Volume I, Number 2 – September 1992
© Donlevy-Rosen & Rosen, P.A.
SUPREME COURT SETTLES RETIREMENT PLAN CONTROVERSY:
Creditors Cannot Reach Retirement Plan Interests
The U.S. Supreme Court recently settled a conflict among the Circuit Courts regarding the question of whether a creditor can reach a debtor’s qualified retirement plan interests to satisfy his claim. InPatterson v. Shumate, a unanimous Court held that a participant’s interest in an ERISA qualified retirement plan is protected from the claims of his creditors in bankruptcy.
BACKGROUND. In a nonbankruptcy context, a court will look to the relevant state and federal laws to determine the availability of a debtor’s assets to satisfy the claims of his creditors. Many states, including Florida, have enacted statutory exemptions which protect qualified plan interests. Therefore, in a nonbankruptcy case, if state law exempts retirement benefits from creditors’ claims, the issue was settled.
Problems resulted when bankruptcy filings were involved. Bankruptcy cases often involve an interplay of state and federal laws. The issue of which law preempted which law was often unclear and quite complex, but the real question always boiled down to whether the participant’s retirement plan interests should be included in the bankruptcy estate – ie., used to pay his creditors – or whether such interests should be excluded from the bankruptcy estate. The Bankruptcy Code starts out with the premise of including in the bankruptcy estate all of the legal and equitable property interests of the debtor. As with most laws, there are exceptions and exclusions. Section 541(c)(2) of the Bankruptcy Code excludes from the bankruptcy estate property in a trust (such as a pension trust, for example) that is subject to a restriction on transfer that is enforceable under applicable nonbankruptcy law. In order for a pension, profit-sharing, or other employee retirement plan to qualify for favorable tax treatment under the Internal Revenue Code, both the Internal Revenue Code and ERISA (Employee Retirement Income Security Act of 1974) require that each such plan contain a provision prohibiting the assignment or transfer of a participant’s interest in the plan. Conflicts among the federal circuit courts arose from varying court decisions interpreting whether this federal requirement constituted “applicable nonbankruptcy law”. Among these decisions were those which held that the phrase only included state laws, and that the ERISA prohibition on transfer had no effect in such cases; those which held that any state law exemption (such as Florida’s) was preempted by ERISA, and that the ERISA prohibition did not constitute applicable nonbankruptcy law, with the result being no protection; while other courts held that the ERISA provision did apply, with the result that the plan interests were excluded from the bankrupt’s assets available to satisfy creditors’ claims.
THE SUPREME COURT DECISION. Joseph Shumate, Jr. had been employed for over 30 years by the Coleman Furniture Corporation. He participated, along with 400 others in the company’s pension plan. The plan satisfied the applicable ERISA requirements, and qualified for favorable tax treatment under the Internal Revenue Code. Among other ERISA-required provisions contained in the plan, it contained an anti-alienation provision which provided that benefits under the plan could not be assigned or alienated (transferred). Shumate’s interest in the plan was valued at $250,000.
The company and Shumate separately filed for protection under the Bankruptcy Code. As part of the company’s proceeding, its bankruptcy trustee terminated and liquidated its pension plan, providing full distribution to all participants except Shumate. Shumate’s bankruptcy trustee (Patterson) sued to compel the distribution of Shumate’s plan interest to him for use in paying Shumate’s creditors. Shumate argued that the ERISA-required anti-alienation provision contained in the plan was a restriction on transfer enforceable under applicable nonbankruptcy law, and, as such, should result in the exclusion of his plan interest from the bankrupt estate. Patterson argued that the Bankruptcy Code reference to “nonbankruptcy law” should be interpreted to mean only state law, and not federal law such as ERISA.
In a unanimous decision, the U.S. Supreme Court held that “applicable nonbankruptcy law” is not limited to state law, stating: “Plainly read, the provision encompasses any relevant nonbankruptcy law, including federal law such as ERISA.” Referring to Section 541, the Court said that “The text contains no limitation on `applicable nonbankruptcy law’ relating to the source of the law.”
In support of its holding, the Court stated that its decision will: ensure that the protection of pension benefits will not vary based upon the beneficiary’s bankruptcy status; give full and appropriate effect to ERISA’s goal of protecting pension benefits; and ensure that the security of a debtor’s pension benefits will be governed by ERISA, and not left to the vagaries of state spendthrift laws.
EXCEPTIONS. As mentioned above, with any rule of law, there are exceptions. First among these exceptions is the Qualified Domestic Relations Order (QDRO), which permits the recognition of a court ordered assignment of qualified plan benefits in a divorce or child support case. Federal tax liens are another exception. It appears that pre-bankruptcy tax liens filed against qualified plan benefits will remain enforceable. However, if bankruptcy is filed before the tax lien, the IRS is in the same boat with the other creditors. Finally, the impact of Patterson v. Shumate is not clear with respect to certain retirement plans which are not required to contain the ERISA anti-alienation provision addressed by the Supreme Court, among which are IRA’s, certain Keogh plans, and tax sheltered annuities. However, Florida and many other states have provided statutory exemptions for these plans which appear to be effective. Thus, with the exceptions noted, it can be stated with certainty that your qualified retirement plan interest is now protected from creditors.