Post-Petition Funds from 401(k) Loan Payoff May Not Be Voluntarily Contributed to Retirement Fund

Posted by NCBRC - February 17, 2012

In an opinion that strains to uphold the conclusion that the “core purpose” of BACPA is to “maximize[e] creditor’s recover[y],” the Sixth Circuit has held that “post-petition income that becomes available to debtors after their 401(k) loans are fully repaid is ‘projected disposable income’ that must be turned over to the trustee for distribution to unsecured creditors pursuant to § 1325(b)(1)(B) and may not be used to fund voluntary 401(k) plans.” Seafort v. Burden, No. 10-6248 (6th Cir. Feb. 15, 2012). The debtor appealed the Bankruptcy Appellate Panel’s reversal of the Bankruptcy Court’s decision in debtor’s favor.

Seafort Opinion

Finding that Hamilton v. Lanning, 130 S.Ct. 2464 (2010), requires that the above-median debtor’s certain or virtually certain post-petition income be considered at plan confirmation, the Sixth Circuit framed the question as whether the debtor’s income stream following repayment of the 401(k) loans was “otherwise excluded” from projected disposable income. Based on three illustrative cases, the court outlined the possible conclusions as:

1)      Regardless of when they begin, all voluntary contributions to 401(k) plans are excluded from the bankruptcy estate subject only to maximum contribution levels under non-bankruptcy law and good faith. In re Johnson, 346 B.R. 256 (Bankr. S.D. Ga. 2006).

2)      Only contributions being made at the time of petition are excluded and those contributions may continue in same amount during course of plan. In re Seafort, 437 B.R. 204 (B.A.P. 6th Cir. 2010).

3)      No contributions to 401(k) plans may be made once the plan commences because section 541(b)(7) is only intended to protect amounts already in the employer’s possession at the time of the bankruptcy petition. In re Prigge, 441 B.R. 667 (Bankr. D. Mont. 2010).

The Sixth Circuit affirmed the decision by the Bankruptcy Appellate Panel but did so under the reasoning of Prigge.

Citing Colliers on Bankruptcy ¶ 541.22C[1] (15th ed. Revised) and quoting Prigge, the court stated that section 541(b)(7) “seems intended to protect amounts withheld by employers from employees that are in the employer’s hands at the time of filing bankruptcy, prior to remission of the funds to the plan.” Reliance on Colliers for this proposition, however, is mistaken as ¶ 1322.20 (16th ed.) of that treatise addresses the very issue presented in Seafort. Discussing cases finding that funds used to repay a 401(k) loan must be applied to the plan once the loan is fully repaid, Colliers explains that “[I]t is not clear whether these decisions comport with the directions of the Supreme Court in Ransom v. FIA Card Servs., N.A., [131 S.Ct. 716 (2011)] that changes in the debtor’s ability to pay using the plan should be dealt with by modification. At the time the payments on the pension loan are finished the debtor may have other expenses, or it may be appropriate for the debtor to make pensions contributions that would be excluded from disposable income by section 541(b)(7).”

Moreover, interpreting the intent of section 541(b)(7) to be limited to the protection only of those funds already turned over to the employer makes little sense as those funds would already be exempted by section 522(d)(12), and, further, would not fit the definition of “disposable income” set forth in section 1325(b)(2).

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