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COPYRIGHT 2006 Aspen Publishers, Inc.
Early last year, Congress passed the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (the act). (1) Although this legislation was designed to address bankruptcy abuse and fraud, and to enact administrative reform, such as increasing the number of bankruptcy judges and streamlining procedures, the act contains several important pension reform provisions. Most of the provisions of the act became effective with respect to bankruptcy filings made on or after October 17, 2005.
Generally, the act strengthens the requirements which must be met in order for a debtor to discharge all of his or her debts in bankruptcy. For example, the act prevents individuals with income above certain limits from receiving a complete discharge of debts altogether. The act also contains several provisions which affect both individual and business bankruptcy filings with respect to employee benefits. Under the act, retirement plans and funds governed by certain sections of the Internal Revenue Code (the Code), such as a qualified retirement plan, traditional IRA, or Roth IRA, are exempt from inclusion in an individual debtor's bankruptcy estate. However, the exemption for IRAs and Roth IRAs is generally subject to an inflation adjusted $1 million cap (qualified plan rollovers and related earnings are excluded for purposes of calculating the cap). In addition, the act clarifies the protections applicable to business owners who participate in a plan that does not cover common law employees.
The act also excepts amounts withheld from a debtor's paycheck for repayment of plan loans from the automatic stay provisions of the Bankruptcy Code, and excepts such loans from discharge in bankruptcy. The act also exempts certain education individual retirement accounts, known as Coverdell education savings accounts, and qualified state tuition programs from property of the bankruptcy estate, if the designated beneficiary is the debtor's child or grandchild. The new provisions explicitly allow an individual debtor to continue making contributions to certain retirement accounts and health insurance plans regulated by state law.
With respect to employer bankruptcies, an employer who serves as a plan administrator must continue serving in such capacity, unless a trustee is serving in the bankruptcy proceeding and can take over the role of administrator. This provision helps to prevent plans from being abandoned during and after the bankruptcy. Furthermore, the act prohibits employers from paying certain retention bonuses and making severance payments to "insiders," such as corporate officers and directors, unless the payments are approved by the bankruptcy court. In addition, employers engaged in a Chapter 11 bankruptcy, which allows business debtors to reorganize and continue operations, are limited in their ability to modify or terminate retiree health and welfare benefits either during or within six months prior to commencing bankruptcy proceedings.
Most importantly for plan sponsors, the act resolves several issues faced by plan sponsors and other plan fiduciaries under previous law. For example, although some retirement funds were considered exempt under previous law, the new amendments to the Bankruptcy Code eliminate uncertainty regarding whether IRAs and certain other types of retirement accounts are protected from inclusion in the bankruptcy estate. In addition, plan sponsors can also continue to collect on loans made to a participant from, for example, a 401(k) plan, without wondering whether the repayments will have to be reversed after the fact.
This column provides a brief overview of the bankruptcy law provisions applicable to employee benefit plans and the amendments to existing law which were included in the act. There are many exceptions to the general bankruptcy rules described below. Plan sponsors or other fiduciaries to an employee benefit plan who wish to apply these rules to a specific situation should consider seeking legal advice. However, this column will assist such plan sponsors and fiduciaries in spotting issues related to bankruptcy filings of both plan participants and employers who sponsor benefit plans, and contrast the new provisions of the act with prior bankruptcy law.
Application of Bankruptcy Law to Employee Benefit Plans
In order to understand the recent revisions to bankruptcy law, it is necessary to have a basic understanding of the types of bankruptcy available to individual debtors and business entities. Generally, individual debtors can file for two types of bankruptcy: Chapter 7 and Chapter 13. The primary difference between the two options lies in whether the debtor's pre-bankruptcy debts are completely extinguished by the bankruptcy.
Bankruptcy Crash Course
In a Chapter 7 "liquidation" bankruptcy proceeding, all of a debtor's assets are "collected" in the bankruptcy estate, which will be distributed to creditors of the debtor in payment of their claims. Certain exemptions apply which protect some of the debtor's property from being included in the bankruptcy estate; for example, the debtor's home is usually exempt from inclusion....
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