Editor's Note:Part II of this article will appear in the March 2005 issue.

On Dec. 1, 2004, counsel for the debtors and their panel trustee squared off before the Supreme Court. The Court had granted certiorari in June to resolve a split among three circuits on an issue important to many individual debtors: Whether (and to what extent) Individual Retirement Accounts (IRAs) are exempt under Bankruptcy Code §522(d)(10)(E). The Rouseys filed their joint chapter 7 in 2001. Among their assets were two IRAs rolled over from their retirement plans with their previous employer. The debtors claimed an exemption under §522(d)(10)(E) for the bulk of their IRAs. The trustee objected, and the bankruptcy court sustained her objection.¹ The Bankruptcy Appellate Panel (BAP)² and then the Eighth Circuit Court of Appeals₃ affirmed the bankruptcy court's decision. Twenty years earlier, the Third Circuit had reached a similar result,⁴ but four other appeals courts had subsequently come to the opposite conclusion.⁵ The Supreme Court granted certiorari on June 7, 2004.⁶

The Exemption Provision in the Proceedings Below

Section 522(d)⁷ begins with 11 specific descriptions of exempt property. Seven of the exemptions are described in terms of the debtor's "interest" in particular types of property. Another speaks to a life insurance contract "owned" by the debtor. A ninth exempts health aids "for" the debtor. Finally, there are two exemptions framed in terms of a debtor's "right to receive" certain payments ranging from social security benefits to compensation for lost future earnings. The full subsection at issue in Rousey, §522(d)(10), reads as follows:

(10) The debtor's right to receive—

(A) a social security benefit, unemployment compensation or a local public assistance benefit;
(B) a veterans' benefit;
(C) a disability, illness or unemployment benefit;
(D) alimony, support or separate maintenance, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor;
(E) a payment under a stock bonus, pension, profit-sharing, annuity or similar plan or contract on account of illness, disability, death, age or length of service, to the extent reasonably necessary for the support of the debtor and any dependent of the debtor, unless—

(i) such plan or contract was established by or under the auspices of an insider that employed the debtor at the time the debtor's rights under such plan or contract arose;
(ii) such payment is on account of age or length of service; and
(iii) such plan or contract does not qualify under §401(a), 403(a), 403(b) or 408 of the Internal Revenue Code of 1986.

Both the bankruptcy court and BAP in Rousey denied the claimed exemption in the IRAs for two reasons. First, they concluded that an IRA was not sufficiently "similar" to the four retirement plans enumerated in §522(d)(10)(E) because the debtors could withdraw all the funds from the IRAs at any time subject only to a 10 percent income tax surcharge if the withdrawal took place before age 59 1/2. Rousey I, 275 B.R. at 312-16; Rousey BAP, 283 B.R. at 269-70. Second, both courts concluded that the lack of restriction on withdrawal also meant that the debtors did not maintain the IRAs "on account of illness, disability, death, age or length of service" and thus did not fit within the ambit of §522(d)(10)(E). Rousey I, 275 B.R. at 316-17; Rousey BAP, 283 B.R. at 272-73.

The Eighth Circuit affirmed only on the second of these grounds. It acknowledged that the Rouseys' IRAs indeed were "similar" to the specific retirement devices listed in the statute. Rousey 8th, 347 F.3d at 692.⁸ But it went on to conclude that potential payments from the IRAs were not "on account of illness, disability, death, age or length of service" because the Rouseys had "unfettered discretion to withdraw from the corpus at any time subject only to modest early withdrawal tax penalties." Id. at 693 (internal quotation marks omitted).

