Available: SSRN – “Whose Problem is it, Anyway? Some Thoughts on § 541(b)(7)’s Hanging Paragraph”
Abstract:
This edition of Bankruptcy Law Letter explains the “hanging paragraph” problem of § 541(b)(7). It argues that the Ninth Circuit’s 2024 decision in In re Saldana has the potential to direct attention away from Congress and toward the Supreme Court to resolve the problem with the hanging paragraph. It concludes that Congress should act to resolve the problem it created and clarify the meaning of the hanging paragraph through a Bankruptcy Code amendment.
Summary:
The article examines one of the more notorious drafting disasters left behind by BAPCPA: the so-called “Hanging Paragraph” in 11 U.S.C. § 541(b)(7). The dispute centers on whether voluntary retirement contributions—particularly 401(k) contributions—made after the filing of a Chapter 13 case are excluded from “disposable income” that must be committed to a Chapter 13 plan.
The author focuses on the Ninth Circuit’s decision in In re Saldana, where the court wrestled with whether postpetition retirement contributions may be shielded from creditors under the awkwardly drafted language Congress inserted into § 541(b)(7). Rather than cleanly amending Chapter 13’s disposable income provisions directly, Congress embedded language in a “hanging paragraph” attached to a subsection defining property of the estate. The result has been years of litigation and inconsistent interpretations among courts.
The article argues that the judiciary is increasingly being asked to solve what is fundamentally a legislative drafting failure. While courts—including the Supreme Court in other BAPCPA disputes—often attempt to impose coherence on the Bankruptcy Code, the article contends that Congress itself should fix the statute through amendment rather than leaving bankruptcy judges and appellate courts to reverse engineer congressional intent from syntactically tortured text.
Commentary:
BAPCPA may have been marketed in 2005 as a sophisticated reform package designed to crack down on supposed bankruptcy abuse, but twenty years later consumer bankruptcy attorneys are still cleaning up the legislative debris field. The “Hanging Paragraph” discussed in this article is only one of many dangling statutory monstrosities inserted into the Code during BAPCPA. Indeed, the term “Hanging Paragraph” itself feels like something bankruptcy lawyers had to invent simply to describe provisions so awkwardly drafted that normal statutory interpretation terminology became inadequate.
Of course, the most famous Hanging Paragraph remains the unnumbered paragraph following § 1325(a)(9)—the infamous “910-day vehicle anti-cramdown” provision that turned ordinary car loan litigation into a cottage industry for years after BAPCPA. Congress apparently decided that if numbered subsections worked reasonably well, then unnumbered floating text fragments scattered throughout the Bankruptcy Code would work even better.
The retirement contribution issue discussed in this article is particularly important because it demonstrates something that academics—and sometimes even courts—frequently misunderstand about Chapter 13 bankruptcy: Chapter 13 often requires debtors to pay less to unsecured creditors than they would effectively surrender in Chapter 7.
That sounds counterintuitive to non-bankruptcy lawyers, but it is absolutely true in many cases.
One reason is the exclusion of 401(k) contributions from disposable monthly income calculations. If voluntary retirement contributions are excluded from projected disposable income, debtors can continue saving for retirement rather than diverting those funds to unsecured creditors. That can substantially reduce plan payments.
And importantly, this exclusion may actually make the difference between receiving a discharge and being pushed out of bankruptcy entirely. Without the ability to deduct or exclude those retirement contributions, some debtors could suddenly appear to have sufficient “Disposable Monthly Income” to fail the Means Test or become trapped in unaffordable Chapter 13 plans.
Another major example is the “hypothetical liquidation test” under § 1325(a)(4). In determining what unsecured creditors must receive in Chapter 13, courts compare what creditors would hypothetically receive in a Chapter 7 liquidation. But that hypothetical Chapter 7 distribution must account for the commissions, administrative expenses, trustee compensation, liquidation costs, broker fees, tax consequences, and other expenses a Chapter 7 trustee would incur.
Once those hypothetical Chapter 7 administrative expenses are properly deducted, the amount unsecured creditors would actually receive in Chapter 7 may shrink dramatically. In many cases, Chapter 13 debtors can therefore confirm plans paying far less than outsiders assume, while retaining assets that would have been seized and sold in a Chapter 7 liquidation.
Consumer bankruptcy practitioners understand this reality because they see it every day. Yet scholarship and commentary about Chapter 13 often continues to describe it as a system where debtors necessarily “repay” creditors more than in Chapter 7. Frequently, that is simply incorrect.
What Chapter 13 often really provides is a structured mechanism for debtors to retain assets, protect retirement savings, cure mortgage defaults, save vehicles, preserve co-debtor relationships, and obtain broader relief—while still paying creditors at least what the Bankruptcy Code hypothetically requires after accounting for all the friction and expense inherent in liquidation.
And that, ironically enough, is precisely why the drafting of provisions like § 541(b)(7) matters so much. A few stray words in a BAPCPA hanging paragraph can determine whether a debtor keeps saving for retirement, qualifies for bankruptcy relief at all, or must instead devote years of future income to unsecured creditors.
For something Congress treated almost as an afterthought in statutory drafting, the consequences are enormous.
To read a copy of the transcript, please see:
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