by The Sixth Circuit held that “the bankruptcy code’s text does not permit a Chapter 13 debtor to use a history of retirement contributions from years earlier as a basis for shielding voluntary post-petition contributions from unsecured creditors. This is true even if the debtor had no ability to make further contributions in the six months preceding filing; the code makes no exception for such circumstances.” Penfound v. Ruskin (In re Penfound), No. 19-2200 (6th Cir. Aug. 10, 2021).
In this case, the debtor, Mr. Penfound, made regular voluntary contributions to his 401(k) for many years until he switched jobs. Because his new employer did not offer a 401(k) plan, the debtor’s voluntary contributions ceased for at least six months prior to his bankruptcy petition. He then began a new job with an employer that offered a retirement plan, and at some point began making voluntary contributions to the plan. Just over one month after beginning his new job, Mr. Penfound and his wife filed for chapter 13 bankruptcy. They sought to deduct the 401(k) contributions from the disposable income calculation. The trustee objected to confirmation of their plan.
The bankruptcy court found that, under dictum in Seafort v. Burden (In re Seafort), 669 F.3d 662 (6th Cir. 2012), the debtors’ plan could not be confirmed. The debtors drafted a new plan in accordance with the court’s order, and the bankruptcy court confirmed it with the proviso that the debtors retained their right to appeal its earlier decision. They did so and the district court affirmed.
Section 541(b) provides that property of the estate does not include—
“(7) any amount—
(A) withheld by an employer from the wages of employees for payment as contributions—
(i) to—
(I) [a 401(k)-retirement plan]
. . .
except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2) . . . .”
This section, including the oddly worded hanging paragraph, were enacted by Congress with the BAPCPA amendments in 2005.
On appeal, the circuit court conducted a tour of the treatments voluntary contributions to 401k plans have received since Congress introduced section 541(b)(7). The majority view, represented by Baxter v. Johnson (In re Johnson), 346 B.R. 256, 263 (Bankr. S.D. Ga. 2006), removes all good faith voluntary contributions from the calculation of disposable income regardless of when they are begun. The opposite view was set forth in In re Prigge, 441 B.R. 667, 677 & n.5 (Bankr. D. Mont. 2010), where the court held that voluntary contributions to a 401k could never be withheld from disposable income.
The third and fourth approaches permit continuation of pre-bankruptcy contributions. In Burden v. Seafort (In re Seafort), 437 B.R. 204 (B.A.P. 6th Cir. 2010) (Seafort-BAP), the debtors entered bankruptcy while paying off loans from their 401(k)s. They sought to continue making contributions to their retirement accounts after the loans were fully paid. That panel “construe[d] the hanging paragraph to exclude the debtor’s pre-petition contribution amount—rather than merely her accumulated savings—from her disposable income,” and expressed the view that to the extent a debtor had been making payments to a retirement fund prior to bankruptcy, she may continue to do so during bankruptcy. Under that reasoning, the debtor could not rededicate loan repayment funds to voluntary contributions during the course of the bankruptcy because those contributions did not pre-date the bankruptcy.
Similarly, the approach represented by In re Anh-Thu Thi Vu, No. 15-41405-BDL, 2015 WL 6684227, at *3 (Bankr. W.D. Wash. June 16, 2015) and In re Bruce, 484 B.R. 387, 391–94 (Bankr. W.D. Wash. 2012), relied on section 541(b)’s reference to section 1325(b)(2) which uses the debtor’s current monthly income to calculate disposable income (the “CMI” interpretation). Under that interpretation, a debtor may exclude the average monthly contributions made in the six months preceding the bankruptcy petition. Thus, the debtor who begins making voluntary contributions less than six months prior to entering bankruptcy may have a higher disposable income than they would under Seafort-BAP.
The Sixth Circuit first addressed the issue in the debtor’s appeal from Seafort-BAP. In affirming that decision, the court rejected the Johnson approach, which permits any good faith retirement contributions, and indicated in dictum that it adhered to the strict holding in Prigge against permitting voluntary contributions to be deducted from disposable income under any circumstances.
That dictum was later discarded in Davis v. Helbling (In re Davis), 960 F.3d 346, 355–57 (6th Cir. 2020). There, the debtor entered bankruptcy at a time when she had been making regular voluntary contributions to the 401k for at least six months. The court found those contributions could be excluded from the disposable income calculation. Thus, in Seafort, the circuit court definitively rejected Johnson, and in Davis, it definitively rejected Prigge.
The debtors here asked the court to extend its holding in Davis to allow them to reinstitute voluntary contributions post-petition, arguing that Mr. Penfound he had stopped making the contribution only because his short-lived employer did not offer that option. The court declined to do so. It found that while the debtor’s history of voluntary contributions indicated the requisite good faith for plan confirmation, that was not enough to remove such contributions from the calculation of disposable income. The court reasoned that neither the Davis approach nor the CMI approach permit a court to look back further than six months prior to the bankruptcy petition for determining whether a debtor’s voluntary contributions may be excluded from disposable income. To the extent that policy arguments favor the debtor, the court found that the issue was one for Congress to address. The court, therefore, did not decide between the Seafort-BAP approach and the CMI approach.
The court affirmed.