The following is a case update written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal. Ret.), analyzing a recent decision of interest:

According to the United States Court of Appeals for the Eighth Circuit, a Chapter 7 debtor who was awarded part of his ex-wife’s Individual Retirement Account (IRA) and her 401(k) account in their prepetition dissolution proceeding may not claim those funds as exempt “retirement funds” under Section 522(b)(3)(C). Lerbakken v. Sieloff & Assoc., P.A. (In re Lerbakken), 949 F. 3d 432 (8th Cir. 2020).

To view the opinion, click here.

FACTS

A state court awarded Brian A. Lerbakken part of his ex-wife’s individual IRA and all of her 401(k) in a dissolution decree. Two months later, the court ordered an attorney’s lien against Lerbakken for the legal services of Sieloff & Assoc., which had represented him in the dissolution, and expressly permitted Sieloff to recover the unpaid fees from Lerbakken’s interests in the IRA and 401(k). Lerbakken filed a chapter 7 petition six months later and claimed the IRA and 401(k) exempt as “retirement funds” under Bankruptcy Code Section 522(b)(3)(C).

Both the bankruptcy court and the Bankruptcy Appellate Panel for the Eighth Circuit disallowed the exemptions, concluding that the interests were not retirement funds under Clark v Rameker, 573 U.S. 122 (2014), which had held that Section 522(b)(3)(C) applied only to the person who created and contributed to the retirement account. Debtor appealed to the circuit court, which affirmed.

REASONING

Following the analysis in Clark, the circuit court started with the dual requirements of Section 522(b)(3): (1) that the funds must be “retirement funds” and (2) that they must be in a covered account. To be “retirement funds”, account holders (1) are able to make additional contributions to the funds, (2) are not obligated to withdraw the funds, and (3) must pay a penalty to withdraw the funds prior to the age of 59 ½.

Lerbakken relied on a provision of the Internal Revenue Code which says that an individual retirement account transferred incident to divorce is treated as an IRA of the recipient spouse. The circuit court found that provision was insufficient to meet the Bankruptcy Code requirements. On the petition date, Lerbakken’s interest in the IRA was only conditional because it had not been renamed or transferred into an account under his name. Moreover, under state law Lerbakken was obligated to withdraw his conditional interest in the IRA; his interest had been defined in the court decree and attorney’s lien as a debt owed to Sieloff. Under those controlling documents, Lerbakken was supposed to effectuate a transfer of the funds to Sieloff. The circuit court found the IRA funds failed the second characteristic, were not “retirement funds,” and therefore were not exempt.

As for the 401(k), Lerbakken refused to submit a Qualified Domestic Relations Order (QDRO), which the court had ordered. This refusal came back to bite him because, although as an alternate payee he had an interest in the 401(k), he could not enforce that interest without a QDRO. Absent that federal protection, state law again determined his property interest as a debt owed to Sieloff. As with the IRA, state law mandated that he withdraw the funds, failing the second characteristic of “retirement funds.” The 401(k) was also not exempt.

AUTHOR’S COMMENTS

When I saw the summary of the 8th Circuit’s holding, I thought that the case might be the death knell for the ability of a recipient of interests in IRA’s, 401(k)’s, or similar accounts in a dissolution to claim such funds as exempt. Since the Supreme Court in Clark had already squelched an exemption for inherited IRA’s (a ruling that went against the majority of the lower appellate courts which had addressed the issue), it looked like no exemption would be available for funds not created and contributed to directly by a debtor. However, after seeing the reasoning of the circuit court here, I am not as pessimistic for future debtors.

The actual holding here is quite narrow and turns on the exact interest of the debtor in the funds as defined by state law on the petition date. The dismal result for Lerbakken could have been avoided if he had done the required transfer and renaming of the IRA prepetition and if he had presented the court with the QDRO as ordered to do. Both steps could well have qualified the funds as “retirement funds” and put them into the necessary account on the petition date to be exempt. However, perhaps it is not so surprising that he did not do so, since if the debtor had complied with all the state law mandates, the money would have been paid to Sieloff to satisfy the lien. Hopefully there will be another debtor who has been awarded similar funds in a dissolution without a lien attached and we can learn whether those funds can be exempted as “retirement funds.”

These materials were written by the Hon. Meredith Jury (United States Bankruptcy Judge, C.D. Cal. Ret.), a member of the ad hoc group, with editorial contributions by Corey R. Weber, a partner at Brutzkus Gubner Rozansky Seror Weber LLP, a member of the ad hoc group and the Chair of the CLA Business Law Section. Thomson Reuters holds the copyright to these materials and has permitted the Insolvency Law Committee to reprint them. This material may not be further transmitted without the consent of Thomson Reuters.