Sixth Circuit Affirms Holding that Contributions to a 401(k) Plan Made More than Six Months Prior to Bankruptcy Cannot be Excluded from Disposable…

The U.S. Court of Appeals for the Sixth Circuit recently ruled in a case involving a Chapter 13 debtors attempt to shield contributions to a 401(k) retirement account from projected disposable income, therefore making such amounts inaccessible to the debtors creditors.[1] For the reasons explained below, the Sixth Circuit rejected the debtors arguments.

Case Background

This appeal involves the Chapter 13 bankruptcy filing of a husband and wife (the Debtors). The issue on appeal was whether the Debtors could exclude future 401(k) contributions from their disposable income and creditors. The Husband/Debtors work and prior 401(k) contribution history weighed heavily in the Sixth Circuits analysis.

As part of their petition, the Debtors sought to exclude $1,375.01 per month from their disposable income as voluntary contributions to Husband/Debtors 401(k) plan. The Chapter 13 Trustee objected to the exclusion and the bankruptcy court ruled in favor of the Trustees argument. The Debtors appealed to the District Court, which affirmed the bankruptcy courts ruling, and then Debtors appealed to the Sixth Circuit.

Analysis

As a general principle, a Chapter 13 bankruptcy debtor may obtain some relief from his/her debts while retaining his/her property. However, in order to receive such protection, a debtor must agree to and abide by a court-approved plan under which he/she pays creditors out of future income. In general, a debtor must commit all projected disposable income to the payment of creditors for a fixed period of time.

The Sixth Circuit explained that while the Bankruptcy Code does not define projected disposable income, it does define disposable income as a debtors current monthly income . . . less amount reasonably necessary to be expended . . . for the maintenance or support of the debtor. 11 U.S.C. 1325 (6)(2).

Current monthly income is defined as the average monthly income from all sources (other than those specifically excluded) that the debtor [has] receive[d] in the six months preceding filing for bankruptcy. 11 U.S.C. 101(10A).

This case, therefore, boiled down to whether the post-petition amounts the Debtors intended to contribute to a 401(k) plan constitute projected disposable income. The Sixth Circuit ruled that such amounts should be treated as projected disposable incomes that are available to pay creditors.

In its analysis, the Sixth Circuit noted that, prior to the 2005 amendments to the Bankruptcy Code, there was consensus among the bankruptcy courts that wages voluntarily withheld as 401(k) contributions formed part of a debtors disposable income. Therefore, such amounts were routinely available to unsecured creditors as part of a Chapter 13 plan.

After 2005, following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), bankruptcy courts began adopting different approaches for the treatment of 401(k) contributions as disposable income.

The splintering of opinionswith four competing approaches adopted by different courtsresulted from what is known as the hanging paragraph in Section 541(b)(7)(A) of the Bankruptcy Code, which defines what property should not be included as property of the estate in a bankruptcy case. While Section 541(b)(7)(A) provides that amounts withheld by an employer for contribution to an employees 401(k) plan are to be excluded from property of the estate, the hanging paragraph at the end of the section states except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).

In analyzing this case, the Sixth Circuit revisited its ruling in Davis v. Helbling (In re Davis), which also involved a debtor who sought to exclude future 401(k) contributions from disposable income. The key difference from this case, however, is that in Davis the debtor had been steadily making 401(k) contributions for at least six months prior to bankruptcy.

Accordingly, in Davis, the Sixth Circuit concluded that the hanging paragraph is best read to exclude from disposable income a debtors post-petition monthly 401(k) contributions so long as those contributions were regularly withheld from the debtors wages prior to her bankruptcy.

In this case, the Debtors did not make 401(k) contributions during the six months prior to bankruptcy. The Debtors argued that this shouldnt matter, and grounded their arguments in equity. They urged the Sixth Circuit to consider the totality of circumstances and assess the husbands good faith. They argued that the husbands consistency in contributing to his 401(k) account in the years preceding the six-month lookback period should be relevant, and that Davis interpretation of the hanging paragraph would be inequitable on these facts.

The Sixth Circuit rejected all of these arguments. It held that the bankruptcy codes 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.

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Sixth Circuit Affirms Holding that Contributions to a 401(k) Plan Made More than Six Months Prior to Bankruptcy Cannot be Excluded from Disposable...