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CCH® PENSION — 10/26/10

Debtors prohibited from deferring funds available following repayment of 401(k) loan

Debtors in a Chapter 13 bankruptcy case may not use income which becomes available once 401(k) plan loans are repaid to begin making elective deferrals to the plans, a Bankruptcy Panel of the U.S. Court of Appeals in Cincinnati (CA-6) has ruled in Burden v. Seafort.

Elective deferrals under Chapter 13 plan following repayment of loan

Participants in 401(k) plans filed for bankruptcy relief under Chapter 13 of the Bankruptcy Code. At the time of the filing, the debtors were repaying plan loans, but were not making contributions to the plan. Under proposed Chapter 13 plans, the debtors looked to complete repayment of the loans (before the end of the five-year commitment period of the bankruptcy plans) and then continue payroll deductions as 401(k) plan contributions in the same amount as the loan repayments. Under the plans, as proposed by the debtors, the cessation of the loan repayments would not increase the amount of the funds being paid to the debtors' creditors under the plans. The bankruptcy trustee objected to the confirmation of the proposed Chapter 13 plan, maintaining that, because the debtors were not making 401(k) contributions as of the commencement of the bankruptcy proceeding, they were required to increase the payments under the bankruptcy plan to their creditors by the amount of the loan repayments, once the loans were paid in full. A federal bankruptcy court, however, rejected the trustee's position, and affirmed the Chapter 13 plans, ruling that the proposed 401(k) elective contributions could be excluded from the debtors' projected disposable income.

Limited exclusion of 401(k) contributions from bankruptcy estate

Under Bankruptcy Code Sec. 541(b)(7), as added by the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), debtors may exclude contributions to 401(k) and other qualified plans from the bankruptcy estate, up to the amount permitted by the bankruptcy plan. In addition, BAPCPA implemented 11 U.S.C. 1322(f), which prohibits a Chapter 13 plan from altering the terms of a 401(k) plan loan and excludes amounts used to repay loans from qualified plans from the calculation of the debtor's disposable income.

The bankruptcy trustee argued that the Bankruptcy Code, as amended, only allows Chapter 13 debtors to exclude from the property of the estate and disposable income 401(k) plan contributions they are making as of the commencement of the case. The Bankruptcy Panel of the Sixth Circuit agreed, stressing that property of the bankruptcy estate under Bankruptcy Code Sec. 541(a) and exclusions from property of the estate under Sec. 541(b) must be determined on the date of the filing of the case. Pursuant to this understanding, the Panel explained that only 401(k) contributions that are being made at the commencement of the case may be excluded from the property of the estate under Sec. 541(b)(7).

The court added that 11 U.S.C. 1306, which governs property and earnings that come into existence after the debtor files a petition for relief, does not expressly authorize the exclusion of 401(k) contributions from the estate. Sec. 541(b) authorizes the exclusion of 401(k) contributions, but is limited to property in existence at the time the bankruptcy petition is filed. In addition, the court noted that Sec. 541(b)(7) does not shield projected disposable income, which becomes available after the petition is filed. Such funds, the court stated, must be used to make payments to creditors and not directed to 401(k) plan.

Projected disposable income

Under 11 U.S.C. 1325(b)(1)(B), projected disposable income to be received by a debtor during the applicable commitment period must be applied to payments to unsecured creditors. The Panel concluded that, because repayment of a 401(k) loan during the life of the Chapter 13 plan may reasonably be anticipated at time of the confirmation of the plan, the post-petition income that becomes available after the loans are repaid must be considered as projected disposable income that is available to unsecured creditors.

The Panel cited Hamilton v. Lanning (130 S Ct 2464 (2010)), in which the U.S. Supreme Court explained that projected disposable income is based on a debtor's circumstances at the time of confirmation as well as on changes in the debtor's income or expenses that are known or virtually certain at the time of confirmation. Relying on this language, the Panel concluded that the confirmation of a Chapter 13 plan requires debtors to commit the income which becomes available after 401(k) loans are repaid to the payment of unsecured creditors.

CCH Note: The dissent charged that the Panel effectively created an irrebutable presumption that Chapter 13 debtors who increase or begin making contributions to retirement plans after their cases are filed are deemed to be applying all projected disposable income to the payment of their unsecured creditors under their Chapter 13 plans. According to the dissent, the Panel's ruling reflects a presumption that is not contained in the Bankruptcy Code, that contributions to qualified plans are never reasonably necessary to a debtor's maintenance or support, except to the extent that they are ongoing at the time of the filing. The Panel's conclusion, that a debtor may make contributions to a qualified plan during the course of a Chapter 13 bankruptcy only to the extent that such contributions were ongoing at the time the petition was filed, the dissent argued, is not supported by case law or the legislative history underlying BAPCPA.

For more information on this and related topics, consult the CCH Pension Plan Guide, CCH Employee Benefits Management, and Spencer's Benefits Reports.

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