Wednesday, November 22, 2006

Judge Kelly Finds 401k Loans Deductible Under Means Test

Judge Larry Kelly has recently held that 401k loans may be deducted in performing the chapter 7 means test. In re Otero, 06-30691 (Bankr. W.D. Tex. 11/2/06). BAPCPA expressly designates 401k loans as allowable expenses in chapter 13 cases. 11 U.S.C. Sec. 1322(f). However, there is not a similar provision with respect to the chapter 7 means test. Judge Kelly's ruling differs from a recent decision on this issue out of the Northern District. In re Barraza, 346 B.R. 724 (Bankr. N.D. Tex. 2006).

BAPCPA generally gives favorable treatment to retirement plans. Retirement plans loans have an exception from the automatic stay under Sec. 362(b)(19). Retirement plans are exempt up to $1 million under the federal exemptions pursuant to Sec. 522(d)(12). Retirement plan loans are non dischargeable under Sec. 523(a)(18). Finally, amounts withheld from the debtor's wages to be contributed to retirement plans are not property of the estate under Sec. 541(b)(7). However, while chapter 13 expressly allowed the deduction from disposable income, the chapter 7 means test under Sec. 707(b) was silent.

When this issue was argued to Judge Russell Nelms, the parties apparently framed the issue as to whether the payments could be deducted as "other necessary expenses." Judge Nelms found that they could not, but asked "why would Congress presume under section 707(b)(2)(A) that this amount of money could be used to pay unsecured creditors, and then deny unsecured creditors access to that money in chapter 13?"

However, Judge Kelly was asked to decide whether 401k loan payments could be deducted from the means test income as secured debts. While the U.S. Trustee argued that these "loans" were really just advances against the debtor's entitlement to receive retirement plan assets later, Judge Kelly concluded that they met the statutory definitions of secured debts.

Judge Kelly stated:

"The parties do not dispute that funds were advanced to the Debtors, that there exists documentation giving the plan administrator a 'lien claim' against the funds in the Debtors' 401K accounts, and that such accounts represent property of the Debtors. Each loan is therefore certainly a 'claim against property of the debtor' and so also a 'claim against the debtor,' which makes the interest of the plan administrator a 'security interest' against property of these Debtors. This court thus concludes that each loan is a 'secured claim' within the intendment of 11 U.S.C. Sec. 707(b)(2)(A)(iii)."

Judge Kelly's ruling follows an impeccable trail of statutory construction and harmonizes the Code's treatment of retirement plan loans. Not only is Judge Kelly's result right, but it is also the same argument made by this blog at the time that Barraza came out.


The U.S. Trustee appealed Judge Kelly's decision and obtained an opinion from the U.S. District Court reversing it. McVay vs. Otero, 371 B.R. 190 (W.D. Tex. 4/26/07). The District Court looked at the same language as Judge Kelly and concluded that a loan against a 401k plan was NOT a debt, so that it could not be a secured debt deductible under the means test. In making this ruling,the District Court followed the majority position.

The Debtors did not further appeal the District Court ruling. Instead,they converted to Chapter 13 and proposed a plan which allowed them to deduct the 401k payments from disposable income. The Debtor's plan was confirmed on November 19, 2007. Under the confirmed plan, unsecured creditors will receive approximately 3% on their claims.


Dawn Marie Cutaia said...

I'm curious if you think that IRA payments that a debtor has been making regularly would be a permitted deduction from disposable income to reduce a chapter 13 plan. The code is very specific about 401(k)s and 403(b)s under 541(b)(7), but does not permit the same treatment for IRAs. Are you aware of any cases that permit this?

Dawn Cutaia, A bankruptcy attorney in York, PA

Steve Sather said...

I was not able to find anything under BAPCPA. In re Hill, 328 B.R. 490 (Bankr. S.D. Tex. 2005)is typical of these cases. It states:

"Courts have considered whether voluntary 401(k) contributions should be considered in determining a debtor's disposable income. Some courts have likened the 401(k) analysis to earlier analyses of payments into ERISA accounts. In considering payments into ERISA accounts, one court held that 'it would be unfair to the creditors to allow the Debtors in the present case to commit part of their earnings to the payment of their retirement fund while at the same time paying their creditors less than a 100% dividend.' In re Jones, 138 B.R. 536, 539 (Bankr. S.D. Ohio 1991).

"The same reasoning has been applied equally to 401(k) and IRA contributions. See, e.g., In re Behlke, 358 F.3d 429, 435 (6th Cir. 2004); In re Dehart, 195 F.3d 177, 180-81 (3d Cir. 1999). Consequently, there is an 'overwhelming consensus among bankruptcy courts that debtor's voluntary payment into pension, savings, or 401(k)-type plan is not a reasonably necessary expenditure,' and therefore must be included in a debtor's disposable income under § 1325(b)(2). In re Heffernan, 242 B.R. 812, 818 (Bankr. D. Conn. 1999); see also In re Austin 299 B.R. 482, 486-87 (Bankr. E.D. Tenn. 2003); In re Keating, 298 B.R. 104, 110-11(Bankr. E.D. Mich. 2003)."

The issue would be whether the policies behind BAPCPA to encourage retirement savings could be extended to permit IRA savings despite the prior case law and despite the failure to expressly include them in the law.