LEXIS-NEXIS® Congressional Universe-Document
LEXIS-NEXIS® Congressional
Copyright 2000
Federal News Service, Inc.
Federal News Service
April 13, 2000, Thursday
SECTION: PREPARED TESTIMONY
LENGTH: 8495 words
HEADLINE: PREPARED TESTIMONY OF BRUCE A. MARKELL PROFESSOR OF LAW
BEFORE THE
SENATE COMMITTEE ON HEALTH, EDUCATION, LABOR AND PENSIONS
SUBJECT - A MORE SECURE RETIREMENT FOR WORKERS: PROTECTING PENSION ASSETS IN
BANKRUPTCY
BODY:
I thank the Committee for inviting me to appear today. By way of background, I
am a professor of law at the William S. Boyd School of Law of the University of
Nevada, Las Vegas. I am also Of Counsel to the Indianapolis, Indiana law firm
of Ancel
& Dunlap, LLP. During 1999, I served as the Bruce W. Nichols Visiting Professor
of Law at the Harvard Law School, and the Southeastern
Bankruptcy Law Institute Visiting Professor of Law at Georgia State University.
I write and teach in the areas of commercial law and
bankruptcy. I author several chapters in Collier on
Bankruptcy, am a revision editor for the Collier
Bankruptcy Manual. I sit on the advisory board of the American
Bankruptcy Law Journal. I am also a member of the American Law Institute and
a conferee of the National
Bankruptcy Conference. I appear here today in my individual capacity as a scholar and
citizen, and thus neither this statement or my testimony necessarily represents
the official position of any of these organizations, or of my employer, the
University of Nevada.
I. Introduction
The Committee has asked for my views on Section 303(c) of H.R. 833, as passed
by the Senate on February 2, 2000./1 If enacted into law, this subsection would
allow individuals to waive their exemption in retirement assets at any time
before or during
bankruptcy. I believe this section represents bad
bankruptcy policy.
As this is, I believe, the first time the Senate has heard testimony on this
provision, as it was originally introduced after the bill had been reported
on,/2 I will thus try to be explicit in justifying my views. This requires an
exploration of other provisions of H.R. 833, since Section 303(c) relies
heavily on amendments to be made by Section 224 of that bill. As requested by
the committee, I will situate these amendments in the context of the current
state of case law regarding the intersection of rights to retirement assets and
bankruptcy. I next review the demographics of those older Americans filing
bankruptcy, in order to understand the broad scope of change wrought by Section 303(c). I
close with some comments on the potential adverse consequences of Section
303(c).II. The Proposed Amendments
A. Section 303(c) of H. R. 833
Section 303(c) consists of an amendment to Section 522(e) of title 11 of the
United States Code (hereinafter, the
"Bankruptcy Code"). Section 522(e) as it currently reads states that:
(e) A waiver of an exemption executed in favor of a creditor that holds an
unsecured claim against the debtor is unenforceable in a case under this title
with respect to such claim against property that the debtor may exempt under
subsection (b) of this section. A waiver by the debtor of a power under
subsection (f) or (Ii) of this section to avoid a transfer, under subsection
(g) or (i) of this section to exempt property, or under subsection (i) of this
section to recover property or to preserve a transfer, is unenforceable in a
case under this title.
This provision invalidates attempts
by unsecured creditors (such as the normal credit card issuer or utility
service provider) to obtain the ability, upon a debtor's default, to levy upon
and seize exempt assets to satisfy unpaid debts. Thus, this section protects
homesteads and other necessities of life from possible overreaching by
creditors.
Section 303(c) would amend this protection by changing Section 522(e) to read
as follows (with additions in italics, and deletions in strikeouts):
(e) A waiver of an exemption executed in favor of a creditor that holds an
unsecured claim against the debtor is unenforceable in a case under this title
with respect to such claim against property that the debtor may exempt under
subsection (b) action other than under paragraph (3)(C) of that subsection). A
waiver by the debtor of a power under subsection (f) or (Ii) of this section to avoid a transfer, under subsection (g) or (i) of this
section to exempt property (other than property described in subsection
(b)(3)(C)), or under subsection (i) of this section to recover property (other
than property described in subsection (b)(3)(C)) or to preserve a transfer, is
unenforceable in a case under this title.
Simply put, the amendment carves out a certain class of assets--those mentioned
in Section 522(b)(3)(C)-from the protection of the anti- waiver provisions.
Section 522(b)(3)(c), in turn, covers retirement assets, and is a new section
proposed to be added by Section 224 of H.R.833. Thus, if enacted into law, this
change would strip Section 522(e)'s anti-waiver protection from those
retirement assets specified in Section 224.
An examination of Section 224 shows just how far this carve out reaches.
B. Section 224 of H. R. 833
Section 224 attempts to protect retirement assets in
bankruptcy./3 It does so by declaring certain types of retirement assets to be exempt from
creditors' claims in
bankruptcy, thus preserving those assets for the debtor./4 The scope of this intended
protection is, as indicated earlier, broad. Section 224(a)(1)(A)(iv) would add
the following description as property available for exemption:
(C) retirement funds to the extent that those funds are in a fund or account
that is exempt from taxation under section 401, 403, 408, 408A, 414, 457 or
501(a) of the Internal Revenue Code of 1986.
Although Section 224 does not define the term
"retirement funds," this enumeration of taxfavored accounts and funds is
fairly exhaustive, and covers most of the type of retirement plans within this
Committee's purview. In particular, the list of sections specified covers most
employer-provided pension plans (including 401(k) plans and Keogh plans),
regular IRAs, and Roth IRAs.
