The requirement that a chapter 13 debtor submit all disposable income to fund a chapter 13 plan is one of the foundations of chapter 13 practice. It has been seen as a basic protection to unsecured creditors that a debtor is making a best effort to repay debts. The provision requiring net disposable income be paid into a plan was added in 1984 and it is often referred to as the "disposable income test."¹ In general, §1325(b) permits a trustee or a general unsecured creditor to object to the confirmation of a proposed chapter 13 plan if the plan does not provide for the dedication of "all disposable income" to fund the plan or the plan provides for the payment of all allowed unsecured claims in full within three years. The 1984 Act was enacted to create an objective method to determine a debtor's "best effort" in proposing a chapter 13 plan.²

"All disposable income" has been held to include pension benefits,³ Social Security benefits,⁴ settlement of personal injury claims,⁵ proceeds from the sale of a houseboat or gun collection,⁶ and the debtor's tax refund, even where such income would be exempted under state law.⁷

In order to submit all disposable income under §1325(b), the debtor must "submit income received by the debtor which is not reasonably necessary to be expended for the maintenance and support of the debtor or a dependent of the debtor..."⁸ In so doing, the court must examine whether a budgeting expenditure proposed by the debtor is an expenditure that is reasonably necessary for the maintenance and support of the debtor or a debtor's dependent. Courts have scrutinized this matter in a variety of areas with mixed results. Courts have rejected expenditures for luxury items,⁹ and excessive life insurance premiums.¹⁰

In 1995, the Sixth Circuit decided the case of In re Harshbarger, 66 F.3d 775 (6th Cir. 1995). In this case, the chapter 13 trustee objected to the confirmation of a proposed plan in which the expenditures of the debtor disclosed the sum of $61.17 per month being utilized to repay a loan against a debtor's ERISA account. In essence, the debtor's plan in Harshbarger exempted $61.17 per month from the estate's disposable income. The pro rata distribution proposed to the unsecured creditors in that case was 40 percent.

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Even though H.R. 3150 has been called a creditor-oriented bill, the adoption of Buchferer and rejection of Harshbarger could materially improve consumer debtors' post-discharge position in regards to their pension plans.

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The Sixth Circuit noted that the debtor's proposed expenditure served to replenish her ERISA account after a pre-petition early withdrawal. This "replenishment" was an expenditure that was not reasonably necessary for the maintenance and support of the debtor or a debtor's dependent. The court held:

This expenditure may represent prudent financial planing, but it is not necessary for the 'maintenance or support' of the debtors... It is unfortunate that Mrs. Harshbarger's expected pension benefits may be diminished by a future set-off against the unpaid portion of her obligation to the ERISA-qualified account. However, this consideration does not alter the result under the bankruptcy laws.¹¹

As a result of the Harshbarger case, courts have continued to hold that voluntary deductions for a savings account or a voluntary pension fund, retirement program or employee stock purchase plan are not permitted.¹² Cases where debtors proposed to repay two loans to redeem certificates of deposit that secured them, but paid 30 percent to unsecured creditors, were unconfirmable for similar reasons.¹³ Consistently, repayment of borrowings from pension plans had been regarded as simply re-establishing savings that originally occurred during a debtor's employment and are not, therefore, debts to be satisfied under the debtor's chapter 13 plan.¹⁴ Chapter 13 debtors were simply out of luck if they wanted to repay their pension loans.

In 1997, the bankruptcy court for the Eastern District of New York disagreed with the Harshbarger conclusion that repayment of pension loans was not to be permitted under the disposable income test. In In re Buchferer,¹⁵ the debtor proposed a chapter 13 plan that included, as a material provision of the plan, repayment of loans obtained from the debtor's pension fund. In so doing, the debtor listed the amount withheld by his employer ($1,030) as a monthly living expense. While the court noted that an earlier holding of the Second Circuit, In re Villarie,¹⁶ would not permit the repayment of the pension loan, the court rejected such holding. The Buchferer court concluded that the pension administrator held a claim with a right of setoff against the debtor's vested interest in the pension plan. The Buchferer court concluded that because a claim against the debtor included a claim against property of the debtor under §102(2), the administrator's right to offset the amount owed by the debtor against the debtor's vested interest in the pension gave the administrator a valid, secured claim. The court noted:

If one holds a claim against property of the debtor, then one holds a claim against the debtor. Anyone who loses sight of this critical relationship for even the briefest moment will get hopelessly lost in the thorny thicket of the Code...the Retirement Act grants the retirement system the right to offset [Mr. Buchferer's] vested plan account if he terminates his employment with the Board while there is an outstanding balance due under his loans...[B]y providing for the retirement system's right to exercise a setoff against the debtor's property interest under the plan, New York state law confers the status upon the retirement system of a holder of a secured claim against the debtor.¹⁷

The Buchferer court rejected the argument of the trustee that the pension loan was "not a debt," which is the argument the Sixth Circuit relied on in Harshbarger. While the obligation owed to the pension fund by Mr. Buchferer may not have been a personal obligation of the debtor, the fact that a debtor can incur an indebtedness in the form of a non-recourse loan and that such loan satisfies the definition of a "claim" was decided by the Supreme Court in Johnson v. Home State Bank.¹⁸ Accordingly, the obligation that the debtor had to the plan administrator was a claim that could be treated as a secured claim in the chapter 13 plan.

