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Repayment of 401 (k) Loan is Not Disposable Income Under Chapter 13 Bankruptcy Plan, But Creditors May be Entitled to Step Up Plan

By Marshall T. Kizner

In a letter opinion dated June 14, 2010, the Bankruptcy Court confirmed that under the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 ('BAPCPA') a debtor is not required to contribute money to a Chapter 13 Plan that is presently being used to repay a loan borrowed against a 401(k) plan. However, a creditor(s) challenging the confirmation of the plan may (1) inquire as to the terms of repayment and (2) the debtor may be required to propose a plan that steps up payment at a later date. 

In In Re Todd R. Roth, 10-13287 (JHW), the largest unsecured creditor of the debtor, a law firm, filed a motion to dismiss the debtor's Chapter 13 case and objected to the confirmation of the Plan. The Court scheduled an evidentiary hearing to decide the motion to dismiss, but addressed the movant's objection to the confirmation of the Plan.

As to confirmation of the Plan, the moving creditor argued that 401(k) contributions and repayments of a loan from a 401(k) account constitute disposable income that should be dedicated to pay unsecured creditors under the Plan. In opposition, the debtor submitted that post-BAPCPA, regular 401(k) contributions and repayment of a loan from a 401(k) account do not qualify as disposable income. The Court rejected the creditor's arguments because, under BAPCPA, money being contributed to a 401(k) plan and money being used to repay a 401 (k) loan are not deemed disposable income.

However, the Court, recognized that money utilized towards the repayment of a 401(k) loan should be reduced as the loan is repaid. As such, a creditor may inquire about the repayment terms of the loan. Consequently, the debtor may be required to propose a plan that steps up payment at a later date. For example, if the bankruptcy plan is for five years, but the loan will be repaid in two years, payments to creditors must increase at the beginning of the third year. In support, Court relied upon an unpublished bankruptcy court opinion that held that a step up plan may be required to include amounts presently being used to service a 401 (k) loan.

The Bankruptcy Court's letter opinion highlights the need for a creditor objecting to a Chapter 13 Plan to request information and documentation pertaining to the length and repayment terms of a voluntary pension loan. The debtor may be required to pay additional money under the Plan, but without diligent investigation by creditor's counsel, the terms of repayment of the loan may not be disclosed.

Full post as published by New Jersey Law Blog on July 20, 2010 (boomark / email).