Section 224 also classifies such retirement assets as exempt property./5 In
those cases in which Section 522(d) provides the applicable list of
exemptions,/6 Section 224(a)(2)(B) exempts retirement assets meeting the above
definition. In those cases in which a State has opted out of the federal
exemptions (as permitted by current Section 522(b)(1) of the
Bankruptcy Code), Section 224(a)(1)(D) creates a presumption that such retirement funds
are exempt, apparently notwithstanding any applicable State law to the
contrary./7
Thus, Section 224
defines
"retirement assets," broadly, and then gives them broad exemption in
bankruptcy regardless of which set of exemptions--state or federal--apply to any
particular debtor. Section 303(c) limits this breadth, by permitting waivers of
such exemptions. As set forth below, this limitation is both vague and out of
step with the way exemptions are treated in Section 522 of the
Bankruptcy Code.
III.
III.
The Current Law on Exemptions and Their Waiver
Under current law, the filing of a
bankruptcy case by an individual debtor creates an
"estate," consisting of all legal and equitable interests in property of the debtor./8
Entities which are creditors at the time of the filing of the
bankruptcy case are then paid from this estate, and only from this estate. Additions and
subtractions from this estate thus can directly affect creditors' recovery and
debtors' post-filing relief.
An exemption is a statutory
category of assets that is not subject to creditors' claims. That is, an exempt
asset cannot be seized and sold to pay a debtor's debts. Although the exact
list of exempt assets varies generally from State to State, the general policy
behind exemptions is to allow a debtor to keep those assets which are necessary
for a productive life./9
Under the
Bankruptcy Code, all exempt property begins initially as property of the estate. After
filing, however, the debtor may file a list of claimed exempt property./10 If
there is no successful challenge to this list, then the exempt property leaves
the estate and is not available for creditor claims./11
Under some State law, and under federal
bankruptcy law before 1978, a debtor could waive, in advance, the benefit of an exemption
in favor of an unsecured creditor./12 Such waivers, however, were
often obtained through stealth or inadvertence./13 As a result, the
Bankruptcy Code of 1978 contained Section 522(e) which declares that such waivers are
unenforceable in
bankruptcy.
IV. The Current Law on Retirement Assets and
Bankruptcy
The current law on the status of retirement assets in
bankruptcy is somewhat uncertain. In order to understand why this fractured state of
treatment exists, one first has to understand more about how property is
administered in
bankruptcy.
A. General Overview of Distributions in
Bankruptcy
As indicated above, when an individual files for
bankruptcy, Section 541(a) of the
Bankruptcy Code places all of his or her legal or equitable interests in property in an
"estate." A
bankruptcy trustee administers this estate for the benefit of the debtor's creditors by
reducing the assets to cash, paying priority creditors, and then distributing
the remainder of the
cash on a pro rata basis to all unsecured creditors. The scope of estate
property is broad enough to bring almost anything that a person owns or
possesses into the estate. There are some limitations, however, owing to the
fact that State law, not federal law, creates the property relation.
B. Assets Which Never Come Into The Estate--Section 541(c)
In particular, under State law a person may transfer property to a trust for
the benefit of another, and provide in trust instrument that the trust assets
are to be immune from the reach of beneficiary's creditors. These so-called
spendthrift trusts are justified on the basis that the settlor of the trust
could just as well as not given anything to the beneficiary, and that it is the
settlor's wishes that are to be respected./14 Thus, if a beneficiary of such a
trust were to file
bankruptcy, the trust assets would not become property of the estate. This is established
by Section 541(c) of the
Bankruptcy Code which states:
(c) (1) Except as provided in paragraph (2) of this subsection, an interest of
the debtor in property becomes property of the estate under subsection (a)(1),
(a)(2), or (a)(5) of this section not withstanding any provision in an
agreement, transfer instrument, or applicable nonbankruptcy law--()(A) that
restricts or conditions transfer of such interest by the debtor; .... (2) a
restriction on the transfer of a beneficial interest of the debtor in a trust
that is enforceable under applicable nonbankruptcy law is enforceable in a case
under this title.
The restriction in Section 541(c)(2) is important because pension plans subject
to the Employee Retirement and Income Security Act of 1974 ("ERISA"), and some plans which receive tax-favored treatment are also required to
contain a
provision restricting creditors from attaching retirement assets. See 29 U.S.C.
1056(d)(1) (requiring that
"(e)ach pension plan (plan subject to ERISA) shall provide that benefits
provided under the plan may not be assigned or alienated."); 26 U.S.C. S 401(a)(13) (providing that
"(ai trust shall not constitute a qualified trust under this section unless the
plan of which such trust is a part provides that benefits provided under the
plan may not be assigned or alienated.")./15
C. Assets in Retirement Plans Subject to ERISA--Patterson v. Shumate
The logical issue is thus whether these statutorily-created anti- alienation
provisions are the type of
"restrictions" under
"applicable nonbankruptcy law" that will satisfy Section 541(c)(2) and keep retirement assets out of the
bankruptcy estate. The Supreme Court addressed
part of this problem in 1992 in Patterson v. Shumate./16 In Patterson, the
president of a small business filed
bankruptcy. He sought to exclude his pension assets, which were valued at $250,000, from his
bankruptcy estate under Section 541(c). These assets had been held by his company's
pension plan, which qualified for favorable tax treatment under ERISA./17 In
particular, the trust had an anti- alienation clause which satisfied 29 U.S.C. $1056(d)(1).
