By Tulay Turan, J.D.
Vacating the bankruptcy court’s order, the Sixth Circuit’s narrow ruling did not choose between competing federal court interpretations—including its own dictum in a case upon which the bankruptcy court relied—of the disposable income issue.
A debtor’s monthly 401(k) contributions, which her employer regularly withheld from her wages prior to her bankruptcy, are excluded from disposable income under the Bankruptcy Code, the Sixth Circuit ruled, vacating a bankruptcy court’s order and remanding for further proceedings. Although there are competing views as to whether voluntary retirement contributions constitute disposable income in a Chapter 13 bankruptcy, the appeals court, applying canons of construction, concluded the statutory text is best read to exclude them (In re Davis, June 1, 2020, Larsen, J.).
Unsecured debt. In 2017, the debtor filed a petition in federal court for relief under Chapter 13 of the Bankruptcy Code. She had more than $200,000 in debt and less than $39,000 in assets. Most of her debt—more than $189,000—was unsecured. Chapter 13 allows her to satisfy her unsecured debts by paying all her disposable income to her unsecured creditors during a 60-month commitment period.
Disposable income. The debtor proposed a bankruptcy plan that would pay her unsecured creditors a total of $19,380, which was equal to 60 monthly payments of $323. To obtain court approval, her plan needed to provide for payment of all her “projected disposable income” to her unsecured creditors. She believed $323 represented her monthly disposable income. Although she reported gross monthly income of $5,627, she claimed $5,304 in allowable monthly expenses. One of those claimed expenses was a monthly retirement contribution. Long before her bankruptcy, she had authorized her employer to withhold $220.66 from her monthly wages as contributions to a 401(k) plan. She sought to continue those contributions during her bankruptcy. The trustee objected to her plan, contending that wages withheld as voluntary 401(k) contributions are considered disposable income under the Bankruptcy Code. The bankruptcy court sustained the objection, ruling it was bound by the dictum in this court’s decision in Seafort v. Burden (In re Seafort).
Amended plan. As a result of the bankruptcy court’s decision, the debtor filed an amended plan that would pay her unsecured creditors $519 each month. The increase reflected the addition of her 401(k) contributions to her disposable-income calculation. She then objected to her own plan, preserving the disposable income issue for appellate review. The bankruptcy court confirmed the amended plan over her objection, and she filed this appeal.
Amendment confusion. Before addressing the merits of the debtor’s argument, the court explained that prior to 2005, the “overwhelming consensus” among bankruptcy courts was that wages voluntarily withheld as 401(k) contributions formed part of a debtor’s disposable income. In 2005, however, Congress enacted the Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA), which amended the Bankruptcy Code and added 11 U.S.C. §541(b)(7). In relevant part, Section 541(b)(7)(A) provides that property of the estate does not include any amount withheld by an employer from the wages of employees for payment as contributions to a 401(k) retirement plan “except that such amount under this subparagraph shall not constitute disposable income as defined in Code Sec. 1325(b)(2).” The text starting with “except” is known as the “hanging paragraph.” The insertion of that text has led to competing views of whether voluntary retirement contributions constitute disposable income in a Chapter 13 bankruptcy.
Canons of construction. Turning to the merits, the court agreed with the debtor’s argument that the hanging paragraph in Section 541(b)(7) excludes from her disposable income, as defined in Section 1325(b)(2), the amount she contributed monthly to her 401(k) prior to bankruptcy. The court, applying canons of construction, concluded that the hanging paragraph is best read to exclude from disposable income a debtor’s post-petition monthly 401(k) contributions so long as those contributions were regularly withheld from the debtor’s wages prior to her bankruptcy.
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.” Here, BAPCPA’s insertion of the hanging paragraph into Section 541(b)(7) represents a substantial change to the statutory text. The court must, therefore, presume that the hanging paragraph altered existing law.
The presumption against ineffectiveness offers similar guidance. The presumption reflects the idea that Congress does not enact useless laws. “Thus, we should be skeptical of interpretations that deprive the hanging paragraph of any meaningful effect,” the court wrote.
Finally, the canon against surplusage, which conveys the rule that courts should “give effect, if possible, to every word Congress used,” provides a related command. The court found it should favor a construction of the hanging paragraph that leaves both it and Section 1325(b)(2) with independent effect.
Applying these principles, the court concluded the hanging paragraph is best read to exclude from disposable income the monthly 401(k) contribution amount that the debtor’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 wrote. Thus, the court vacated the bankruptcy court’s order confirming the debtor’s Chapter 13 plan and remanded the case for further proceedings.
Dissent. Judge Readler, dissenting, argued the Seafort decision, while not controlling, is correct and should be given the weight it deserves. He also contended that in BAPCPA, “Congress adopted a simple, bright-line rule: 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 the majority’s interpretation of the hanging paragraph does not make sense of its location, is in tension with BAPCPA’s emphasis on curbing perceived abuses of the bankruptcy process by debtors, upsets settled expectations, and invites abuse by debtors.
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