Congress needs to fix the mess it made in Section 541(b)(7) and say clearly whether chapter 13 debtors are entitled to make voluntary contributions to 401(k) retirement plans. As it now stands, there are four interpretations of the section, typically giving three different results.
So far, only the Sixth Circuit has tackled the issue. It will be years before there is enough appellate authority for the Supreme Court to resolve what assuredly will be a split.
As a matter of public policy, it is imperative that Congress decide whether debtors are required to suffer the effects of bankruptcy years later in retirement, if they happen to live in districts and circuits that do not permit 401(k) contributions during chapter 13.
The New and Newer Sixth Circuit Opinions
In a 2/1 decision, the Sixth Circuit held last year that a chapter 13 debtor who was consistently making contributions to a 401(k) for six months before bankruptcy may continue contributions in the same amount by deducting the contributions from “disposable income” in Section 1325(b)(2).
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. Davis v. Helbling (In re Davis), 960 F.3d 346 (6th Cir. 2020). To read ABI’s report on Davis, click here.
In a unanimous opinion on August 10, the Sixth Circuit held that a chapter 13 debtor may not make 401(k) contributions if the debtor had not been making contributions before bankruptcy, even if (1) the debtor had a history of making contributions in prior years when he was able, and (2) the debtor was not eligible for a 401(k) plan in the months before bankruptcy.
The new opinion was authored by Circuit Judge Joan Larsen. She was also the writer of the majority opinion last year in Davis.
The Four-Way Split
Section 541(b)(7)(A) is one of the most poorly drafted provisions in the Bankruptcy Code. It was added in 2005 by the Bankruptcy Abuse Prevention and Consumer Protection Act because courts were mostly holding that wages voluntarily withheld as 401(k) contributions were part of disposable income.
As amended, the section 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 are 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.
This writer respectfully submits that none of the interpretations inexorably flows from the statutory language.
Facts in the New Case
For most of his 17 years working for a former employer, the debtor had been making contributions to his 401(k) plan. In 2017, he took a new job with an employer that did not offer a 401(k) plan, so he could not make contributions.
Six weeks before filing a chapter 13 petition in June 2018, the debtor went to work for a different employer offering a 401(k) plan and began making contributions. Judge Larsen said the record was unclear about when the debtor began making the contributions.
Before Davis came down, the bankruptcy court ruled that the debtor could not deduct the contributions from his payments to creditors. Also before Davis, the district court affirmed. To read ABI’s report on the district court opinion, click here. The appeal to the circuit was held in abeyance pending the outcome in Davis.
The new case presented facts not present in Davis. Although he had a history of making contributions, the debtor had made none consistently in the six months before bankruptcy.
Contributions Before Bankruptcy Are Required
The debtor argued that the circuit court should expand Davis by allowing the debtor to rely on his history of making voluntary contributions when he had been able to so do.
“Because neither the statute nor our caselaw supports” the argument, Judge Larsen upheld the lower courts.
Judge Larsen laid out the four interpretations of the statute and explained how Davis rejected the idea that a chapter 13 debtor may never make voluntary contributions. She cited the Sixth Circuit Bankruptcy Appellate Panel for having ruled that “to the extent a debtor is making recurring 401(k) contributions ‘at the time’ of filing, she may continue to do so post-petition.” Burden v. Seafort (In re Seafort), 437 B.R. 204, 209-210 (B.A.P. 6th Cir. 2010).
“But that also means that a debtor may not begin, resume, or otherwise increase the amount of such contributions post-filing in an attempt to reduce payments to unsecured creditors,” Judge Larsen said, again interpreting the BAP. Id. at 210.
Judge Larsen stated the circuit’s holding as follows:
We hold only that the bankruptcy code’s text does not permit a Chapter 13 debtor to use a history of retirement contributions from years earlier as a basis for shielding voluntary post-petition contributions from unsecured creditors. This is true even if the debtor had no ability to make further contributions in the six months preceding filing; the code makes no exception for such circumstances.
Commentary
In years past, employers offered defined-benefit pension plans that were protected in employees’ bankruptcies. Today, they are few and far between.
If a typical consumer is to provide for retirement, she or he must make contributions to 401(k)s and individual retirement accounts. Otherwise, a worker will be left with nothing more than Social Security benefits and retirement in abject poverty.
A financially struggling consumer may be unable to make 401(k) contributions, even if offered by the employer. Consequently, requiring consistent 401(k) contributions by chapter 13 debtors before bankruptcy flies in the face of reality. Furthermore, a consumer eligible for chapter 7 is not precluded from making contributions immediately after filing.
Typically, requiring a chapter 13 debtor to include 401(k) contributions in disposable income will not result in an additional major recovery by each unsecured creditor.
Congress needs to decide whether chapter 13 debtors must suffer the consequences of bankruptcy in retirement years later, when the benefit to each creditor was nominal.
Chapter 13 was designed not to be punitive when someone files a chapter 13 petition but does not succeed. Barring individuals from providing for retirement makes chapter 13 punitive for debtors who succeed.
Congress needs to fix the mess it made in Section 541(b)(7) and say clearly whether chapter 13 debtors are entitled to make voluntary contributions to 401(k) retirement plans. As it now stands, there are four interpretations of the section, typically giving three different results.
So far, only the Sixth Circuit has tackled the issue. It will be years before there is enough appellate authority for the Supreme Court to resolve what assuredly will be a split.
As a matter of public policy, it is imperative that Congress decide whether debtors are required to suffer the effects of bankruptcy years later in retirement, if they happen to live in districts and circuits that do not permit 401(k) contributions during chapter 13.