by Rejecting its dictum to the contrary in Seafort, the Sixth Circuit held that a debtor’s voluntary contributions to her retirement account, begun prior to bankruptcy, may continue during bankruptcy and are excluded from her disposable income. Davis v. Helbling (In re Davis), No. 19-3117 (6th Cir. June 1, 2020).
Ms. Davis had approximately $200,000 in debt of which approximately $189,000 was unsecured. She proposed a chapter 13 plan paying $323.00 for sixty months. The trustee objected on the basis that she underrepresented her disposable income by failing to include $220/month in wages withheld as a contribution to her employee 401(k) retirement plan. The bankruptcy court reluctantly sustained the trustee’s objection, stating that it was bound to follow the Sixth Circuit’s direction on the issue of voluntary contributions to an IRA as set forth in dictum in Seafort v. Burden (In re Seafort), 669 F.3d 662, 674 n.7 (6th Cir. 2012). Ms. Davis amended her plan to reflect the $220 as additional disposable income then objected to her own plan. The bankruptcy court confirmed the amended plan and certified the case for direct appeal.
The Sixth Circuit noted that, prior to the BAPCPA amendments of 2005, voluntary contributions to an IRA were generally not excluded from the calculation of disposable income. In 2005, however, section 541(b)(7)(A), which provides that property of the estate does not include any amount withheld by an employer from the wages of employees as contributions to a 401(k) retirement plan, was amended to add a hanging paragraph stating, “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2).”
Courts have generally interpreted this provision as excluding from disposable income voluntary contributions to retirement plans. However, the Sixth Circuit threw that conclusion into question when it decided Seafort. In that case, the debtor entered bankruptcy while paying off a loan from her retirement plan. The loan payments were excluded from income pursuant to section 1322(f). The conflict arose out of the debtor’s request to continue to commit the same amount to the retirement account as voluntary contributions once the loan was fully paid off during the course of the plan. The court found that funds made available by completion of payments toward a loan from a retirement plan become part of a debtor’s disposable income under section 1325(b)(1). In a footnote, the Sixth Circuit, citing In re Prigge, 441 B.R. 667 (Bankr. D. Mont. 2010), added that “a Chapter 13 debtor may never deduct ‘voluntary post-petition retirement contributions in any amount regardless of whether the debtor [made] pre-petition retirement contributions.’” It was this dictum that directed the reluctant decision of the bankruptcy court in the current case.
In the current appeal, the Sixth Circuit found that its decision turned on interpretation of “such amount” in the hanging paragraph of section 541(a)(7)(A): whether it refers to the ongoing monthly payments the debtor began prior to bankruptcy, as argued by the debtor, or whether it refers only to the amount the debtor had already committed to her retirement account prior to filing for bankruptcy, as the trustee argued and as the dictum in Seafort directs.
The court began with the observation that “amount” usually refers to a discrete sum representing a value or cost. It further observed that the hanging paragraph, in which the term “except that” does not actually relate to an exception to a previously stated rule, is an example of inelegant drafting. To resolve the confusion, the court looked to the context of section 541(a)(7)(A) and the 2005 amendment. Prior to 2005, the established law was that voluntary contributions to retirement plans were not excluded from the calculation of disposable income. The Sixth Circuit reasoned that the language in the hanging paragraph appeared to be intended to work a change on preceding law, suggesting that Congress intended to exclude those contributions from disposable income.
Based on this reasoning, the court held “that the hanging paragraph is best read to exclude from disposable income the monthly 401(k)-contribution amount that Davis’s employer withheld from her wages prior to her bankruptcy. That interpretation reads the amendment to § 541(b), which added the hanging paragraph, in a way that actually amends the statute. It also gives a meaningful effect—one not already accomplished by § 1325(b)(2)—to Congress’s instruction in § 541(b)(7) that 401(k) contributions ‘shall not constitute disposable income.’”
The court found that the trustee’s argument that the hanging paragraph simply excludes from disposable income the funds the debtor paid into her retirement account prior to filing for bankruptcy would drain the hanging paragraph of all meaning as those funds would not be considered disposable income under section 1325(b)(2). With respect to the “gordian knot” created by Congress’s inexplicable use of the term “except that,” the court pointed to other provisions in the Bankruptcy Code in which Congress similarly used the term, finding that the term is a grammatical error that does not dictate interpretation of the provision. With respect to its dictum in Seafort, the court found that, as dictum, it did not set a precedent to which the doctrine of stare decisis would apply.
The court emphasized that its holding did not extend to contributions a debtor might seek to begin making after the bankruptcy petition.
In a dissenting opinion, Judge Readler argued that the dictum expressed in Seafort stated the correct view: that “a debtor’s pre-filing 401(k) contributions are protected from creditors; those sought to be made during the post-filing Chapter 13 reorganization period are not.” The dissent argued that the enactment of the hanging paragraph was intended to codify the majority view that post-petition contributions to a retirement fund were not excluded from disposable income in the face of a few outlying courts that, prior to BAPCPA and contrary to the majority’s position, had held that they were. Thus, where the majority relied on its conclusion that Congress sought to make a significant change in the prior law, the dissent held the view that Congress sought only to clarify that the prior law was correct. The dissent opined that the “except that” phrase was Congress’s use of redundancy to emphasize its interest in protecting funds contributed to a retirement account prior to the bankruptcy filing.