An interesting question is the extent to which creditors can reach non-probate assets. A deceased participant’s interest in a qualified plan or IRA, including an insured death benefit, is a dramatic species of non-probate asset. Just because an asset is a non-probate asset does not mean that it is automatically exempt from the decedent's debts, but in many instances this may be the result. Recall that there is at least one significant species of property that is a probate asset in the sense that it is subject to testamentary disposition, and yet is not subject to administration without the consent of the surviving spouse, viz., the decedent's interest in the surviving spouse's special community estate.
The courts have long held qualified plan assets to be exempt from execution by creditors, if the debtor is not in bankruptcy.[1] In the case of Patterson v. Shumate[2] a unanimous United States Supreme Court held that a participant’s benefits under a qualified pension plan cannot be reached by creditors in a bankruptcy proceeding. Prior to this decision the courts were divided on this issue.[3]
Since the issue has now been resolved, one may justifiably ask whether there is much point in understanding the issues that had formerly given the lower courts so much trouble. The answer is that the principles involved and their resolution have application in other contexts with which we still must be concerned. For example, there remain numerous retirement type arrangements that are not covered by the Shumate decision. Shumate only covers qualified pension plans subject to Part 2 of Title I of ERISA.[4] As discussed in detail below, Shumate does not apply to welfare benefit plans, nonqualified plans or other plans that are not pension plans governed by Title I of ERISA.
Perhaps the reason that the creditor claims issue had been vexing the lower courts for so long is that its resolution involves the interaction between Bankruptcy Code §541(c)(2) (the exclusion provisions), Bankruptcy Code §522 (the exemption provisions), ERISA §206(d) (the labor law anti alienation rule), ERISA §514(a) (the federal preemption provision), ERISA §514(d) (the federal non impairment provision), IRC[5] §401(a)(13) (the income tax anti alienation rule), and state exemption laws, each of which has its own legislative history. It is easy to see how the thread that holds these statutes together could be lost in the skein. To an extent, the Supreme Court in Shumate made an end run around most of these statutes by simply finding that ERISA §206(d) (the anti alienation rule) was included in Bankruptcy Code §541(c)(2) (the exclusion provisions), thus obviating the need for further analysis. We will attempt to do more here in order to formulate principles of broader application.
To understand the problem and its resolution, one must be familiar with at least six statutes.
We begin with ERISA §206(d)(1): “Each pension plan shall provide that benefits provided under the plan may not be assigned or alienated.” IRC §401(a)(13) is similar: “A trust shall not constitute a qualified trust under this section unless the plan of which such trust is a part provides that benefits provided under the plan may not be assigned or alienated.” The language required by ERISA §206(d)(1) and IRC §401(a)(13) is sometimes referred to as an “anti alienation clause.” Similar language found in most common law trusts is commonly known as a “spendthrift clause.”
ERISA §206(d)(1) is found
in Part 2 of Title I of ERISA. Note now for future reference that Part 2 does not apply to all employee
benefit plans. For example, Part 2 does not apply to “employee welfare
benefit plans,”[6] nor does
it apply to most nonqualified plans,[7]
government plans or most chu
Before proceeding further, it might be useful to discuss and dispose of two issues that do not appear to have bothered the courts, but that might confuse the reader if ignored altogether: (1) Does the fact that benefits may not be assigned or alienated (implying a voluntary act) mean that they are not subject to involuntary alienation? Stating the issue another way: by providing that benefits “may not be assigned or alienated” has the plan made it clear that benefits are not subject to attachment, garnishment, execution, etc., by creditors? The first case clearly denies anyone the power to directly alienate the property; the second means that the property is not even indirectly alienable. (2) One might also reasonably wonder whether a law that requires that a plan contain certain language necessarily means that the language is the law. In other words, if the law requires a plan to say that benefits may not be alienated, does it follow that the law will not allow the benefits to be alienated?
At the risk of sounding nibbling, it would have been more
reassuring on both points if ERISA had also provided that pension benefits “may
not be anticipated, assigned (either at law or in equity), alienated or subject
to attachment, garnishment, levy, execution or other legal or equitable
process,” or something similar. The regulations to IRC §401(a)(13) attempt to
fill this deficit, and the quoted language can in fact be found there.[10]
These regulations were cited with approval in Shumate[11]
and the two issues raised above, stated slightly differently, were effectively
dismissed by the Court.[12]
Therefore, it is clear that if ERISA
§206(d)(1) applies to the plan, the benefits under the plan are simply not
alienable.
Although a state shield law may provided otherwise, ERISA
certainly does not protect assets or benefits after they have been distributed,
even if they were exempt while held in a qualified trust.
In the Third Circuit, payouts from ERISA plans constitute a
distribution, subject to the reach of creditors. In Velis
v. Kardanis, 949 F.2d 78 (3d Cir.1991) (rehearing
denied), the question was whether a debtor could exclude from the estate his
interests in a pension plan, a Keogh plan, and an IRA. In that case the debtor
had borrowed from the plans. The Court
of Appeals for the Third Circuit stated: Even if pension plan assets in the
hands of a [pension] trustee are beyond the reach of creditors because not a
part of the debtor's estate under § 541(c)(2), distributions made from the plan
to the debtor would not enjoy such protection, in the absence of exemption
under § 522(d)(10)(E). 949 F.2d at 81-82.[13]
[Emphasis added.]
The real question in Shumate was whether ERISA §206(d)(1) applied in bankruptcy. The question was answered categorically in the affirmative. Why was this an issue and on what basis was it decided? We proceed to Bankruptcy Code §541.
Bankruptcy Code §541(a)[14] describes the property that comprises the bankruptcy estate. This list is generally very inclusive. For example, “except as provided in subsections (b) and (c)(2) of this section, [the property of the bankruptcy estate includes] all legal or equitable interests of the debtor in property as of the commencement of the case.”[15] The (c)(2) referred to is Bankruptcy Code §541(c)(2), which states:
“a restriction on the transfer of a beneficial interest of the
debtor in a trust that is enfo
Is ERISA nonbankruptcy law? For reasons not apparent on the face of the statute and that would therefore be unclear to the uninitiated, many if not most courts had, prior to Shumate, held that ERISA is not applicable nonbankruptcy law and that applicable nonbankruptcy law means “State law,” or even more narrowly, “State spendthrift trust law.”[17] The basis of the controversy is not found in the statutes, but in the legislative history to §541(c)(2):
“Paragraph (2) of subsection (c) . . preserves restrictions on
transfer of a spendthrift trust to the extent that the restriction is enfo