The Other Circuits

Four appeals courts had rejected the Eighth Circuit's holding that ready accessibility of IRAs at any time for any reason means they are not "on account of" one of the five purposes permitted under §522(d)(10)(E). In 1996, the Fifth Circuit concluded that "[a]s long as the right to receive a payment under a plan or contract can be triggered by one or more of the five listed events, and is therefore exemptible, the fact that payments can also be triggered by some additional factor...cannot destroy exemptibility." Carmichael, 100 F.3d at 379. A year later, the Second Circuit in Dubroff analyzed a New York exemption statute that closely tracked (but was not identical to) §522(d)(10)(E)⁹ and held that IRAs were exempt. Dubroff, 119 F.3d at 80. The Ninth Circuit in 2000 considered a California exemption statute that was materially identical to §522(d)(10(E). McKown, 203 F.3d at 1189. The trustee in McKown did not raise the issue of whether payments from an IRA were "on account of" one of the five permitted reasons. Thus, the court was content to affirm that IRAs are sufficiently "similar" to the four enumerated retirement plans to be exempt. Id. at 1189-90. Then in 2001, the Sixth Circuit weighed in and rejected the trustee's argument that an IRA could not be exempt under §522(d)(10(E) where withdrawals were not limited to one of the five permitted purposes:

This reading...suffers from at least two flaws. In the first place, §522(d)(10)(E) does not contain the word "solely"; it merely provides that the payment must be made "on account of" age.... The fact that early withdrawal might be available—subject, in the case of IRAs, to a 10 percent penalty for withdrawals made before the beneficiary has attained the age of 59 1/2...is irrelevant, as the statute does not require that the payment be made "solely" on account of age. In the second place, the trustee's reading turns part of §522(d) (10)(E)(iii) into surplusage. Brucher, 243 F.3d at 243-44.¹⁰

The only exception to the litany of exemptions prior to Rousey 8th at the appeals court level was the 1983 decision in Clark. The Third Circuit affirmed the bankruptcy court's decision denying an exemption for a 43-year-old debtor's Keogh plan.¹¹ Tax law and the debtor's retirement plan freely permitted withdrawals after age 59 1/2, but subjected most early withdrawals to an income tax surcharge of 10 percent. See IRC §§72(t)(1)-(2) and 4974(c)(4)-(5). Because the debtor did not have a "present right to receive payments from the plan" (Clark, 711 F.2d 22), his claimed exemption did not fall within the literal exemption provided by §522(d)(10)(E), which protects only a "debtor's right to receive a payment," not corpus of the plan. Exemption of a stream of present payments, according to the court, may be necessary to achieve the statutory goal of protecting a debtor's fresh start (Id. at 23), but an asserted "exemption of future payments, however, demonstrates a concern for the debtor's long-term security, which is absent from the statute." Id. (emphasis in the original).

The Rousey Briefs

The trustee in Rousey chose to forego reliance on Clark in seeking to uphold the decision in Rousey 8th, relying instead on trying to convince the court that payments from IRAs were not "on account of" the five permitted purposes and that IRAs were not "similar" to the four enumerated plans. Brief for Respondent at 13-26.¹²

Counsel for the Rouseys and the amicus, not knowing in advance of the trustee's strategic decision to shun Clark, spent some effort in their briefs explaining why the Third Circuit was wrong. The Rouseys' brief gave four reasons why the Court should not follow Clark. First, it asserted on a textual basis that the statutory phrase "right to receive a payment" is not expressly limited to payments presently being received and therefore "contemplates both present and future payment rights." Brief for the Petitioners at 29-30.

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Does §522(d)(10)(E) exempt only rights to payment and not the underlying sources of those payments?

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Second, the Rouseys turned to two pieces of legislative history. They initially noted that the House Committee Report "explains that '[p]aragraph (10) exempts certain benefits that are akin to future earnings of the debtor.'" Id. at 33 (emphasis in original) (citation omitted). Both IRAs and the four enumerated plans can produce "future earnings." Affirming the consequent, the brief concludes that Congress must have intended IRAs also to fall within the ambit of §522(d)(10)(E). Brief for the Petitioners at 34. The brief then turns to the 1973 Report of the Commission on Bankruptcy Laws (the Commission Report) that recommended a broad exemption for retirement benefits: "(6) Before or after retirement, such rights as the debtor may have under a profit-sharing, pension, stock bonus, annuity or similar plan which is established for the primary purpose of providing benefits upon retirement...." Id. (emphasis in original) (citation omitted). Even though Congress considerably narrowed the eventual scope of §522(d) (10)(E), the Rouseys' brief argues that the Commission Report demonstrates a congressional purpose to protect a debtor's right to future payments as well as payments currently received. Id.

