Last month’s decision in Clark v. Rameker affects many millions, if not billions, of dollars in IRAs.
Our last few blog posts have been about the Supreme Court’s bankruptcy decision of last month, Clark v. Rameker. The Court decided that an Individual Retirement Account (IRA) that a debtor had received earlier through the death of the original owner of that IRA was not “exempt,” not protected from the debtor’s creditors. Today we look at some very important practical aspects of this case and about bankruptcy appeals in general.
The Immediate Effect on the Parties
As a result of the Court’s decision, the debtors, Heidi Heffron-Clark and her husband, Brandon Clark, now have to surrender the IRA that she had inherited back in 2001 when her mother died. The IRA had a value of $293,000 when their Chapter 7 case was filed in 2010, but in the meantime has increased in value. The entire IRA is now going to their bankruptcy trustee, who will distribute it to their creditors. Depending on how much is owed, and which creditors file claims against the “bankruptcy estate,” the creditor claimants will be paid in part or in full. If they are paid in full, as are the trustee’s fees, Heidi may even get some of the IRA money back. But this is very unlikely, considering the extremely hefty amount of trustee’s attorney fees for litigating the dispute all the way up to the Supreme Court will likely have to first get paid out of that fund.
The Effect on Everybody Else
This Supreme Court opinion will have an effect likely amounting to many, many millions of dollars on other debtors in similar circumstances, both in the present and in the future.
The scale of the situation was detailed by Heidi and Brandon’s attorneys in their Petition for Writ of Certiorari, the document through which they asked the Court to hear their case:
To begin with, the question presented is of exceptional practical and legal importance, as demonstrated by the number of Americans likely to be affected by its resolution and the sheer amount of money potentially implicated. Some 40% of American households—almost 50 million in all—own IRAs. As of June 2012, approximately $5.1 trillion was held in IRAs, representing more than 25% of all retirement assets in the United States. In fact, IRAs make up 10% of all household financial assets—up from just 5% only twenty years ago. Not surprisingly, as this case vividly illustrates, an IRA will often be the largest personal-property asset in a debtor’s bankruptcy estate.
As IRAs have become more common, so too has the passing of IRAs to beneficiaries upon the owner’s death. IRA ownership is concentrated in older segments of the population, with the aging “baby boom generation” having the highest percentage of ownership. And IRA owners who have reached retirement age are overwhelmingly likely to base withdrawals on their required minimum distributions, thus raising the likelihood that there will be funds left over in their IRAs at the time of death.
It is impossible to say what will be the full effect of such inherited IRAs not being exempt. Some people who hold such IRAs will presumably not file bankruptcy, perhaps instead finding better refuge in state exemption laws. There are already about 7 states which now explicitly exempt inherited IRAs, and some others will surely follow in reaction to the Court’s decision. No doubt some holders of their own IRAs will refrain from making beneficiaries of those who are at risk of filing bankruptcy. Their legal counsel will undoubtedly find ways—through spendthrift trusts and such—to plan around the problem. But no doubt some people with inherited IRAs will continue to file bankruptcy on the mistaken belief that all IRAs are exempt, only to find out that the retirement that they counted on will disappear into the clutches of their creditors.
The Reason for So Few Bankruptcy Appeals
The Petition for Writ of Certiorari also raised a practicality that may sound minor but actually has broad implications for the bankruptcy legal system. In its Petition the debtors asked the Supreme Court to accept the case for review
because, although the question presented arises often in bankruptcy cases, it rarely percolates up to the courts of appeals. That is unsurprising, because the parties in bankruptcy cases often lack the financial resources to pursue protracted litigation. As one commentator has explained, “[t]he nature of bankruptcy cases tends to discourage further appellate review… because of the twin concerns of delay and cost associated with prolonged litigation. For example, only one out of every 1,580 bankruptcy cases reaches the court of appeals level, compared to one in every twelve non-prisoner civil suits. Despite the massive number of bankruptcies in the United States, moreover, bankruptcy appeals represent only 1.2% of all appeals filed in the regional circuits… .
In our last blog we noted that the opportunity to appeal a judge’s decision provides a major check on arbitrariness in the legal system. But people filing bankruptcy often have trouble coming up with even just the fees for a straightforward case, much less the much greater amount that even the simplest contested litigation would cost. Going beyond that another huge step to appealing a bankruptcy court’s unfavorable decision is almost always financially unthinkable. The result is that debtors are absolutely stuck with whatever the perspective of their local bankruptcy judge, no matter how likely that perspective would be overturned by a higher court if the debtors could just afford to take it there.
This may be a reality with no ready solution, but it is still a reality that weakens the integrity and respectability of the bankruptcy system.