In resolving a dispute among lower courts, the Court held that the
anti-alienation provisions of ERISA were the type of provisions that meet the
standards of Section 541(c)(2); that is, Section 1056(d) provided the type of
"applicable nonbankruptcy law" restrictions recognized and respected by nonbankruptcy law. By extension, the
Court held that Section 541(c)(2) thus
precluded the assets from becoming part of Patterson's
bankruptcy estate. The Court thus held that Patterson's trustee Shumate could not seize
the pension funds in order to liquidate them for payment to creditors.After
Patterson, courts have struggled with the Court's phrasing of its holding. The
Court spoke of excluded pension assets in
"ERISA-qualified" plans. Strictly speaking, however, plans are not qualified under ERISA; they
are subject to it./18 This has lead to different tests for assessing whether
plan assets are in an
"ERISA-qualified" plan. Some courts have used a two-step inquiry to determine whether a plan is
subject to ERISA./19 Under the two-step inquiry, courts determine (1) whether
the plan is
"subject to" ERISA, and (2) whether the plan includes an antialienation clause that is
enforceable under ERISA./20 Other courts add a step; these courts insist that,
in addition to the two steps set forth above, the court must determine whether
the plan qualifies for tax exempt status under the Internal Revenue Code./21
Still other courts simply phrase
"(t)he relevant inquiry (as) whether, on the petition date, (the d)ebtor could
have enforced under ERISA the Pension Plan's transfer restriction."/22 These courts find that, even with a anti-alienation clause that facially
meets the requirements of Section 541(c)(2), the pension assets are subject to
claims of creditors because State law would not respect the clause. This
typically occurs in plans for companies in which there is one employee and one
owner, and they are the same, and thus the plan is outside of the coverage of
ERISA./23
D. Assets in Retirement Plans Which Are Subject to, But Do Not Comply With,
ERISA
Courts are divided on the issue of whether assets should be included as
property of the
estate upon a showing that, in operation, a retirement plan fails to comply
with ERISA. For example, some courts have disallowed the section 541(c)(2)
exclusion where it was found that a profit sharing plan's sole participant at
the time of the
bankruptcy proceeding was the debtor who was also the owner and sole employee, thus
scuttling the ability to qualify as an ERISA employee benefit plan./24 Even
where the retirement plan included participants other than the owners of the
plan sponsor at the time of the
bankruptcy, courts have held the plan assets attributable to the owners not eligible for
the Code section 541(c)(2) exclusion when the owners failed to administer the
plan in compliance with ERISA and the Internal Revenue Code, but rather made
use of the plan as a personal bank./25 Other courts take the view that if a
plan is
regulated by ERISA, whether the plan, in operation, complies with ERISA is not
relevant to the issue of whether section 541(c)(2) exclusion is available, so
long as the plan has a valid ERISA anti-alienation provision. For example, in
In re Baker,/26 a creditor argued that a debtor's majority shareholder's
profitsharing plan account balance should be included in the property of the
bankruptcy estate. By the time of the
bankruptcy, the shareholder had borrowed a significant portion of his profit sharing plan
account balance to support the failing business, and he was the only remaining
participant in the plan. The plan loans allegedly failed to comply with ERISA
in various respects.
The creditor claimed the shareholder was the
"employer," not an
"employee," and debtor's plan could thus not constitute an
"employee pension benefit plan" covered by ERISA./27 Furthermore, the
creditor asserted that the shareholder was an ERISA fiduciary, had flouted his
ERISA duties and, therefore, it would be inequitable for him to invoke ERISA as
a shield to protect his ERISA plan assets.
The court rejected each of the creditor's arguments, stating that whether the
shareholder was the sole remaining participant, or violated ERISA, was
irrelevant to whether the plan was
"ERISA- qualified." The court reasoned that the relevant inquiry was whether the plan was subject
to ERISA regulation, not whether the debtor observed the rules of ERISA.
E. Assets in Retirement Plans Which Are Not Subject to ERISA
There is obviously more to retirement assets than ERISA. As indicated above by
Section 224's definition of retirement assets, some retirement plans that are
not subject to ERISA nonetheless qualify for tax favored treatment. Some of
these plans must have antialienation clause in order to qualify for tax-favored
treatment; others need not. The treatment in
bankruptcy of these retirement assets varies, but does focus on the validity of the
antialienation provision under nonbankruptcy law.
1. Assets in Plans Subject to Section 401 of the Internal Revenue Code
As indicated above, Section 401(a)(13) of the Internal Revenue Code requires
retirement plans qualified under Section 401 of the Internal Revenue Code (such
as 401(k) plans and Keogh plans) to contain an anti-alienation clause. Courts
are mixed in whether such a clause qualifies under Section 541(c)(c) of the
Bankruptcy Code. Some hold that Section 541(c)(2) exemption does not apply./28 These
courts reason that the anti-alienation provisions of the Internal Revenue code
relate solely to the criteria for tax qualification under the Internal Revenue
Code. A transfer in violation of the Internal Revenue Code's
anti-alienation provisions could result in tax consequences. However, the
Internal Revenue Code does not provide for any substantive rights that a
beneficiary or participant of a qualified retirement trust can enforce./29
Other courts hold that the assets of a tax-qualified plan that is not deemed to
be ERISA qualified may nevertheless be protected under Code section 541(c)(2),
if the plan contains an anti-alienation provision that is enforceable under
applicable State nonbankruptcy law./30 2. Assets in Other Plans Receiving
Tax-Favored Treatment Such as IP, As IRAs (both the original type and Roth
IRAs) do not require anti- alienation clauses to receive tax-favored
treatment./31 Notwithstanding the absence of such a requirement, may IRA
arrangements contain such clauses. When courts have been asked to construe
these clauses, they have generally
found IRAs exempt, with the inquiry centering around whether the IRA account
contained an anti-alienation provision that would be effective under State law.
