McDonnell v. Gilbert (In re Gilbert)

According to the Third Circuit Court of Appeals (the Circuit Court) there is a distinction between whether ERISA applies to and governs a retirement plan and whether the plan complied with ERISA’s requirements to receive tax benefits.  Therefore, even if the debtors’ defined benefit retirement plans were not “qualified” under ERISA because of violations in their use, they still were excluded from his bankruptcy estate by 11 U.S.C. § 541(c)(2).  McDonnell v. Gilbert (In re Gilbert), ___ F4th ___, 2024 WL 4645582 (3rd Cir. November 1, 2024).  To view the opinion, click here:

https://www2.ca3.uscourts.gov/opinarch/232944pa.pdf

FACTS:

Eric Gilbert (the Debtor) filed chapter 7 bankruptcy, listing among his assets his interest (nearly $1.7 million) in retirement accounts set up under two defined benefit retirement accounts (the “Retirement Plans”).  These Retirement Plans had been established under the Employee Retirement Income Security Act (“ERISA”), federal statutes which govern many employer retirement plans.  The Debtor claimed that the Retirement Plans were excluded from his bankruptcy estate under 11 U.S.C. § 541(c)(2), which protects a debtor’s “beneficial interest…in a trust” that is subject to a “restriction on…transfer…enforceable under applicable nonbankruptcy law,” also known as an anti-alienation provision.   

John McDonnell, the chapter 7 trustee, filed a declaratory judgment complaint, asserting that the Retirement Plans were not excluded from the estate because their operation flouted not only ERISA rules but also those developed under the Internal Revenue Code which provides certain tax benefits to plans which are qualified.  The complaint alleged that the Debtor had utilized the 401(k) Plan as “an extra bank account without having to pay required taxes.”  The Debtor brought a motion to dismiss the complaint based on the exclusion provided by § 541(c)(2).

The bankruptcy court granted Debtor’s motion to dismiss and the district court affirmed.  The trustee appealed to the Circuit Court, which also affirmed in a published opinion.

REASONING:

The bankruptcy court dismissed the trustee’s declaratory judgment complaint because a “plain meaning reading of § 541(c)(2)” excluded the Retirement Plans from the estate even if they were operated in violation of ERISA and the IRC   It had ruled that § 541(c)(2) applied by following analysis of the Supreme Court in Patterson v Shumate, 504 U.S. 753,756-59 (1992), which held that the provision’s reference to “applicable nonbankruptcy law” included federal laws like ERISA. The trustee claimed that Patterson required a different result here because the plan referred to in that opinion had “satisfied all applicable requirements of [ERISA] and qualified for favorable tax treatment under the [IRC.]” Patterson, 504 U.S. at 755.   

Casting aside confusion which has arisen over the term “ERISA-qualified” as not relevant, the Circuit Court noted that whether the Retirement Plans were tax-qualified under ERISA and the IRC was not pertinent to its decision.  “Simply put, McDonnell confuses two distinct questions: whether ERISA applies to (and so governs) the Retirement Plans and whether the Plans complied with ERISA’s requirement.  It cannot be the case that a retirement plan normally governed by ERISA escapes it by brazenly violating its rules, as McDonnell seems to suggest here.”

The Circuit Court agreed with decisions that concluded that plans governed by ERISA were excluded from the bankruptcy estate under § 541(c)(2) because of the statute’s anti-alienation command, citing to In re Baker, 114 F. 3d 636, 640 (7th Cir. 1997.)  The failure of the Retirement Plans to be tax-qualified did not change the plain meaning of the statute.

The Circuit Court also rejected equitable arguments, relying on the Supreme Court’s ruling in Law v. Siegel, 571 U.S. 415, 421-22 (2014), and procedural arguments which were both unavailing and insufficiently developed in the record.

AUTHOR’S COMMENTS:

The Circuit Court’s plain meaning approach answers this question.  The term “ERISA-qualified” has been frequently referred to in the cases as the criteria for whether retirement plans are either excluded or exempted from bankruptcy estates.  It would behoove consumer practitioners to make the distinction between “governed by ERISA,” which would make its anti-alienation clauses applicable, and ERISA-qualified, which is not relevant to whether the account is excluded from the estate.  From this author’s reading, it appears that only the Seventh Circuit has also ruled on this issue.  Unfortunately for debtors, that might mean trustees have prevailed in bringing into the estate assets which otherwise should be excluded just because the accounts were not tax-qualified, an argument which this opinion rejects. 

[The Commercial Financial Newsletter is written by an ad hoc group of the California Lawyers Association (CLA) Business Law Section.  This article was written by the Hon. Meredith Jury (U.S. Bankruptcy Judge, CD CA, ret.), a member of the ad hoc group.  The opinions contained herein are strictly those of the author.]