by The court held its nose and slogged through the trustee’s lengthy complaint riddled with errors and legal misconceptions to find that the debtor’s retirement accounts totaling approximately $1.7 million were not property of the bankruptcy estate. McDonnell v. Gilbert (In re Gilbert), No. 21-12725, Adv. Proc. No. 22-1005 (Bankr. D. N.J. Aug. 23, 2022).
When the debtor filed for chapter 7 bankruptcy, he was the named beneficiary on two retirement accounts: a 401(a) Defined Benefit plan holding over $1.6 million, and a 401(k) plan holding over $47,000. The trustee filed an initial adversary complaint against both the debtor and his ex-wife. The debtor’s ex-wife was dismissed with prejudice and the trustee filed an amended complaint against the debtor. The amended complaint sought declaratory judgment, injunctive relief, and recovery of money or property. The debtor moved to dismiss the amended complaint.
In Count One of the complaint, the court untangled the trustee’s argument to address the contention that the plans were property of the bankruptcy estate under section 541, and that they were not exempt under section 522(d)(12). Because a negative answer to the first question avoids the necessity of addressing the second, the court began with what constitutes estate property.
The court looked to whether the accounts fell under the umbrella of section 541(c)(2), which excludes from the bankruptcy estate a debtor’s interest in property where that interest is in a trust that is subject to a “restriction on the transfer . . . enforceable under applicable nonbankruptcy law.”
The court found the two accounts had a “trust res,” a beneficiary, and a trustee, thereby establishing that they were “trusts” within the meaning of section 541(c)(2). The court turned to the issue of whether there was a restriction on transfer enforceable under nonbankruptcy law to satisfy the remaining requirement of section 541(c)(2). It noted that both accounts included anti-alienation clauses.
The Court in Patterson v. Shumate, 504 U.S. 753 (1992), established that “applicable nonbankruptcy law” is not limited to state law but may include federal laws such as ERISA and the Tax Code. In Patterson, the plan at issue satisfied both ERISA and relevant tax provisions. For that reason, and because the Court in Patterson used the term “ERISA-qualified,” some later courts found that in order to satisfy the anti-alienation requirement of section 541(c)(2), the interest must comply with all tax regulations even if the plan otherwise complies with ERISA. Here, the trustee argued that the plans did not meet the requirement of anti-alienation because, while the restriction on transfer was enforceable under ERISA, it was not enforceable under the Tax Code.
The court rejected that line. It found that the text of section 541(c)(2) imposes no such requirement, and that had Congress intended to impose a tax qualification to the anti-alienation provision, it could have done so. Rather, the court found that “[f]or purposes of § 541(c)(2) it only matters that the plan at issue be subject to ERISA and contain an anti-alienation clause as required by § 206(d)(1) of ERISA.” The court disagreed with In re Goldschein, 244 B.R. 595 (Bankr. D. Md. 2000) where the court found that Congress intended the Tax Code and ERISA to work “in consort” for purposes of exclusion from the bankruptcy estate. The court also found several other cases relied on by the Trustee were inapposite as they merely interpreted whether state instruments met their own internal requirements.
Although the Trustee framed the issue in Count One as whether the accounts were exempt, the court found the Trustee failed to make a distinction between estate property that is removed from the bankruptcy estate as exempt, and that which never becomes part of the bankruptcy estate in the first place. Finding that the accounts here satisfied the requirements for exclusion set forth in section 541(c)(2), the court granted the debtor’s motion to dismiss Count One.
In Count Two the trustee sought an order enjoining the debtor from taking distributions from the accounts. In a previous order, the court imposed “temporary restraints [which would] remain in place through the conclusion of that hearing and entry of further order if warranted.” The court observed that the standards for a stay pending appeal and a preliminary injunction are the same. Because the temporary injunction was still in place as of the date of the opinion, the court agreed to set a hearing on the injunction with the understanding that that hearing could be in the context of a stay pending appeal.
Count Three was a “conceptually flawed” effort to obtain return of a preferential transfer, specifically seeking to “claw back” the entire contents of both accounts. The court found the claim “baffling” as the contents of the accounts were actually in the accounts as of the petition date. Moreover, if the accounts were part of the bankruptcy estate, the court reasoned, the Trustee would have control over them without need of a claw back. If the accounts were not part of the estate, as the court found here, the Trustee would have no right to a “claw back.”
In addition to that basic flaw, the court found that other elements of preferential transfer were not present, including that there was no actual transfer and no benefit to any creditor. The Trustee’s argument hinged on a July, 2020, amendment to the debtor’s DB plan which the Trustee maintained memorialized the ex-wife’s half share of the account and the transfer of that interest to the debtor in accordance with a Marriage Settlement Agreement. But the court found the restatement of the DB was simply a housekeeping task required for all DB plans by the IRS. In fact, the court found no evidence that the debtor transferred any property interest belonging to the estate for the benefit of any creditor. Moreover, the Trustee failed to allege that, to the extent there was a transfer, it was made while the debtor was insolvent.
The remaining counts involving similar challenges to an alleged transfer, failed for the same reasons as well as for the additional failures to allege the other elements necessary to maintain the claims. The trustee’s attempt to stand in the shoes of the IRS for transfer avoidance purposes under section 544’s strong-arm provision, failed because the IRS was not a creditor and there was no evidence that the debtor had any tax liability in the 10 years before filing for bankruptcy. “In other words, [the court said], the Trustee is skipping over the crucial step of alleging sufficient facts in the complaint to allow this court to conclude that there is ‘a creditor holding an unsecured claim that is allowable under section 502.’”
Finally, the court declined to allow the Trustee the opportunity to amend the complaint again, finding that, given the pervasive problems with the current complaint, amendment would be futile.
The court granted the debtor’s motion to dismiss.