The filing of a bankruptcy case results in the creation of a “bankruptcy estate.” As a general rule, “all legal or equitable interests of the debtor in property as of the commencement of the case” “wherever located and by whomever held” becomes property of the estate. There are, however, limited exceptions to the general rule. One such exception is that an interest of a debtor in a trust does not become property of the estate if there is a “restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law.” The interpretation of this exception is the subject of the October 24, 2024 decision of the United States Court of Appeals for the Third Circuit in In re Gilbert.
The debtor in Gilbert filed a voluntary Chapter 7 bankruptcy case. He disclosed that he had interests in two retirement accounts valued at nearly $1.7 million but asserted that they were not property of his estate because the Employee Retirement Income Security Act (“ERISA”) provided that his interests were not subject to claims of his creditors. The Chapter 7 trustee, John McDonnell, filed an adversary proceeding seeking a declaratory judgment that Gilbert’s interests in the retirement plans were property of the estate because the plans had not been administered as required by ERISA and the Internal Revenue Code (“IRC”) and had been “utilized…as an extra bank account without having to pay required taxes.” McDonnell argued that the Supreme Court in Patterson v. Shumate had held only that “ERISA-qualified” accounts are excluded from bankruptcy estates and that Gilbert’s retirement accounts were not ERISA-qualified because they had not been administered in accordance with ERISA and the IRC.
The bankruptcy court held that whether the retirement accounts had been administered in accordance with ERISA and the IRC did not matter. Because Gilbert’s accounts contained anti-alienation provisions and ERISA provides that such provisions are enforceable against creditors, Gilbert’s interests in the accounts were subject to a “restriction on the transfer of a beneficial interest of the debtor in a trust that is enforceable under applicable nonbankruptcy law.” The United States District Court affirmed the decision of the bankruptcy court, and McDonnell appealed to the Third Circuit.
The Third Circuit noted that the term “ERISA-qualified” that the Supreme Court used in Patterson “is not a term of art and is not defined in the Bankruptcy Code, the IRC, or ERISA” and “is not even a term used by employee benefit practitioners.” The Third Circuit dismissed the Supreme Court’s use of the term ERISA-qualified as “beside the point” in any event because the “plain language of the Bankruptcy Code and ERISA is our determinant.”
The Third Circuit said that it found nothing in ERISA’s text supporting the proposition “that ERISA’s anti-alienation language does not apply to retirement plans operated in violation of its commands.” In the view of the Third Circuit, “It would be strange if a statute whose… principal object…is to protect plan participants and beneficiaries…lowered its shield at the first violation.” The Third Circuit also said that it found no language in the IRC rendering an anti-alienation provision in an ERISA plan unenforceable if the plan was not administered in accordance with the IRC.
McDonnell cited two cases in which lower courts had held that plans not administered in accordance with ERISA and the IRC ceased to be “ERISA-qualified” and thus included in bankruptcy estates. However, the Third Circuit said that neither of the courts in those cases had “performed its own statutory analysis” or pointed to any “statute or authority suggesting that ERISA’s anti-alienation bar fails to protect from misbehaving plan administrators.”
Finally, McDonnell appealed to equity, arguing that Gilbert “will receive a windfall of over $1 million in a sham retirement account while living in Puerto Rico at the expense of his creditors.” The Third Circuit brushed this argument aside, citing the rule that “equity cannot be used to override bankruptcy’s detailed scheme delineating the property of the bankruptcy estate.”
The Third Circuit’s statement that there is no statute “suggesting that ERISA’s anti-alienation bar fails to protect from misbehaving plan administrators” implies that it was concerned that savings of innocent retirement plan participants and beneficiaries might be subjected to claims of their creditors by the malfeasance of unaffiliated plan administrators if it ruled in McDonnell’s favor. The fact that Gilbert “declined to tell McDonnell the identity of an administrator of the Retirement Plans” “despite repeated requests” suggests that the plan administrator in his case may not have been all that independent.
In re Gilbert is the latest example of courts deciding issues based on the “plain language” of statutes. Yet few would describe the language of either ERISA or the IRC as “plain.”