For example, in Meehan v. Wallace (In re Meehan),/32 the court held that a
Georgia exemption statute provided the restriction on transfer required by
Patterson v. Shumate to exclude the debtor's IRA from the estate./33
F. Exemption Statutes Related to Retirement Plans
1. Section 522(d)(10)(E) of Title 11
Section 522(d)(10)(E) allows an exemption for the right to receive benefits
"under a stock bonus, pension, profit-sharing, annuity, or similar plan or
contract on account of illness, disability, death, age or length of service."/34 There is a significant limitation here, however: these payments may be
exempted only to the
extent necessary for the support of the debtor and the debtor's dependents. As
a consequence, some cases hold that a debtor may exclude funds from a pension
plan held to be property of the estate only when the debtor and his or her
dependents require the funds to subsist./35 If the debtor's current income is
sufficient, the courts are reluctant to allow any exemption under this
provision if the debtor will have an opportunity to reestablish a retirement
fund and meet current expenses./36
An example of this rule in action is Warren v. Taft(In re Taft)./37 In that
case, the court stated that in determining to what extent a pension is
reasonably necessary for the support of a debtor and any dependent of the
debtor under section 522(d)(10)(E), the court should set aside an appropriate
amount sufficient to sustain the debtor's basic needs,
taking into account other income and exempt property of the debtor and, where
appropriate, the special needs of a retired and elderly debtor, without
considering the debtor's status or the lifestyle to which the debtor is
accustomed./38
Clause (E) also contains within it restrictions. If a payment covered by clause
(E) is on account of age or length of service and the plan or contract was
established by an insider that employed the debtor at the time his or her
rights arose, the right to such payments is not exempt unless the plan or
contract qualifies under specified sections of the Internal Revenue Code.
2. State Exemption Statutes State exemption statutes can be very generous, and
often specifically provide that taxfavored retirement plans, such as IRAs, are
exempt from creditor execution or garnishment./40 When exemptions have been
claimed under these statutes, most circuit courts of appeal have upheld IRAs as
property of the estate, but also as permissibly
exempt upon a proper election./41
G. Summary
The following table summarizes, in rough form, the present treatment of pension
assets in
bankruptcy: (NOTE: Table not transmittable)
V. The Probable Impact--The Demographics of
Bankruptcy for Older Americans
Permitting waivers of exemptions in pension assets obvious set in motion a
tension between the past and the future. Pension assets typically provide for
support during old age, and allowing a debtor effectively to transfer those
assets to creditors on debts incurred while young in essence allows borrowing
or stealing from the future.
The scope of the problem is, as this Committee understands, huge. Retirement
assets are a large part of the asset holdings of American families. Indeed, by
recent estimates, approximately 41% of American families had some type of
pension coverage
in 1998./42 Further, the National
Bankruptcy Review Commission reported in 1997 that
"(r)etirement funds are the largest single type of financial asset held by
American families, constituting over 25% of financial assets held by families
in 1995."/43
A. Older Americans and the General Population
To assess these numbers, however, some general statistical data is in order. As
of 1998, approximately 12.7% of the United States' population was age 65 or
older./44 The Census Bureau currently estimates that by 2010 that percentage
will increase to 13.3%, and that by 2030 fully 20% of the population will be 65
or older./45
B. Older Americans and
Bankruptcy
Reliable demographic data about who files
bankruptcy and why they file is scarce./46 But that is not to say that there is no data.
Within the last year, several studies have been
published which undertake to assess questions about who files and for what
reasons./47 In particular, these scholars have looked at the number of elderly
citizens who have filed
bankruptcy.
The most recent estimates are that in 1997, when the number of nonbusiness
bankruptcies filed equaled 1,350,118,/48 about 237,200 people aged 50-64 filed for
bankruptcy relief, and about 42,800 people aged 65 or older did the same./49 The reasons
given for filing are relevant. The chart which follows lists the reasons given
by older Americans who filed
bankruptcy in 1991 as to why they filed (note: the totals exceed 100% because many
individuals listed more than one reason for filing).
/50 (Note: Graph Not Transmittable)Other observations can be made from this
data. As Americans age, they have increasing problems with medical expenses,
despite various
social programs aimed at assisting them./51 As stated in the Minority Views of
Senators Leahy, Kennedy, Feingold and Schumer to the report on S. 625:
We may not be surprised that older Americans who file for
bankruptcy often cite catastrophic medical problems as the cause of their financial
distress, but perhaps more eye-opening is the fact that older Americans also
cite employment problems as the reason they filed for
bankruptcy.44 Today, Americans work longer and harder into their senior years and a
growing percentage of the population is over the age of 85, and predominantly
female.Some, particularly those over 65, cannot find a replacement job. Others
may be able to find alternative employment but at substantially lower wages or
without the health and other benefits that become increasingly important with
age. These circumstances do not show up
in our low unemployment rates--which often are touted as proof that we should
not be seeing so many
bankruptcies--but they nonetheless may produce a severe financial shock./52
The data also suggest that job-related reasons for filing decrease with age.
This does not mean, however, that the elderly have more stable employment or,
more likely, if they are leaving the work force because they are able to draw
their pensions and social security benefits. If the later, the provisions of
Section 303(c) could affect more older Americans financial state.
C. The Changing Demographics
Older Americans do not currently account for anything close to a majority of
bankruptcy filings. In 1991, for example, those 55 and older accounted for 9.2% of all
bankruptcy filings, and there is evidence to believe that percentage was stable into
1997./53 Researchers point to high rates of filing for those in the so-called
"baby-boomer" generation, and wonder if those rates (and the financial habits and social
context which lead to them) will persist into their retirement years./54
VI. The Interpretive Conundrums Introduced by Section 303(c)
Against this background, the changes effected by Section 303(c) are uncertain.
The few words added by Section 303(c) would permit a waiver of exemptions as to
certain property--retirement assets--in situations in which that waiver would
be unenforceable if any other exempt asset were involved. Given the current
treatment of retirement assets in
bankruptcy, and the ways in which waiver is handled in other parts of the
Bankruptcy Code, this amendment raises several interpretive questions.
A. Section 303(c) Does Not Address Distinctions Made Under Current Law
As an initial matter, Section 303(c) will only make worse the current
state of the law on whether a particular plan is ERISA-qualified. It does this
by increasing the stakes of this determination. Note first that the definition
of
"retirement assets" to be added by Section 224 does not reflect the current case law distinction
between ERISA- qualified plans and non-ERISA plans. Thus, the distinction will
continue to exist, and ERISA-qualified plans, since they are not within the
referring phrase added by Section 303(c), will not be subject to the waiver
exception carved out by Section 303(c). Debtors who may have executed a waiver
will thus have added incentive to try and classify their particular plans as
ERISA-qualified under Patterson v. Shumate and related cases.