The Buchferer court also held that the contribution of the debtor's post-petition income to satisfy this claim did not run afoul of §1325(b). The satisfaction of a secured loan was clearly not an invasion of the funds that would be available to unsecured creditors in the case. As such, the court reasoned that a "chapter 13 debtor can treat a non-recourse claim under a plan, and that includes satisfying that claim during the term of the plan from the debtor's post-petition income."

The recent Conference Report of H.R. 3150, considered by the 105th Congress, expressly rejected Harshbarger. In §201 of H.R. 3150 (Conference Report), §362(b) of the Code would have been amended so as to permit the continued withholding of sufficient funds from a debtor's wages to satisfy a pension, profit sharing or other loan as permitted by ERISA. The bill would have amended §523(a) to preclude the discharge of any obligation owing to a pension, profit sharing or other plan under ERISA. The provision would also amend §1322 to prohibit the modification of the terms of a pension loan in a chapter 13 plan. The proposed reform bill would have made the holding of Buchferer the law of chapter 13.

From a debtor's perspective, the overturning of Harshbarger could provide a meaningful opportunity to preserve retirement benefits. Debtors who are now incapable of repaying ERISA-qualified loans as part of their chapter 13 payments are facing additional tax obligations post-petition as a result of such non-payment.¹⁹ To be sure, significant risks of bankruptcy planning exist in such a model as outlined in In re Fulton.²⁰ While creditors could be adversely affected by the possible inclusion of post-petition taxes in a chapter 13 plan pursuant to §1305 resulting from the ERISA tax consequences, the tax ramifications equal only a small percentage of the unpaid retirement loan and are not equal to the total amount necessary to repay pension loans. The court in Fulton observed that a savvy consumer bankruptcy planner could withdraw pension benefits in advance of retirement, apply such funds to expand exempt assets or spend such benefits improvidently, and then claim the post-petition income necessary to replenish the protected fund.

In any examination of bankruptcy overhaul contemplated by the 106th Congress, it could be expected that Congress will again give debtors the opportunity to replenish their pension accounts. Even though H.R. 3150 has been called a creditor-oriented bill, the adoption of Buchferer and rejection of Harshbarger could materially improve consumer debtors' post-discharge position as to their pension plans.

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Footnotes

¹ The Bankruptcy Amendments and Federal Judgeship Act of 1984 Pub. L. No. 98-353, §317. Congressional comments also referred to the provision as an "ability to pay" test, personal bankruptcy: Oversight Hearings Before the Subcommittee on Monopolies and Commercial Law of the House Committee on the Judiciary, 97th Congress, 1st and 2nd Sess. 213 (1981-1982). Return to article

2 See, e.g., In re Kerr, 199 B.R. 379, 371 (Bankr. N.D. Ill. 1996). Return to article

3 Matter of Ross, 18 B.R. 364 (Bankr. N.D.N.Y. 1982). Return to article

4 In re Hagel, 184 B.R. 793 (9th Cir. BAP 1995). Return to article

5 In re Claud, 206 B.R. 374 (Bankr. W.D. Pa. 1997). Return to article

6 In re Burris, 208 B.R. 171 (Bankr. W.D. Mo. 1997). Return to article

7 Freeman v. Schulman, 86 F.3d 478 (6th Cir. 1996). Return to article

8 Section 1325(b)(2) has been amended to withdraw from disposable income "charitable contributions...to a qualified religious or charitable entity or organization... in an amount not to exceed 15 percent of the grossed income of the debtor for the year in which the contributions are made..." Return to article

9 In re Carter, 205 B.R. 733 (Bankr. E.D. Pa. 1996). Return to article

10 In re Smith, 187 B.R. 678 (Bankr. D. Idaho 1995). Return to article

11 At page 777-778. Return to article

12 In re Hesson, 190 B.R. 229 (Bankr. D. Md. 1995). In In re Cavenaugh, 175 B.R. 369 (Bankr. D. Idaho 1994), the court disallowed voluntary contributions to the retirement fund. In re Fountain, 142 B.R. 135 (Bankr. E.D. Va. 1992). Return to article

13 In re Tucker, (Bankr. W.D. Tenn. 1998). Return to article

14 In re Anes, 216 B.R. 514 (Bankr. M.D. Pa. 1998). See, also, New York City Employees Retirement System v. Villarie, 648 F.2d 810 (2nd Cir. 1981); In re Fulton, 211 B.R. 247 (Bankr. S.D. Ohio 1997); In re Delnero, 191 B.R. 539 (Bankr. N.D.N.Y. 1996). Return to article

15 216 B.R. 332 (Bankr. E.D.N.Y. 1997). Return to article

16 Supra at n. 10. Return to article

17 Supra at 337. Return to article

18 501 U.S. 78, 111 S.Ct. 2150, 115 L.E2d 66 (1991). Return to article

19 Taxes include a tax on the loan proceeds as income (an early withdrawal) and a penalty equal to 10 percent of the loan amount remaining unpaid, if the debtor is under the age of 59-1/2. Return to article

20 211 B.R. 247 (Bankr. S.D. Ohio 1997). Return to article