Third, the Rouseys argued a reducto ad absurdum: "[T]he Third Circuit's rule would produce grossly inequitable—indeed bizarre—results that Congress could not have intended: A debtor aged 591/2 would be permitted to exempt as much of his IRA as is necessary for support, while a 59-year-old debtor could exempt nothing at all." Brief for the Petitioners at 35. If §522(d)(10)(E) protects only a "right to receive a payment" in the present, then a debtor could not exempt an inchoate future income stream. The Rouseys reducto assumes that a right to exempt even current payments extends to the corpus that produces the payments. However, their argument fails if §522(d)(10)(E) applies only to a "right to receive a payment" and nothing more.

Finally, the Rouseys' brief turns pragmatic: Debtors "who are on the verge of retirement" have a present need to preserve assets for retirement. Brief for the Petitioners at 36. Policy rather than statutory construction should drive the decision to permit exemption of IRAs for those who would otherwise be unable "to recreate a retirement nest-egg from scratch." Id. Exempting IRAs thus preserves a "right to receive a payment," but not a right to payment from the retirement plan. Instead, exempting IRAs preserves the right to continue to receive all of the debtor's current income in lieu of diverting a substantial portion of it to replenishing retirement funds. Unfortunately for the Rouseys, the text of §522(d)(10)(E) limits the source of payments to the four enumerated plans and "similar plans or contracts," which can hardly be read to include a debtor's current income.

The brief of the amicus AARP contains a mixed view of Clark. On one hand the brief asserts that "[t]he Third Circuit's statutory interpretation is inconsistent with both the text and purpose of §522(d)(10)(E)." Brief of Amicus AARP at 29. On the other hand, it holds out that "if this Court does not conclude that all IRAs qualify for §522's exemption, it should at least affirm the Third Circuit's approach." Id. The AARP's brief critiques Clark for only the first of the reasons asserted by the Rouseys: "[T]he statute's language does not require ongoing payments from the IRA at the time of the bankruptcy petition or even present rights to receive such payments. The statute uses the term 'right to receive...a payment,' a phrase that necessarily encompasses both present and future rights." Id. The AARP grounds its rationale for its broad understanding of the phrase "right to receive a payment" on the "akin to future earnings" language from the House Report noted in the Rouseys' second argument summarized above. Id. at 29-30.

The Question Not Raised

The arguments of the parties and the amicus focused on public policy and two contested issues of statutory construction.¹³ The Rouseys and the AARP stressed the importance of preserving sources of retirement income for an aging population. The trustee gave short shrift to this argument in favor of concentrating on interpreting the language of the statute. But all parties argued over whether IRAs could be a "similar plan or contract" to the four enumerated plans and whether heightened access to IRAs meant that they were not "on account of" one of the five permitted purposes.

The Third Circuit's decision in Clark raises, albeit none too clearly, a more fundamental question: Does §522(d)(10)(E) exempt only rights to payment and not the underlying sources of those payments? The text itself at least suggests this possibility, one that was not advanced in the Respondent's Brief or argued before the Court. If this section applies only to a right to payment, then debtors must turn to other exemptions (or exclusions) to protect the corpus of their retirement funds. Because the Court did not address this issue, I will insert myself at occasional points into the dialogue in oral argument to suggest that at the least the Court must consider this possibility.

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Footnotes

¹ In re Rousey, 275 B.R. 307 (W.D. Ark. 2002) (Rousey I). Return to article

² Rousey v. Jacoway (In re Rousey), 283 B.R. 265 (8th Cir. BAP 2002) (Rousey BAP). Return to article

³ Rousey v. Jacoway (In re Rousey), 347 F.3d 689 (8th Cir. 2003) (Rousey 8th). Return to article

⁴ Clark v. O'Neill (In re Clark), 711 F.2d 21 (3d Cir. 1983). Return to article

⁵ See Dubroff v. First Nat'l. Bank (In re Dubroff), 119 F.3d 75 (2d Cir. 1997) (construing similar New York exemption statute); Carmichael v. Osherow (In re Carmichael), 100 F.3d 375 (5th Cir. 1996); Dettmann v. Brucher (In re Brucher), 243 F.3d 242 (6th Cir. 2001); Farrar v. McKown (In re McKown), 203 F.3d 1188 (9th Cir. 2000). Return to article

