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Changing Views on Pension Plan Loans in Bankruptcy— Is it a “Debt”?

Changing Views on Pension Plan Loans in Bankruptcy— Is it a “Debt”?
September 7, 2022 by Tyson A. Crist, Partner | Robert L. Gauss, Partner
In the event a plan participant files bankruptcy—typically 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 taken the view that a pension plan loan does not create a “debt” for purposes of the bankruptcy. This view, which avoids various thorny issues that could otherwise arise for both the pension plan and participant, emanates from a decision by the United States Court of Appeals for the Second Circuit, In re Villarie, 648 F.2d 810 (2d Cir. 1981). Recently, however, a bankruptcy court has challenged this seemingly well established concept, which could have ramifications for pension plans. This article will provide further background, an explanation of the recent decision, and identify one potential effect.

The Villarie decision concerned a loan from the New York City Employees’ Retirement System (NYCERS) to a member who later filed chapter 7 bankruptcy. The Second Circuit ruled that because NYCERS could not sue the member to recover the advance (it could only recoup from future benefits), the loan did not create a “debt” for purposes of the Bankruptcy Code. The landmark 2005 amendments to the Bankruptcy Code [3] and subsequent case law largely followed this approach, at least to the extent of ensuring that bankruptcy does not impact the repayment of an outstanding plan 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 plan loans in bankruptcy, a court in New Mexico, within the Tenth Circuit, has recently challenged the status quo. See Montoya v. Dubbin (In re Dubbin), Adv. No. 21 1004 t, 2021 WL 3476959 (Bankr. D.N.M. Aug. 6, 2021). Although the court acknowledged “[t]here is substantial support for Defendant’s position that pension plan loans are not debts under the Bankruptcy Code,” the court went on to hold that “[p]ension plan loans are bona fide debts outside of bankruptcy and are recognized as such by the Bankruptcy Code.” Id. at *2, 8. This opinion adopts the view that the Supreme Court undercut the Villarie analysis when it held, a decade later, that nonrecourse secured obligations, such as plan loans, are both debts and claims under the Bankruptcy Code. Id. (discussing Johnson v. Home State Bank, 501 U.S. 78, 84 (1991)). And this approach has gained traction in one of the nation’s busiest bankruptcy courts. [5]

The Dubbin ruling highlights two main points for governmental plans. First, case law dealing with private retirement plans, such as 401(k)’s, can have precedential effects for public retirement plans. Second, if pension plan loans are treated as “debts” (more specifically “nonrecourse secured debts”) by more bankruptcy courts, then pension plans may face increased litigation arising from participant bankruptcies. This could include, as it did in Dubbin, efforts by a chapter 7 trustee to claw back loan repayments made prior to bankruptcy, within certain windows of time — typically 90 days or, sometimes, up to 1 year. 

[1] Title 11 of the United States Code (11 U.S.C. §§ 101 1532). 
[2] The Bankruptcy Code of 1978 replaced the Bankruptcy Act of 1898. 
[3] Bankruptcy Abuse Prevention and Consumer Protection Act (BAPCPA) of 2005. 
[4] See, e.g., 11 U.S.C. §§ 362(b)(19) (the automatic stay does not apply to wage withholdings to repay plan loans), 523(a)(18) (excepting from discharge debts owed to pensions for permitted plan loans), 1322(f) (a chapter 13 plan may not materially alter the terms of a plan loan). 
[5] See In re Livingston, Case No. 21 10879 (LSS), 2022 WL 951339 (Bankr. D. Del. March 29, 2022) (quoting In re Dubbin, 2021 WL 3476959 at *7).

This publication is intended for general informational purposes only and does not, and is not intended to, constitute legal advice. The reader should consult with legal counsel to determine how laws or decisions discussed herein apply to the reader’s specific circumstance.

This post was previously published in NCPERS PERSist.

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