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6th Cir. Holds Voluntary 401(k) Contributions Are Not ‘Disposable Income’ for Chapter 13 Bankruptcy Plans

bankruptcyThe U.S. Court of Appeals for the Sixth Circuit recently held that wages withheld as a voluntary 401(k) contribution prior to filing bankruptcy were not considered “disposable income” under a Chapter 13 bankruptcy plan.

A copy of the opinion in In re Camille Davis is available at:  Link to Opinion.

An individual debtor (“consumer”) filed a Chapter 13 bankruptcy with more than $200,000 in debt ($189,000 unsecured debt) and fewer than $39,000 in assets.

As you may recall, a Chapter 13 allows a consumer to satisfy her unsecured debts by paying all her disposable income to her unsecured creditors during a 60-month commitment period.

The consumer proposed a bankruptcy plan that would pay her unsecured creditors 60 monthly payments of $323 based on her reported gross monthly income of $5,627 and $5,304 in claimed allowable monthly expenses. The claim expenses included $220.66 her employer withheld as a contribution to a 401(k) retirement plan.

The trustee objected to the consumer’s plan and contended that 401(k) contributions are considered disposable income. The bankruptcy court sustained the trustee’s objection. As a result, the consumer filed an amended bankruptcy plan that would pay her unsecured creditors $519 each month, which included the 401(k) contributions as part of her disposable-income calculation. The consumer then objected to her own plan to preserve it for appellate review.

The plan was confirmed by the bankruptcy court, and the consumer appealed.

The Sixth Circuit started its review by examining Section 1325(b)(1) of the Bankruptcy Code.  This paragraph provides that, upon objection, a bankruptcy plan cannot be approved “unless . . . [it] provides that all of the debtor’s projected disposable income to be received in the applicable commitment period . . . will be applied to make payments to unsecured creditors.” Section 1325(b)(2) defines “disposable income” as the debtor’s “current monthly income . . . less amounts reasonably necessary to be expended . . . for the maintenance or support of the debtor.” “Projected disposable income,” as used in § 1325(b)(1), is not defined anywhere in the Bankruptcy Code.

The Court next noted that before 2005, the “overwhelming consensus” among bankruptcy courts was that wages voluntarily withheld as 401(k) contributions formed part of a debtor’s disposable income. However, in 2005, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA).

BAPCPA amended the Bankruptcy Code and added 11 U.S.C. § 541(b)(7). In relevant part, § 541(b)(7)(A) provides:

     (b) 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).

The language “except that such amount under this subparagraph shall not constitute disposable income as defined in section 1325(b)(2)” is known as the “hanging paragraph” and its meaning has led to considerable disagreement and spawned four competing interpretations.

The leading interpretation is Baxter v. Johnson (In re Johnson), 346 B.R. 256, 263 (Bankr. S.D. Ga. 2006) where the bankruptcy court concluded that the hanging paragraph “plainly state[s] that [401(k)] contributions ‘shall not constitute disposable income.’” Id. (quoting 11 U.S.C. § 541(b)(7)). In its view, BAPCPA “placed retirement contributions outside the purview of a Chapter 13 plan.” Id. Thus, Johnson held that a debtor’s disposable income does not include the wages she contributes to her 401(k) plan — whether or not those contributions began prior to bankruptcy. Id.

In re Prigge, 441 B.R. 667 (Bankr. D. Mont. 2010), offers a competing interpretation and held 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.” That interpretation focuses on the hanging paragraph’s location within Section 541. Section 541 defines the contours of the bankruptcy estate—a concept that deals primarily with pre-petition assets. Drawing clues from that context, the Prigge interpretation construes the hanging paragraph to reach only pre-petition assets. See id.; McCullers, 451 B.R. at 504–05; Prigge, 441 B.R. at 677 n.5. In effect, this interpretation reads the hanging paragraph as excluding from disposable income under Section 1325(b)(2) only accumulated 401(k) savings—rather than an ongoing contribution amount.

