Lump Sum Workers’ Compensation Settlement Exempt under 522(d)(11)

Posted by NCBRC - February 11, 2015

Contrary to majority opinion, proceeds of a lump sum workers’ compensation settlement were found to be exemptible under section 522(d)(11)(E), to the extent necessary for support of the debtor and his dependents. In addition, a Medicare “set aside” is not property of the estate. Carr v. Arellano (In re Arellano), No. 14-990 (Bankr. M.D. Pa. Jan. 5, 2015).

After sustaining a broken hip at work the debtor entered into a workers’ compensation settlement agreement under which he received a lump sum payment of $225,000. In addition, $72,741.88 was paid to the debtor as a Medicare “set aside,” representing the estimated cost of future treatment. The debtor used some of the money to buy a truck and two pieces of real property one of which he then sold to his brother in an installment agreement. When the debtor later filed chapter 7 bankruptcy he sought to exempt both real properties, the vehicle and the funds remaining from the worker’s compensation settlement under section 522(d)(11)(E). Citing In re Michael, 262 B.R. 296 (Bankr. M.D. Pa. 2001), the trustee objected to the exemptions on the basis that that section does not apply to workers’ compensation claims.

Section 522(d)(11)(E) permits a debtor to exempt “property that is traceable to . . . a payment in compensation of loss of future earnings of the debtor . . . , to the extent reasonably necessary for the support of the debtor and any dependent of the debtor.”

The court began with the controversy surrounding application of sections 522(d)(10) and 522(d)(11) to workers’ compensation funds, acknowledging that in Michael, the court upheld the trustee’s objection to the exemption on the basis that workers’ compensation claims must be exempted, if at all, under section 522(d)(10)(C). The court noted that Michael is not alone in drawing a distinction between paragraphs (d)(11) and (d)(10) as applied to workers’ compensation claims. “The rationale of these cases, based primarily on the legislative history, is that § 522(d)(10) applies to payments in lieu of future earnings and § 522(d)(11) addresses compensation for tort type recoveries. Finding workers’ compensation awards to be compensation for the loss of future earnings, these courts have determined that § 522(d)(11)(E) is unavailable.” In this case, because the workers’ compensation claim was settled, like a tort claim, with a lump sum payment, it did not fall neatly into either of the paragraphs as interpreted by the majority of courts.

The Arellano court rejected the distinction, reasoning that by interpreting the two paragraphs as mutually exclusive, debtors in Arellano’s position are arbitrarily deprived of the benefit of the exemption. Instead the court turned to other cases that have questioned the majority view. In re Holstine, 458 B.R. 392, 395 (Bankr. E.D. Mich. 2011) aff’d, No. 11-14573, 2012 WL 2891220 (W.D. Mich. July 15, 2012); In re Sanchez, 362 B.R. 342 (Bankr. W.D. Mich. 2007). Those courts recognized the injustice of differentiating between worker’s compensation claims which were paid over time (exemptible under paragraph (d)(10)) and those paid in a lump sum (not exemptible under either (d)(10) or (d)(11)). Both courts concluded that the language of section (d)(11) does not limit the exemption to tort claims. Workers’ compensation claims are designed to compensate a worker for loss of future earnings and, so long as the funds are traceable to that claim and are necessary to provide for the needs of the debtor and/or his dependents, section 522(d)(11) plainly applies.

The court turned to the Medicare “set aside” which was created in accordance with the Workers’ Compensation Medicare Set Aside Arrangements “WCMSA.” Notwithstanding the absence of an explicit designation of the fund as a “trust” the court found that the express intent of the set aside was “to create a fund from which Debtor was to pay for his medical treatments and prescription drugs related to his work-related injury. Even though the agreement does not specifically state that Debtor is to hold the funds as trustee for the benefit of his medical providers, no such words are needed in order to create an express trust.”  As such, the funds were excluded from the bankruptcy estate under section 541(d).

The court then addressed whether the property and funds that were traceable to the workers’ compensation settlement were necessary for the support of the debtor and his dependents. The burden was on the trustee to demonstrate that the debtor could not meet the requirements of this aspect of the exemption. The trustee challenged the debtor’s use of the settlement funds to purchase real property and a truck as demonstrating that the funds were not necessary for support.

The court disagreed. It found that that debtor purchased a “modest” house, a truck and investment property, all of which were traceable to the workers’ compensation proceeds. With respect to the investment property, the court found that the bulk of the installment payments went to repay the principal and that the amount representing interest was too small to be of significant value to the bankruptcy estate. Given that the debtor and his wife and three children were living just above the poverty level, the debtor, at forty-four, was too young to receive social security or pension benefits in the near future, the debtor spoke little English and there was no evidence to suggest that he could find employment, the court found that the weight of the evidence demonstrated that the property and funds were necessary for the support of the debtor and his family.

Arellano Bankr MD Pa opinion


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