Davis Clears up Seafort Footnote

Attorney Jeremy Shephard submitted an article to the Summer 2020 issue of the Michigan Bankruptcy Journal. This is quarterly journal produced by the Western District of Michigan Federal Bar Association Bankruptcy Steering Committee. The article can be downloaded here: Summer 2020 – Michigan Bankruptcy Journal – Shephard. It is also reproduced below.

The Chapter 13 debtors in the case of Seafort v. Burden (In re Seafort), 669 F.3d 662 (6th Cir. 2012) were paying back 401K loans but they were not making a voluntary contribution to their 401K plans at the time of filing their Chapter 13 plans. The debtors were going to pay those 401K loans off prior to completion of their Chapter 13 plans. The debtors’ plans proposed that upon completion of the 401K loans that the debtors would begin making voluntary contributions to their respective 401K plans instead of using the freed-up 401K loan money to pay unsecured creditors. Their Chapter 13 trustee disagreed with that position and objected to that treatment in their respective plans.

The debtors’ argument won initially with the Bankruptcy Court; however, the Bankruptcy Appellate Panel ruled in favor of the Trustee, and by February 2012 the case had made it to the Sixth Circuit Court of Appeals. The Sixth Circuit Court of Appeals sided with the Trustee stating that the postpetition income that becomes available to a debtor after a 401K loan is repaid cannot be used to fund a voluntary 401K and it needs to be committed to the Chapter 13 reorganization plan. The opinion itself was straightforward; however, the Sixth Circuit Court of Appeals decided to add a footnote that would create additional problems for debtors.

Footnote 7 in the Seafort case stated “[t]he Trustee “concedes” that if a debtor is making voluntary retirement contributions when the bankruptcy petition is filed, such continuing contributions may be excluded from disposable income. We do not agree with this assertion, …. However, our view is not relevant here, because this issue is not presently before us.” The Sixth Circuit Court of Appeals seemed to be providing unsolicited guidance that existing 401K deductions were improper and that continuing contributions should be stopped in favor of paying more into the Chapter 13 plan.

The dicta in Footnote 7 of Seafort lead to confusion in the Sixth Circuit for over eight long years. In June 2020, the issue of voluntary retirement contributions came full circle in front of the Sixth Circuit Court of Appeals in the case of Davis v. Helbling (In re Davis), No. 19-3117 (6th Cir. June 1, 2020).

Retired bankruptcy Judge Eugene Wedoff argued on behalf of the debtor that voluntary retirement contributions should be excluded from disposable income. The Sixth Circuit Court of Appeals agreed with the debtor’s position that discontinuing voluntary 401K deductions is not required. While Seafort remains good law as to 401K loans in the Sixth Circuit, Footnote 7’s dicta no longer remains in the shadows blanketing this issue in uncertainty.

The Davis decision is welcome news in making Chapter 13 a more attractive option to those debtors contemplating bankruptcy because the ability to put away funds for retirement keeps the debtors on a level playing field for those similarly situated contemplating Chapter 7. Additionally, the decision harmonizes with Congressional goals of protecting retirement accounts under the available bankruptcy exemptions and allowed deductions on the Chapter 13 means test.