B. Section 303(c) Contains No Safeguards Against Inadvertent or Coerced Waiver
The possibility of inadvertent waders leading to such arguments
under ERISA is not fanciful. Section 303(c) does not, as other provisions of
the
Bankruptcy Code do, provide any procedural protections to ensure that any waiver is
voluntary and intentional. There is no requirement that the waiver be written,
or that it be tested by an administrative or judicial tribunal. This is in
stark contrast to the protections given with respect to liabilities reaffirmed
by the debtor (that is, agreed to be paid notwithstanding the
bankruptcy discharge). By way of example, Section 524(c) of the
Bankruptcy Code, as currently drafted, sets forth specific requirements that any waiver
of a discharge must contain to be effective./55 These include requirements of
clear and conspicuous language setting forth the waiver, and independent checks
on whether the waiver is in the debtor's best interest.
As a consequence, unless other doctrines apply, a wader could be found in an
application for unsecured credit (such as those
for a credit card), or in an amendment of such agreements. It might very well
find its way into the terms of service for those who provide services on
unsecured credit such as doctors and even utility companies. Although common
law contract doctrine has tools for invalidating such waivers, these tools are
not designed or adapted to handle waders of exemptions for assets meant for use
in the future./56
C. Section 303(c) Casts Doubt on the Status of Retirement Assets Subject to
Section 401 of the Internal Revenue Code In addition, Section 303(c) would
introduce doctrinal confusion over the treatment of retirement assets in plans
subject to Section 401 of the Internal Revenue Code. As indicated above, such
plans, because Section 401(a)(13) requires an anti-alienation clause, are often
subject to the
same analysis as the Supreme Court undertook in Patterson. That is, these plans
are excluded from the estate under Section 541(c)(2) of the
Bankruptcy Code because nonbankruptcy courts would give effect to the required
anti-alienation clause.
Section 303(c), combined with the definition of
"retirement assets" in Section 224, muddies this analysis. If plans subject to Section 401 are
exempt, as indicated by Section 224, then there seems to a presupposition that
the plans are property of the estate-it does not make sense to exempt an asset
that never was part of the estate. But if the current cases are correct that
such plan assets are excluded from the estate, then the label of
"exempt' makes no sense./57 In short, since it would make no sense to exempt
property that would never become property of the estate (you cannot exempt what
isn't there), the ultimate interpretation of plans under Section 401 of the
Internal Revenue
Code will become further confused.
D. Section 303(c) May Cause Creditors to Seek to Take Liens or Security
Interests in Retirement Assets
Finally, the changes to Section 522(e) brought about by Section 303(c) may
cause not only uniformed waivers as to unsecured creditors, but also may cause
creditors to try and obtain security interests or liens on retirement assets.
To see this point, it is necessary to understand that the granting of a
security interest in an asset also generally carries with it a waiver of any
claim of exemption to that asset as to the creditor receiving the security. In
short, when a debtor grants a creditor a security interest in an asset, she or
he also simultaneously grants to the creditor a waiver of any exemption in that
asset.
Initially, this might not
seem to be a realistic problem: Section 522(e) only applies to
"Ia) waiver of an exemption executed in favor of a creditor that holds an
unsecured claim." As a consequence, a creditor with security will not be affected by Section
522(e). Under Section 506(a) of the
Bankruptcy Code, however, a creditor who is undersecured (that is, whose debt exceeds the
value of its collateral) holds two claims: a secured claim to the extent of the
value of the collateral, and an unsecured claim for the balance./58 Thus, a
creditor with a debt larger than the debtor's pension assets could try and
obtain a security interest in those assets, and claim that the waiver of
exemption was obtained as part of its unsecured claim. To the argument that an
anti-alienation provision would prevent such security interests, the creditor
will respond that Section 522(e) overrides
any other provision.
VII. Conclusion Section 303(c) is bad
bankruptcy policy. It would create an exception in
bankruptcy for exempt retirement assets that does not exist for any other type of exempt
asset. Further, by permitting this exception to apply in cases of
"waiver," when there are no procedural or substantive safeguards on the granting of such
a waiver, it effectively allows relatively easy relinquishment of rights to
retirement assets. Given the numbers of older Americans who need to file
bankruptcy, and the job and medical reasons that impel them to file, Section 303(c) can be
seen as a pernicious trading of the future for the past, with adverse
consequence to all but the creditors involved.
I thank the Committee for the opportunity to present my views on this very
important matter.
Endnotes
1. H.R. 833 was passed
in Roll Call Vote Number 5 by an 83-14 vote. It consists essentially of the
text of S. 625, 106th Cong., 1st Sess. (1999).
I have confined my remarks to Section 303(c) and its effects on waivers of
exemptions. I have not addressed other thorny issues presented by H.R. 833's
treatment of retirement assets.
These include the proper treatment of repayments of qualified plan loans in
chapter 13.
2. Section 303(c) was introduced by Amendment No. 2515 on November 5, 1999 as
part of a modified Manager's Amendment. Cong. Rec. S14099 (daily ed. Nov. 5,
1999). It was passed by unanimous consent on November 10th. Id. at S14490.
3. In this respect, the Senate followed a
portion of the recommendation of the National
Bankruptcy Review Commission. National
Bankruptcy Review Commission,
Bankruptcy: The Next Twenty Years, Recommendation 1.2.5, at pp. 139-141 (1997). The
Commission's recommendation, however, was only to exempt funds held by trusts
exempt from income tax under Sections 408 or 501(a) of the Internal Revenue
Code.
4. Section 224 was part of S. 625 as reported on in the Senate. The
accompanying report, however, does not give much guidance as to its scope. The
full text of explanation of the Section is as follows:
Section 224. Protection of Retirement Savings in
Bankruptcy
This section provides that retirement plans sponsored by government and
nonprofit employers are exempted from a
bankruptcy estate. The section also provides that individual retirement accounts are also
exempt from a
bankruptcy estate.
