Sixth Circuit Says 401 (k) Plan Contributions Made More Than Six Months Before Bankruptcy Cannot Be Excluded From Disposable Income

The United States Court of Appeals for the Sixth Circuit recently ruled in a case involving an attempt by Chapter 13 debtors to protect contributions to a 401 (k) retirement account from “projected disposable income”, thereby rendering these amounts inaccessible to creditors of debtors.^[1] For the reasons explained below, the Sixth Circuit rejected the debtors’ arguments.

Case background

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

• Between 1993 and 2017, the husband / debtor worked for a company that offered a 401 (k) plan, and he regularly contributed part of his salary to the plan.
• In 2017, he went to work for a new employer that did not offer a 401 (k) plan, so he was unable to contribute during his tenure there.
• In May 2018, he started working for a third company that had a 401 (k) plan and he started making 401 (k) contributions again.
• Debtors filed for bankruptcy in June 2018.

As part of their petition, the debtors sought to exclude $ 1,375.01 per month from their disposable income as voluntary contributions to the husband / debtor’s 401 (k) plan. The Chapter 13 trustee opposed the exclusion and the bankruptcy court ruled in favor of the trustee’s argument. The debtors appealed to the district court, which upheld the bankruptcy court’s decision, and then the debtors appealed to the Sixth Circuit.

To analyse

Generally, a Chapter 13 bankruptcy debtor can get some relief from his debts while still retaining his assets. However, to benefit from such protection, a debtor must agree to and adhere to a court-approved plan under which he pays creditors out of future income. In general, a debtor must commit all of the “projected disposable income” for the payment of creditors during a specified period.

The Sixth Circuit explained that although the Bankruptcy Code does not define “projected disposable income”, it defines “disposable income” as “current monthly income.” . . less the amount reasonably necessary to spend. . . for the maintenance or subsistence of the debtor. 11 USC 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] to receive[d]»In the six months preceding the filing of bankruptcy. 11 USC 101 (10A).

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

In its analysis, the Sixth Circuit noted that prior to the 2005 changes to the Bankruptcy Code, bankruptcy courts agreed that wages withheld voluntarily because 401 (k) contributions were part of the disposable income of a debtor. Therefore, these amounts were routinely available to unsecured creditors under a Chapter 13 plan.

After 2005, following the enactment of the Bankruptcy Abuse Prevention and Consumer Protection Act (“BAPCPA”), bankruptcy courts began to adopt different approaches to the processing of 401 (k) assessments. as disposable income.

The bursting of opinions – with four competing approaches taken by different courts – resulted from the so-called “suspended paragraph” in section 541 (b) (7) (A) of the Bankruptcy Code, which defines which assets 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 contributions to an employee’s 401 (k) plan are to be excluded from the property of the estate, the “suspended paragraph” in the end of the section reads “except that this amount under this subparagraph does not constitute disposable income within the meaning of Article 1325 (b) (2)”.

In analyzing this case, the Sixth Circuit reconsidered its decision in Davis v. Helbling (In re Davis), which also involved a debtor seeking to exclude future 401 (k) contributions from disposable income. The main difference with this case, however, is that in Davis the debtor had made regular 401 (k) contributions for at least six months prior to the bankruptcy.

Accordingly, in Davis, the Sixth Circuit concluded that “the suspended paragraph is best read to exclude from disposable income a debtor’s monthly 401 (k) contributions after the petition as long as those contributions were regularly withheld from the debtor’s salary prior to bankruptcy.”

In this case, the debtors have not made 401 (k) contributions in the six months preceding the bankruptcy. The debtors argued that it shouldn’t matter and based their arguments on fairness. They urged the Sixth Circuit to consider the “totality of the circumstances” and assess the husband’s “good faith”. They argued that the regularity of the husband’s contribution to his 401 (k) account in the years leading up to the six-month retrospective period should be relevant, and that Davis the interpretation of the suspended paragraph “would be unfair” on these facts.

The Sixth Circuit rejected all of these arguments. He ruled that “the text of the bankruptcy code does not allow a Chapter 13 debtor to use a history of pension contributions from previous years as a basis to protect voluntary post-petition contributions from unsecured creditors.”