The Sixth Circuit itself previously held that “post-petition income that becomes available to debtors after their 401(k) loans are fully repaid is ‘projected disposable income’” under § 1325(b)(1). Seafort v. Burden (In re Seafort), 669 F.3d 662, 674 n.7 (6th Cir. 2012). This interpretation is referred to as “Seafort-BAP” and construes the hanging paragraph to exclude the debtor’s pre-petition contribution amount—rather than merely her accumulated savings—from her disposable income under § 1325(b)(2). Under this interpretation, a debtor may deduct 401(k) contributions from her disposable income if she made an equal or greater monthly contribution prior to her bankruptcy.

The fourth interpretation is a modified version of Seafort-BAP known as the “CMI interpretation” which construes the hanging paragraph as excluding the debtor’s pre-petition contributions from the calculation of her “current monthly income”—a subcomponent of § 1325(b)(2)’s disposable-income calculation.

The Sixth Circuit next noted, among the four competing interpretations of the hanging paragraph, three support the consumer’s view: Johnson, Seafort-BAP, and CMI. However, the Sixth Circuit has previously rejected the Johnson interpretation, which leaves the consumer with the Seafort-BAP and CMI interpretations for support. In contrast, the Prigge interpretation supports the trustee’s position, which is that voluntary retirement contributions can never be excluded from disposable income, regardless of whether the debtor was making such contributions prior to her bankruptcy.

In examining the competing interpretations, the Sixth Circuit relied on established canons of construction to guide its ruling.

First, the reenactment canon provides that whenever Congress amends a statutory provision, “a significant change in language is presumed to entail a change in meaning.” Arangure v. Whitaker, 911 F.3d 333, 341 (6th Cir. 2018). The court must therefore presume that the hanging paragraph altered existing law.

Next, the presumption against ineffectiveness offers similar guidance. See Antonin Scalia & Bryan A. Garner, Reading Law 63 (2012). That presumption reflects “the idea that Congress presumably does not enact useless laws.” United States v. Castleman, 572 U.S. 157, 178 (2014) (Scalia, J., concurring). In other words, when the plain meaning of a provision is not clear, [the court] should avoid interpretations that render the provision a “dead letter.” United States v. Hayes, 555 U.S. 415, 427 (2009). Thus, the court should be skeptical of interpretations that deprive the hanging paragraph of any meaningful effect.

Finally, the canon against surplusage provides a related command. It conveys the familiar rule that courts should “give effect, if possible, to every word Congress used.” Nat’l Ass’n of Mfrs. v. Dep’t of Def., 138 S. Ct. 617, 632 (2018) (quoting Reiter v. Sonotone Corp., 442 U.S. 330, 339 (1979)).

The Sixth Circuit concluded that the hanging paragraph is best read to exclude from disposable income the monthly 401(k)-contribution amount that the consumer’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. The Court noted that 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 Sixth Circuit clarified that its holding was narrow and should not be read to curtail the good-faith analysis required by § 1325(a)(3). That provision prohibits a bankruptcy court from confirming a Chapter 13 plan unless the debtor proposed it in good faith. See Shaw v. Aurgroup Fin. Credit Union, 552 F.3d 447, 455 (6th Cir. 2009).

The Court’s reading of the hanging paragraph may necessitate a more searching good-faith analysis to minimize the risk that a debtor contemplating bankruptcy might begin making 401(k) contributions prior to filing to lower the amount she must ultimately repay her creditors. Here, however, there was no assertion that the consumer proposed her plan in bad faith.

Accordingly, the Sixth Circuit vacated the bankruptcy court’s order confirming the Chapter 13 plan.

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The attorneys of Maurice Wutscher are seasoned business lawyers with substantial experience in business law, financial services litigation and regulatory compliance. They represent consumer and commercial financial services companies, including depository and non-depository mortgage lenders and servicers, as well as mortgage loan investors, financial asset buyers and sellers, loss mitigation companies, third-party debt collectors, and other financial services providers. They have defended scores of putative class actions, have substantial experience in federal appellate court litigation and bring substantial trial and complex bankruptcy experience. They are leaders and influencers in their highly specialized area of law. They serve in leadership positions in industry associations and regularly publish and speak before national audiences.

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