By Columbia-Lexington Bankruptcy Attorney Lex Rogerson
In the third in a series of articles on debtor-friendly U.S. Supreme Court decisions, we look at a 1992 opinion that excludes ERISA-qualified retirement plans from the bankruptcy estate.
Today, bankruptcy lawyers in Columbia routinely assume that all retirement plans are protected when a participant files bankruptcy. But this was not always a safe assumption. In our last post, we discussed the Rousey decision, where the Supreme Court held that IRA’s are protected by a law exempting pension, profit-sharing, and similar plans. In this article, we look at an earlier decision that put most pension plans completely outside the reach of the bankruptcy system. Patterson v. Shumate, 504 U.S. 753 (1992).
Joseph Shumate worked most of his adult life for Coleman Furniture Corporation in Pulaski, Virginia, eventually rising to president of the company. He and the other 400 employees were covered by the company’s employer-funded pension plan, which qualified under the Employee Retirement Income Security Act (ERISA), the main federal law regulating employee benefit plans. This meant the company could take its contributions as a tax deduction.
When Coleman Furniture became insolvent, Shumate also was forced to file bankruptcy. His trustee moved to seize the funds in his pension account, and the lower courts disagreed on whether this was permissible. Because appeals courts around the country had also reached conflicting answers, the Supreme Court agreed to consider the issue.
The Bankruptcy Law Issue
The pivotal question was whether the pension plan was property of Shumate’s bankruptcy estate. When a bankruptcy case is filed, virtually all the debtor’s assets become part of an estate. In chapter 7, where Shumate’s case ended up, the trustee in theory liquidates the estate and distributes the proceeds to creditors. In the vast majority of cases, because of liens and exemptions, the trustee is not able to reach any of the debtor’s property. However, the surest way to protect property is to exclude it from becoming property of the estate in the first place.
Under section 541(c)(2) of the Bankruptcy Code, the debtor’s rights in any trust are excluded from his bankruptcy estate if they are subject to a transfer restriction that is “enforceable under applicable nonbankruptcy law.” This exclusion most often protects “spendthrift trusts,” in which, typically, the donor puts assets into the hands of a manager to be handled for the benefit of a family member, directing that neither the beneficiary nor his creditors can sell the assets. The question became whether this exclusion applied to pension plans.
The Supreme Court’s Answer
In order to qualify under ERISA, a retirement plan must prohibit the employee from transferring his benefits to others. The Coleman Furniture plan contained such an anti-alienation provision, and neither Shumate nor his creditors could get into his benefits before the normal distribution schedule. Reading the words of section 541 in their plain meaning, the Supreme Court held that ERISA was an “applicable nonbankruptcy law” and that the Coleman Furniture anti-alienation provision therefore kept the plan benefits out of Shumate’s bankruptcy estate. His bankruptcy trustee could not liquidate his pension account.
Nowadays Shumate is less important for its holding than for the legislation it spurred. Increasingly over the last 20 years, Congress and state legislatures have expanded their exemption laws to protect almost all types of retirement plans. But had the Supreme Court decided differently in1992, who knows whether these protections would have been enacted?