401(k) Loan Not a "Necessary Expense": 9th Circuit

May 29, 2009 (PLANSPONSOR.com) - The repayment of a 401(k) loan may be a real debt obligation, but it's not a "necessary expense" for bankruptcy purposes, according to a recent court decision.

Applying the "means test" from the Bankruptcy Abuse Prevention and Consumer Protection Act of 2005 (BAPCPA), the United States Court of Appeals for the 9 ^th Circuit held (in an issue of first impression for the court) that the section 401(k) plan loan was not a "secured debt" or a "necessary expense" of the debtor.  

Accordingly, the court upheld a bankruptcy court's determination that the debtor's Chapter 7 bankruptcy petition was "presumptively abusive" under the BAPCPA's "means test."

The Case

Scott Lee Egebjerg filed a voluntary Chapter 7 bankruptcy petition on December 31, 2006. At the time, Egebjerg, who had been employed by Ralph's grocery store for 27 years and earned a gross income of $6,115.56 per month, was single with no assets other than an automobile he used for work and a timeshare.   The 9th Circuit noted that he also had unsecured consumer debt of about $31,000.

Approximately two years before he filed for bankruptcy, Egebjerg had taken a loan from his 401(k) plan. The plan subsequently deducted $733.90 from his paycheck each month to repay this loan, which was scheduled to be fully repaid by September 2008. The court noted that, according to Egebjerg's amended schedule of necessary expenses (in which he included the 401(k) repayment), he was left with a monthly disposable income of $15.31.

The Bankruptcy Court

The bankruptcy trustee objected to Egebjerg's bankruptcy petition, arguing that he had improperly included the Section 401(k) loan repayment as a "necessary" expense.  

The U.S. Bankruptcy Court for the Central District of California rejected that argument, concluding that the 401(k) loan was, in fact, a "secured debt" and one that could therefore be deducted from Egebjerg's monthly income for purposes of the means test.  

However, despite that finding, the 9 ^th Circuit said that the bankruptcy court incorrectly applied the same "totality of the circumstances" test that the bankruptcy trustee had relied on, even though it ultimately dismissed Egebjerg's Chapter 7 petition.   The 9 ^th Circuit noted that the lower court made its determination after concluding that the 401(k) plan loan would be repaid within a year and, after the loan was repaid, Egebjerg would have sufficient monthly income to meet his obligations.   The bankruptcy court concluded that Egebjerg could therefore "pay a significant amount of his debts in a Chapter 13 proceeding and that, because of his ability to pay, it would be an abuse to permit the case to continue as a Chapter 7 proceeding." Egebjerg appealed that decision.