S. Rep. No. 106-49, 106th Cong., 1st, Sess.
27 (1999).
5. Section 224's use of the term
"exempt" is not consistent with current
bankruptcy practice. As indicated in the text, an exemption in
bankruptcy only has meaning if the property that is to be exempt is property of the
estate; otherwise, there is nothing capable of being exempt.
Section 224, however, states that retirement assets shall be
"exempt from the estate." Section 224(a)(1)(D), and this locution is repeated in the Senate Report on
Section 224. S. Rep. No. 106-49, 106th Cong., 1st, Sess. 27 (1999) ("The section also provides that individual retirement accounts are also exempt
from a
bankruptcy estate."). This raises questions as to whether the bill attempts to exclude the
retirement assets from the estate, or whether they are to be kept in the estate
subject to the debtor's election to remove them. As will be seen in the
discussion of Patterson v. Shumate, this distinction has some bite.
6. Under
current Section 522(b), a State may choose to
"opt-out" of the federal exemption scheme and make only that State's exemptions
available to its citizens. According to Collier on
Bankruptcy, the following 34 States have thus far enacted legislation prohibiting their
domiciliaries from electing the federal exemptions contained in 11 U.S.C. $ 522(d): Alabama, Arizona, California, Colorado, Delaware, Florida, Georgia,
Idaho, Illinois, Indiana, Iowa, Kansas, Kentucky, Louisiana, Maine, Maryland,
Mississippi, Missouri, Montana, Nebraska, Nevada, New York, North Carolina,
North Dakota, Ohio, Oklahoma, Oregon, South Carolina, South Dakota, Tennessee,
Utah, Virginia, West Virginia, and Wyoming. 4 Collier on
Bankruptcy, 522.02(1), at n.3 (15th rev. ed., 2000).
7. That this override of State law is intended is confirmed by the
Senate Report on S. 625. S. Rep. No. 10649, 106th Cong., 1st Sess. 71 (1999) ("These standards would apply regardless of the State policy on exemptions.").
8. 11 U.S.C. 541(a)(1).
9. See National
Bankruptcy Review Comm'n, supra note 3, at 117. 11
10 11 U.S.C. S 522(/).
11. This statement is not without exception. Exempt property may still be
liquidated if necessary to pay certain marital or child support claims, or to
pay taxes. 11 U.S.C. Section 522(c)(1).
Unavoidable liens and tax liens also are unaffected by exemption. Id. S
522(c)(2).
12. See Broadway v. Household Fin. Corp., 351 So. 2d 1373 (Alabama Ct. App.),
cert denied 351 So.
2d 1378 (Alabama S. Ct. 1977), in which such a waiver was upheld. A collection
of cases on this topic is collected in annotation, Validity of Contractual
Stipulation or Provision Waiving Debtor's Exemption, 94 A.L.R.2d 967 (1997).
Exemptions typically apply only against unsecured creditors. Under the law of
most States, a secured creditor may ignore an exemption with respect to the
assets which serve as its collateral; a mortgage lender, for example, can
ignore a homestead exemption in most States when foreclosing on its mortgage.
See Dominion Bank v. Nuckolls (In re Nuckolls), 780 F.2d 408 (4th Cir. 1985)
(waiver of an exemption is unenforceable only as against an unsecured claim.
Therefore, if a creditor has an enforcable security interest in a
debtor's assets, the waiver of exemption would not be vulnerable under section
522(e)).
13. See Orlando v. Finance One of West Virginia, Inc., 179 W. Va. 447, 369
S.E.2d 882 CW. Va. 1988) (finding that blanket waiver of exemptions, inserted
in 5000 installment loan notes over a three-year period, did not constitute an
unfair trade practice or an unconscionable contract even when it was
acknowledged that West Virginia law did not validate such waivers).
14. Note, however, that under trust law once the beneficiary receives a
distribution from trust assets, those assets are his property and may be
attached by his creditors. See Guidry v. Sheet Metal Workers Nat'l Pension
Fund, 39 F.3d 1078 (10th Cir.), cert. denied, 514 U.S.
1063 (1994) (holding that distributions from a pension fund subject to ERISA
are not immune from garnishment by virtue of the anti-alienation provisions of
ERISA).
15. These anti-alienation provisions are not absolute. Retirement assets in
such plans can be reached by a
"Qualified Domestic Support Order" under either ERISA, 29 U.S.C. S 1056(d)(3), or with respect to plans under
Section 401 of the Internal Revenue Code, 26 U.S.C. S 401(a)(13)(B). Retirement
assets may also be reached by writs of garnishment for debts owed to the
federal government. United States v. Sawaf, 74 F.3d 119 (6th Cir. 1996).
16. 504 U.S. 753 (1992).
17. Actually, Patterson's company filed for
bankruptcy first, and Patterson second. The dispute was over the
forced distribution from the liquidation of the company's pension plan.
18. Judge Easterbrook has summarized the odd language in Patterson as follows:
What is an
"ERISA-qualified" plan? The term does not appear in the statute, and its provenance is
mysterious. Some plans are tax- qualified, a term of art meaning that
contributions to the plan are deductible at the corporate level and not taxed
to the employee until the plan distributes benefits. Taxation has nothing to do
with the question at hand, however. Most likely, the Court used
"ERISA- qualified" to mean
"covered by Subchapter I of ERISA". Not all pension plans need contain an anti-alienation clause. See 29 U.S.C. $$1003(b). Early in its opinion the Court referred to
"the anti-alienation provision required for qualification under '$ 206(d)(1) of ERISA, 29 U.S.C. $$ 1056(d)(1)".
