An Individual's Retirement Benefits Under the Bankruptcy Code
| Publication year | 1987 |
| Pages | 1211 |
| Citation | Vol. 16 No. 7 Pg. 1211 |
1987, July, Pg. 1211. An Individual's Retirement Benefits Under the Bankruptcy Code
Commencement of a bankruptcy case creates an estate consisting of all legal or equitable interests owned by the individual debtor.(fn1) A major issue in cases interpreting the scope of estate property has been whether pensions, profit sharing plans and related retirement benefit plans should be included in, or excluded from, the bankruptcy estate.
This article discusses the current debate over excluding retirement benefit plans from the bankruptcy estate of an individual under § 541(c)(2) of the Bankruptcy Code ("Code").(fn2) The article also describes the circumstances under which the debtor may successfully claim an exemption for retirement benefits, and the tax consequences of treating retirement plan assets as estate property.
The Code has expanded the definition of "estate property" contained in the former Bankruptcy Code to include virtually all property owned by the debtor. The debtor then is permitted to exempt out certain property needed for a fresh start.
Code § 541(c)(2) provides that property of the estate does not include the debtor's beneficial interest in a trust if two requirements are met: (1) the trust fund contains a restriction on transfer of the debtor's interest in the fund and (2) the transfer restriction is enforceable under "applicable nonbankruptcy law."
Most retirement benefit plans, including ERISA, KEOGH and Employee Stock Ownership Plans ("ESOPs"), must restrict the transfer of plan assets in order to qualify for special tax treatment;(fn2) accordingly, such qualified plans meet the first requirement imposed by Code § 541(c)(2). However, substantial judicial debate has arisen concerning the meaning of the second requirement that the transfer restriction be enforceable under applicable nonbankruptcy law.
The majority of courts have ruled that "applicable nonbankruptcy law" is intended to be a narrow reference only to state spendthrift trust law and not a broad reference to all other laws, including ERISA.(fn3) They rely primarily on the legislative history of Code § 541(c)(2) in concluding that Congress intended to exclude from the estate only those spendthrift trusts traditionally beyond the reach of creditors under state law. The House Report accompanying H.R. 8200 explains that property of the estate under the Code is intended to continue an exclusion for the debtor's interest in a spendthrift trust to the extent the trust is protected from creditors under state law.(fn4) Further, both House and Senate reports expressly state that the application of § 541(c)(2) is limited to spendthrift trusts.(fn5)
In addition, the overall scheme of the Code demonstrates that a per se exclusion for all ERISA funds under Code § 541(c)(2) would render the exemption provisions of § 522 superfluous. Section 522 permits a debtor to elect between either the state or federal exemptions.(fn6) If the federal exemptions are selected, a debtor may exempt payments under a pension, profit sharing or similar plan if certain requirements are met.(fn7) Thus, Congress specifically protected ERISA benefits via an exemption in Code § 522, yet made no reference to such benefits in Code § 541. If § 541(c)(2) were interpreted broadly to exclude routinely ERISA qualified plans from the estate, the exemption provision as it relates to such plans would be surplusage. However, a narrow interpretation of § 541(c)(2) would not conflict with the exemption provision because retirement plans sometimes would be included in the estate and sometimes would not.(fn8)
Finally, the majority of courts have noted that while ERISA preempts state law, it is not intended to affect the operation of other federal law.(fn9) Consequently, the Code supercedes any ERISA provisions which are inconsistent, including restrictions on alienation of plan assets.(fn10) Since the Code defines property excluded under § 541(c)(2) by reference to spendthrift trusts as defined under state law, the court must look to state law rather than to ERISA.
In contrast to the majority rule, a minority of courts interpret Code § 541(c)(2) expansively by defining "applicable non-bankruptcy law" as encompassing both state and federal laws restricting alienation and assignment.(fn11) For these courts, the appropriate test is not whether the plan
Further, the minority courts reason that Congress, when it enacted ERISA, intended to preempt all state laws regulating retirement benefit plans. Accordingly, federal rather than state nonbankruptcy law controls whether the restrictions on transfer are enforceable in bankruptcy.(fn12) Had Congress intended for the Code to overturn the state preemption provisions of ERISA, it would have done so explicitly. The minority courts see no conflict between the exemption provisions of Code § 522 and Code § 541(c)(2). Where § 541(c)(2) only excludes ERISA qualified plans, § 522(d) permits the debtor to exempt those retirement benefits that do not qualify as spendthrift trusts.
Judge Clark has rendered two decisions on the meaning and scope of Code § 541(c)(2). In In re Pruitt,(fn13) Judge Clark rejected a narrow interpretation of § 541(c)(2) and adopted the minority rule that on its face the section does not limit itself to spendthrift trusts. Moreover, it is broad enough to encompass both state and federal nonbankruptcy law, including ERISA. Since the statute is clear on its face, Judge Clark maintained that there was no need to resort to legislative history. Judge...
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