In the event that a plan member declares bankruptcy – usually Chapter 7 or 13 – a number of issues can arise for a pension plan. Since the Modern Bankruptcy Code 1 of 1978 was enacted 2 , many courts have held that a pension plan loan does not create a “debt” for bankruptcy purposes. This view, which avoids various thorny issues that might otherwise arise for both the pension plan and the member, stems from a decision of the United States Court of Appeals for the Second Circuit, In re Villarie, 648 F.2d 810 (2nd Cir. 1981). Recently, however, a bankruptcy court challenged this seemingly well-established concept, which could have ramifications for pension plans. This article will provide more context, an explanation of the recent decision and identify a potential effect.
The Villarie The decision involved a loan from the New York City Employees’ Retirement System (NYCERS) to a member who later filed for Chapter 7 bankruptcy. The Second Circuit ruled that because NYCERS could not sue the member to recover the advance (it could only recover future benefits), the loan did not create “debt” for purposes of the Bankruptcy Code. The historic 2005 amendments to the Bankruptcy Code 3 and subsequent case law has largely followed this approach, at least insofar as it ensures that bankruptcy does not affect the repayment of an unpaid loan. 4 The United States Court of Appeals for the Ninth Circuit later echoed this position. See Egebjerg v. Anderson (In re Egebjerg)574 F.3d 1045 (9th Cir. 2009).
Notwithstanding this established treatment of diet loans in bankruptcy, a New Mexico court in the Tenth Circuit recently challenged the status quo. See Montoya v. Dubbin (In re Dubbin), Adv. No. 21 1004 t, 2021 WL 3476959 (Bankr. DNM August 6, 2021). Although the court acknowledged “[t]there is substantial support for defendant’s position that pension plan loans are not debts under the bankruptcy code,” the court went on to state that “[p]Pension plan loans are non-bankrupt bona fide debts and are recognized as such by the Bankruptcy Code. Identifier. at *2, 8. This opinion takes the view that the Supreme Court undermined Villarie’s analysis when it ruled, a decade later, that non-recourse secured obligations, such as diet loans, are both debts and claims under the Bankruptcy Code.
Identifier. (discussing Johnson v. Home State Bank, 501 US 78, 84 (1991)). And this approach has gained traction in one of the busiest bankruptcy courts in the country. 5
The Dubbin The decision highlights two main points for government plans. First, case law dealing with private pension plans, such as 401(k), may have precedent effects for public pension plans. Second, if pension plan loans are treated as “debt” (specifically “non-recourse secured debt”) by more bankruptcy courts, pension plans could face an increase in litigation stemming from bankruptcies of participants. This could include, as it did in Dubbin, a Chapter 7 trustee’s efforts to collect pre-bankruptcy loan repayments within certain time windows – typically 90 days or, sometimes, up to 1 year.
1. Title 11 United States Code (11 USC §§ 101 1532).
2. The Bankruptcy Code 1978 replaced the Bankruptcy Act 1898.
3. Bankruptcy Abuse Prevention and Consumer Protection Act 2005 (BAPCPA).
4. See, for example11 USC §§ 362(b)(19) (automatic stay does not apply to payroll deductions to repay plan loans), 523(a)(18) (except discharge debts due to pensions for permitted plan loans), 1322(f) (a Chapter 13 plan cannot materially alter the terms of a plan loan).
5. See In re LivingstonCase No. 21 10879 (LSS), 2022 WL 951339 (Bankr. D. Del. Mar. 29, 2022) (citing
In re Dubbin2021 WL 3476959 at *7).
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.