Benn And The Tax Refund Exemption In Bankruptcy Part II

(Reprinted with permission. Bankruptcy Law Network October 2011)

By Wendell Sherk, Missouri Bankruptcy Attorney

In the previous installment, we discussed the 8th Circuit’s Benn decision which began a sea change in Missouri bankruptcy exemptions.

To see how Benn‘s unusual opinion created  uncertainty in Missouri bankruptcies, one need look no further than our state teacher pension plans.  Prior to 2010, almost no one seriously imagined a state employee’s pension plan would be unprotected in bankruptcy.  Well-established pensions are like battleships, with layer after layer of armor protecting them from creditors typically.  And no single attack can get through.

In Missouri the pension plan law itself provides protection:

Neither the funds belonging to the retirement system nor any benefit accrued or accruing to any person…shall be subject to execution, garnishment, attachment or any other process whatsoever, nor shall they be assignable….  (169.090 RSMo.)

Yet Bankruptcy Judge Arthur Federman of the Western District of Missouri applied Benn and found Missouri’s laws wanting.  He reasoned Benn‘s reading of the Bankruptcy Code command that the state’s lawmakers use precise language — “magic words” in lawyer parlance — in order for a law to be an exemption in bankruptcy cases.

Benn said:

“Exemption” is a term of art in bankruptcy, and we agree with the dissenting judge of the BAP that “[w]hile exemption may mean different things in different contexts, in the context of Sec. 522, it refers to laws enacted by the legislative branch which explicitly identify property [that] judgment-debtors can keep away from creditors for reasons of public policy. (Benn at 814)

It is interesting to note however that the Bankruptcy Code itself does not actually define the word “exemption” but only defines how (and from what sources of law) a debtor may “exempt” property from the estate.

Judge Federman’s In re Nathan Smith opinion argues that the legislature enacted specific exemption laws for other pension plans but the teacher pension at issue did not use the magic word “exempt.”  And further the judge could find no legislative history to indicate the Missouri General Assembly intended to protect the pensions in bankruptcy cases.  (The lack of evidence is not surprising as the Missouri legislature does not maintain legislative history, though.)

Before any Missouri teacher panics, even Judge Federman acknowledges in a final footnote that there are other means than the statute at issue to preserve the pension in bankruptcy.  But he did expand on the dictum in the Benn decision and conclude that Missouri in fact does have a separate system of protections for consumers, inside or outside of bankruptcy, because the 8th Circuit “was quite clear that, in order to create an exemption in bankruptcy, the Missouri legislature must use that word [exemption].”

So prior to Benn, the laws of exemptions had generally been interpreted expansively to benefit the debtor because bankruptcy is considered a remedial process to help debtors obtain a fresh start. Indeed, prior to Benn, this same statute had been upheld as a bankruptcy exemption in In re Olson, 108 B.R. 232 (Bankr.W.D.Mo. 1989).  Indeed, the ruling seems to presuppose that the pension plan was even property of the estate, which seems unlikely under the Supreme Court’s 1992 Patterson v. Shumate decision.

Yet after Benn, the law of exemption became a narrowly-defined process.  In the next installment, we’ll discuss other issues created and then how things may recover in the future.

Wendell J. Sherk is an attorney in St. Louis, practicing primarily in consumer bankruptcy and debtor representation. He graduated from Washington University in 1986 and Washington University School of Law in 1989. He is a principal of the firm Sherk & Swope, LLC as well as a member of the National Association of Consumer Bankruptcy Attorneys, American Bankruptcy Institute, and The Missouri Bar. He contributes to the blog and his e-mail is: [email protected].

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