⁶ See, generally, Supreme Court Update, ABI Journal, October 2004 at 6 (excerpting petition for certiorari and brief in opposition) for the substance of the arguments before the Supreme Court in Rousey v. Jacoway. The transcript of the oral argument can be accessed via the ABIhome page at http://www.abiworld.org/pdfs/rousey_jocaway.pdf. Return to article

⁷ Of course, none of the exemptions under §522(d) are available to debtors who are domiciled in states that have opted out of the federal bankruptcy exemptions pursuant to §522(b)(1). Thirty-five states have exercised their power to opt out, so the Court's decision in Rousey v. Jacoway will be directly applicable in only the remaining states. See, generally, Pryor, C. Scott, "Rock, Scissors, Paper: ERISA, The Bankruptcy Code and State Exemption Laws for Individual Retirement Accounts," 77 Am. Bankr. L.J. 65, 66 (2003) (hereinafter Pryor, "Rock, Scissors, Paper"). Return to article

⁸ "We agree that where an individual retirement account serves as a substitute for future earnings, Congress would probably consider it a 'similar plan or contract' as those explicitly listed in §522(d)(10)(E)." Return to article

⁹ N.Y. Debt. & Cred. Law §282(2(e) contained a crucial addition to the text of §522(d)(10(E). It provided that "[t]he debtor's right to receive or the debtor's interest in...(e) all payments under...." (emphasis added.) As we shall see, in light of the Third Circuit's analysis in Clark, this addition makes Dubroff inapposite to the examination of §522(d)(10)(E) in Rousey. Return to article

¹⁰ The reference to §522(d)(10)(E)(iii) in Brucher alludes to a statutory exception to exemption. No otherwise exemptible right to payment could be exempt if the underlying plan was established by an insider that employed the debtor, the payment under the plan was on account of age or length of service, and the plan failed to qualify under one of four sections of the Internal Revenue Code (including §408, which creates IRAs). Section 522(d)(10)(E)(i)-(iii). The court argued to the effect that Congress would not have excluded some IRAs from exemption unless they were exemptible in the first place; therefore, the lack of restriction on withdrawals from IRAs must be irrelevant. The court committed the logical fallacy of affirming the consequent and, as we shall see, ignored the significance of the subject of the exemption: "the debtor's right to receive a payment under...." Return to article

¹¹ A "Keogh Plan" or an "H.R. 10 Plan" is simply a reference to the 1962 amendments to IRC §401(c) that permitted self-employed individuals to participate in qualified pension plans. Since 1992, such plans could be excluded from the bankruptcy estate under Patterson v. Shumate, 504 U.S. 753 (1992), but only if there were more participants than the sole proprietor and his or her spouse. See 29 C.F.R. §§2510.3-3(b), -3(c)(1). In any event, the court's reasoning with respect to the "right to receive a payment" language remains instructive. Return to article

¹² The trustee's rationale for steering clear of Clark is uncompromising:

The Third Circuit has held that a debtor may exempt the right to payment from an IRA once he or she has reached the age of 591/2, but not before [citing Clark]. Because the right to withdraw from an IRA is not linked to age regardless of the debtor's age at the time of the bankruptcy filing, we do not urge the Third Circuit's construction of §522(d)(10)E) on this Court. Brief for Resp. at 21, n.8.

The trustee suggests that neither IRAs nor payments from them should be exempt regardless of the debtor's age. It thus appears that under the trustee's theory IRAs would not be exempt even were the debtor of retirement age and using withdrawals for support. Return to article

¹³ The parties also proffered differing interpretations of the effect of the inclusion of IRC §408 in the exclusionary clause of §522(d)(10(E)(iii). The competing argument appeared so inconclusive that discussion at length appeared unwarranted. In any event, the competing understandings of the exclusionary clause have no bearing on the fundamental issue of whether §522(d)(10)E) exempts anything more than a stream of payments. Return to article