541(b)(7)(A), one of the most poorly drafted provisions added in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act, 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).”
Finally, Section 707(b) provides grounds for dismissal and uses the term “current monthly income.” While charitable contributions are specifically excluded as grounds for dismissal, the statute is silent about contributions to a retirement plan.
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.
So far, only the Sixth Circuit has tackled the split. See Davis v. Helbling (In re Davis), 960 F.3d 346 (6th Cir. 2020). In a 2/1 decision, the majority 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 in Davis rejected the holding by some courts that contributions are never included in disposable income, whether or not the debtor was making contributions before bankruptcy. The dissenter would have held that a debtor cannot make contributions after bankruptcy, even if he or she was making them beforehand. To read ABI’s report on Davis, click here.
The Fourth Circuit ducked the split on statutory interpretation in 2017. See Gorman v. Cantu (In re Cantu), 713 F. App’x 200, 202 (4th Cir. 2017). To read ABI’s report, click here.
Two of the circuit judges in Cantu believed that the trustee had only appealed the bankruptcy court’s good faith finding and not a second question of statutory interpretation. The appeals court decided that the bankruptcy court’s finding of good faith was not clearly erroneous because the debtor was only planning to contribute $3,200 a year when the maximum permissible contribution under tax law would have been $18,000.
The creditor wanted Judge Burris to adopt the approach of the dissenter in Davis and bar contributions to retirement plans, even if the debtor was making contributions before bankruptcy.
Tackling the question herself, Judge Burris noted that neither Section 1325 nor Section 707 “explicitly authorizes” deduction of retirement contributions from disposable income.
Judge Burris declined to follow the Davis dissent and “instead joins the majority and other courts within the Fourth Circuit that have held that post-petition voluntary retirement contributions are not considered disposable income, so long as such contributions are made in good faith.” She interpreted the hanging paragraph to show the intent of Congress “to exclude retirement contributions from available disposable income under Section 1325(b).”
Turning to the question of good faith, Judge Burris saw the Fourth Circuit as calling for an examination of the totality of the circumstances.
First, Judge Burris refused to infer bad faith solely because the debtor would continue making retirement plan contributions.
The creditor had defeated the debtor regarding good faith when the original plan came on for confirmation. The amended plan, Judge Burris said, “is significantly different and provides far more” for creditors.
In addition, the debtor had been making contributions for several years “and in amounts consistent with what she intends post-petition,” Judge Burris said. Although she was only 36 years of age, “her monthly contribution is well within the allowable limit” of $19,500.
Furthermore, Judge Burris said that a “substantial portion” of unsecured debts would be paid by the plan. She therefore overruled the objection regarding good faith and directed entry of an order confirming the plan.
Observations
The issue raises questions of policy and statutory interpretation. Given that the statutory muddle has been on the books for 16 years, the prospect of a congressional fix is remote. “It is more likely that the issue will continue to be left to the judiciary to clean up,” Jamie Olinto told ABI.
Ms. Olinto is a partner in the Jacksonville, Fla., office of Adams & Reese LLP. She saw this newest case as showing a tendency for courts to “settle on a standard which allows for flexibility in balancing the oft-competing interests of debtors and their creditors to reach what the jurist reasons to be a fair and equitable result rooted in whether the debtor is acting in good faith.”
In other words, debtors in different parts of the country will live under different regimes until Congress or the Supreme Court resolves the split.
Given the lack of clarity in the statute itself, this writer submits that courts are entitled to use their common sense and notions of fairness to divine an answer.
Fewer and fewer Americans have defined benefit pension plans funded altogether by their employers. If a worker is lucky enough to have any retirement plan, it likely will be a defined contribution plan where the employer may only make matching contributions.
Barring or limiting pension contributions precludes chapter 13 debtors from cashing in on significant tax advantages available to other Americans and means they will have lower incomes in retirement. When retirees may have nothing more than meager Social Security benefits and whatever they have been able to contribute to 401(k)s or IRAs, preventing chapter 13 debtors from providing for their retirements is bad policy, in this writer’s view.
Courts should not make policy choices preventing some Americans from taking advantage of tax benefits, unless the result is clearly commanded by the Bankruptcy Code, in this writer’s view.
With qualifications implying that all chapter 13 debtors may not qualify, Chief Bankruptcy Judge Helen E. Burris of Spartanburg, S.C., sided with the majority and allowed the debtor to continue making voluntary contributions to her retirement account.
Before bankruptcy, the 36-year-old debtor had been making monthly contributions of some $470 to her retirement account, enough to qualify for her employer’s maximum contribution. The debtor had been making the contributions for three years. The balance in her retirement account was $38,000, Judge Burris said in her May 20 opinion.
Originally, the debtor’s chapter 13 plan called for $98,400 in payments over the five-year life of the plan. The chapter 13 trustee objected, leading to a compromise where the debtor upped the payments to $109,000.
A creditor objected to confirmation of the amended plan, contending that the debtor was not devoting all her disposable income to the plan and that the plan was not filed in good faith, given ongoing contributions to the retirement plan.
To the extent the statute provides an answer, several sections are pertinent. To confirm the plan, the debtor is required to devote all of her “projected disposable income” to unsecured creditors under Section 1325(b)(1).
Section 541(b)(7)(A), one of the most poorly drafted provisions added in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act, 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).”
Finally, Section 707(b) provides grounds for dismissal and uses the term “current monthly income.” While charitable contributions are specifically excluded as grounds for dismissal, the statute is silent about contributions to a retirement plan.