6th Circ rejects bankruptcy shield for 401(k) contributions, in certain cases

August 11, 2021

  • Retirement funds can be protected if made within six months before bankruptcy
  • 'Disposable income' must go to creditors

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(Reuters) - Individuals who have filed for Chapter 13 bankruptcy may not protect 401(k) contributions from creditors if they were not already making those contributions in the months leading up to the bankruptcy, an appeals court ruled on Tuesday.

In a 13-page decision, a three-judge panel of the U.S. 6th Circuit Court of Appeals upheld a Michigan federal district court’s finding that unless individual debtors were already putting money toward retirement savings accounts in the six months before the bankruptcy, they cannot begin doing so after the bankruptcy is filed, as those funds must be set aside for creditors.

The decision was penned by U.S. Circuit Judge Joan Larsen and joined by U.S Circuit Judges Richard Griffin and John Nalbandian.

The appeal stems from the 2018 bankruptcy of John and Jill Penfound in the Eastern District of Michigan. The Chapter 13 trustee opposed their request to exclude $1,375 per month from their disposable income, which under bankruptcy law must be set aside for unsecured creditors, to put toward a 401(k) retirement plan. The judge overseeing the bankruptcy agreed with the trustee and rejected the request. That finding was upheld by a district court judge, who concluded that all voluntary post-bankruptcy contributions to a 401(k) account are disposable income, and therefore cannot be shielded from creditors.

In June 2020, the 6th Circuit held in a similar case, Davis v. Helbling, that Chapter 13 debtors could withhold their monthly 401(k) contributions from their disposable income if the debtor had been making regular contributions in the six months before the bankruptcy. But the Penfounds’ case was different because they were not making those contributions in the six months before the bankruptcy, the court said in Tuesday’s decision.

The Penfounds argued that their situation should be treated like the Davis case because John had been contributing to his 401(k) for many years previously, which they said speaks to his good faith. He stopped because he took a new job that did not offer a 401(k) option. But the court held that a debtor’s prior history of contributing to a 401(k) is not sufficient to show that the money constitutes “current monthly income,” which is protected by bankruptcy law against creditor collections and is defined as the debtor’s average income over the six months before the bankruptcy.

“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,” Larsen wrote.

A lawyer for the Penfounds did not immediately respond to a request for comment.

The case is John S. Penfound et al v David W. Ruskin et al, U.S. 6th Circuit Court of Appeals, No. 19-2200.

For Penfound: Aaron Scheinfield of Goldstein Bershad & Fried

For the Chapter 13 trustee: Stuart Gold of Gold Lange Majoros & Smalarz

Maria Chutchian reports on corporate bankruptcies and restructurings. She can be reached at maria.chutchian@thomsonreuters.com.