504 U.S. at 755, 112 S.Ct. at 2244.
Understanding
"ERISA-qualified" to mean nothing more complex than
"containing the anti-alienation clause required by $$ 206(d)(1) of ERISA" makes the phrase mesh with the topic of the opinion: whether ERISA is
"applicable nonbankruptcy law". (Perhaps the term
"ERISA- qualified" has some significance elsewhere in the law; our discussion of its scope
applies only to the question whether a creditor can reach funds in
bankruptcy.)
In re Baker, 114 F.3d 636, 638 (7th Cir. 1997).
19. See In re Orkin, 170 B.R. 751, 753-54 (Bankr. D. Mass. 1994) (discussing
approaches to the term
"ERISA qualified").
20 See In re Baker, 114 F.3d 636, 638 (7th Cir. 1997); In
re Bennett, 185 B.R. 4, 6 (Bankr. E.D.N.Y. 1995); In re Hanes, 162 B.R. 733,
740 (Bankr. E.D. Va. 1994); see also In re Kaplan v. First Options of Chicago,
Inc., 189 B.R. 882, 890 (holding that it is not necessary to ascertain whether
a plan is
"tax qualified" but only that it is covered by ERISA).
21 See ln re Hall, 151 B.R. 412, 418-19 (Bankr. W.D. Mich. 1993); In re Sirois,
144 B.R. 12, 14 (Bankr. D. Mass. 1992); In re Witwet, 148 B.R. 930, 934 (Bankr.
C.D. Cal. 1992).
22. Lowenschuss v. Selnick (In re Lowenschuss), 171 F.3d 673, 680 (9th Cir.),
cert. denied
120 S. Ct. 185 (1999).
23. Id. 24 Id. See also Watson v. Proctor, 161 F.3d 593 (9th Cir. 1998); In re
Kaplan v. First Options of Chicago, Inc., 189 B.R. 882 (E.D. Pa. 1995) (section
541(c)(2) exclusion disallowed where retirement plan's sole participants were
owners of employer, such that the plan did not cover any employees); In re
Acosta, 182 B.R. 561 (N.D. Cal. 1994) (holding that a sole shareholder of a
corporation does not qualify as an ERISA employee because a sole shareholder is
deemed to be an employer and an employer is prohibited from receiving any
benefit from an ERISA plan).
25. See, e.g., In re Harris, 188 B.R. 444 (Bankr. M.D. Fla. 1995).
26. 114
F.3d 636 (7th Cir. 1997).
27 Id. at 640.
28. See In re Kuraishi, 237 B.R. 172, 176-77 (Bankr. C.D. Cal. 1999); In re
Acosta, 182 B.R. 561, 566 (N.D. Cal. 1994); In re Kellogg, 179 B.R. 379, 386
(Bankr. D. Mass. 1995); In re Witwer, 148 B.R. 930, 937 (Bankr. C.D. Cal. 1992).
29. In re Witwer, 148 B.R. 930, 937 (Bankr. C.D. Cal. 1992).
30. See Ehrenberg v. Southern Cal. Permanente Med. Group (In re Moses), 167
F.3d 470 ( 9th Cir. 1999) (finding that a nonalienation provision in a
self-settled tax qualified Keogh plan, which was not
ERISA qualified, was nevertheless enforceable under applicable nonbankruptcy
State spendthrift law); ln re Johnson, 191 B.R. 75 (Bankr. M.D. Pa. 1996)
(finding nonalienability provision of Internal Revenue Code section 403(b)
retirement plan enforceable under applicable State nonbankruptcy law).
31. See Carmichael v. Osherow (In re Carmichael), 100 F.3d 375 (q Cir. 1996).
32. 102 F.3d 1209 (11th Cir. 1997).
33. See also Orr v. Yuhas (In re Yuhas), 104 F.3d 612 (3d Cir.), cert. denied,
521 U.S. 1105 (1997) (New Jersey statute that protected a qualified IRA from
claims of creditors constitutes a
"restriction on the transfer of a beneficial interest of the debtor in a
trust" within the meaning of Code $ 541(c)(2), even if the restriction is not in the document itself).
34. The availability of Section 522(d)(10)(E) is limited by whether the State
in which the debtor is domiciled has opted out of the federal exemption scheme,
as have 34 States.
35. In re Comp, 25 C.B.C.2d 300 (Bankr. M.D. Pa. 1991); see also Boggess v.
Boggess (In re Boggess), 105 B.R. 470 (Bankr. S.D. Ill. 1989).
36. In re Moffatt, 959 F.2d 740 (9th Cir. 1992) (debtor could not exempt annual
annuity of approximately $17,000 when current income exceeded $90,000); see also In re Montavon, 52 B.R. 99 (Bankr. D. Minn. 1985) (IRA of
young debtor who can meet their current living
expenses out of current income is not exempt).
37. 10 B.R. 101 (Bankr. D. Conn. 1981).
38. See also In re Kochell, 732 F.2d 564 (7th Cir. 1984); In re Clark, 711 F.2d
21 (3d Cir. 1983).
39. The applicable text of the section exempts:
(10) The debtor's right to receive--a payment under a stock bonus, pension,
profit-sharing, annuity, or similar plan or contract on account of illness,
disability, death, age, or length of service, to the extent reasonably
necessary for the support of the debtor and any dependent of the debtor, unless
(i) such plan or contract was established by or under the auspices of an
insider that employed the debtor at the time the debtor's rights under such
plan or contract arose;
(ii) such payment is on account of age or
length of service; and
(iii) such plan or contract does not qualify under section 401(a), 403(a),
403(b), 408, or 409 of the Internal Revenue Code of 1986.
40. See National
Bankruptcy Review Comm'n, supra note 3, at 14041 for a discussion of these statutes. See
also 14 Collier on
Bankruptcy (15th rev. ed. 2000) (collecting exemption statutes for all 50 States).
41. See, e.g., Farrar v. McKown (In re McKown), 203 F.3d 1118 (9th Cir. 2000)
(IRA exempt under California law); Dubroff v. First Nat'l Bank of Glens Falls,
119 F.3d 75 (2d Cir. 1997) (IRA exempt under New York statute).
42. Results From the 1998 Survey of Consumer Finances, Federal Reserve
Bulletin, at 13 (Feb. 2000).
43. National
Bankruptcy Review Comm'n, supra note 3, at 139.
44. United States Census Bureau, Statistical Abstract of the United States:
1999, Table No. 14, at page 15 (1999).
45. Id., Table 17, at page 17.
46. Indeed, one of the recommendations of the
Bankruptcy Reform Commission which the current legislation has adopted is effort to obtain
better data for future policy makes. See H.R.833, $$ 602-04.
47. See Teresa A. Sullivan, Elizabeth Warren
& Jay Lawrence Westbrook, The Fragile Middle Class: Americans in Debt (Yale
Univ. Press 2000) (hereinafter
"Fragile Middle Class"); Teresa A. Sullivan, Elizabeth Warren
& Jay Lawrence Westbrook, From Golden Years to Bankrupt Years, Norton
Bankruptcy
Law Advisor 1, 2 (July 1998) (hereinafter
"Golden Years").
48. This data is taken from the American
Bankruptcy Institute's web site. http://www.abiworld.org/stats/1980annual.html. (Visited
April 9, 2000). The ABI compiles its data from information published by the
Administrative Office of the United States Courts.
49. Golden Years, supra note 47, at 2.
50. This graphic and the information contained in it are from Golden Years,
supra note 47, at 5, and from Fragile Middle Class, supra note 47, at 16.
51. In recognition of this effect of aging, some States have increased the
homestead exception for older Americans. See, e.g., Mass. Gen. Law. Ann. ch.
188, $ lA (1999) (increasing from $100,000 to $200,000 the amount of an available homestead exemption for debtors
over the age of 62).
52. S. Rep. No. 106-49, 106th Cong., 1st Sess. 114 (1999) (Minority Statement
of Senators Leahy, Kennedy, Feingold and Schumer).
53. See Golden Years, supra note 47, at 9.
54. See Golden Years, supra note 47, at 9.
55.
55.
The text of Section 524(c) reads as follows:
(c) An agreement between a holder of a claim and the debtor, the consideration
for which, in whole or in part, is based on a debt that is dischargeable in a
case under this title is enforceable only to any extent enforceable under
applicable nonbankruptcy law, whether or not discharge of such debt is waived,
only if--
(1) such agreement was made before the granting of the discharge under section
727, 1141, 1228, or 1328 of this title;
(2) (A) such agreement contains a clear and conspicuous statement which advises
the debtor that the agreement may be rescinded at any time prior to discharge
or within sixty days after such agreement is filed with the court, whichever
occurs later, by giving notice of rescission to the holder of such claim;
and(13) such agreement contains a clear and conspicuous statement which advises
the debtor that such agreement is not required under this title, under
nonbankruptcy law, or under any agreement not in accordance with the provisions
of this subsection;
(3) such agreement has been filed with the court and, if applicable,
accompanied by a declaration or an affidavit of the attorney that represented
the debtor during the course of negotiating an agreement under this subsection,
which states that-
(A) such agreement represents a fully informed and voluntary agreement by the
debtor;
(B) such agreement does not impose an undue hardship on the debtor or
a dependent of the debtor; and
(C) the attorney fully advised the debtor of the legal effect and consequences
of
(i) an agreement of the kind specified in this subsection; and
(ii) any default under such an agreement;
(4) the debtor has not rescinded such agreement at any time prior to discharge
or within sixty days after such agreement is filed with the court, whichever
occurs later, by giving notice of rescission to the holder of such claim;
(5) the provisions of subsection (d) of this section have been complied with;
and
(6) (A) in a case concerning an individual who was not represented by an
attorney during the course of negotiating an agreement under this subsection,
the court approves such agreement as.(i) not imposing an undue hardship on the
debtor or a dependent of the debtor; and
(ii) in the best interest of the debtor.
(B) Subparagraph (A) shall
not apply to the extent that such debt is a consumer debt secured by real
property.
56. Indeed, in Broadway v. Household Fin. Corp., 351 So. 2d 1373 (Alabama Ct.
App.), cert denied 351 So. 2d 1378 (Alabama S. Ct. 1977), the court interpreted
a waiver of a constitutional right of exemption as it would an ordinary
contract waiver, and upheld it. See also Orlando v. Finance One of West
Virginia, Inc., 179 W. Va. 447, 369 S.E.2d 882 CW. Va. 1988) (finding that
blanket waiver of exemptions, inserted in 5000 installment loan notes over a
three-year period, did not constitute an unfair trade practice or an
unconscionable contract even when it was acknowledged that West Virginia law
did
not validate such waivers).
But see Badie v. Bank of America, 67 Cal. App. 4th 779 (Cal. App. 1998) for a
recent example of the use of the doctrine of unconscionability to invalidate
clauses designed to make arbitration the exclusive remedy in disputes between
banks and their nonbusiness customers.
57. If it could be argued that some plans subject to Section 401 of the
Internal Revenue Code do not require an anti-alienation clause, then this
problem would not arise (and would be handled in much the same way as the
Supreme Court handled the existence of Section 522(d)(10)(E) with respect to
excluding ERISA-qualified plans).
58. Section 506(a) states in full:
(a) An allowed claim of a creditor secured by a lien on property in which the
estate has an interest, or that is subject to
setoff under section 553 of this title, is a secured claim to the extent of the
value of such creditor's interest in the estate's interest in such property, or
to the extent of the amount subject to setoff, as the case may be, and is an
unsecured claim to the extent that the value of such creditor's interest or the
amount so subject to setoff is less than the amount of such allowed claim. Such
value shall be determined in light of the purpose of the valuation and of the
proposed disposition or use of such property, and in conjunction with any
hearing on such disposition or use or on a plan affecting such creditor's
interest.
END
LOAD-DATE: April 15, 2000