Annuities and IRA Shelter from Creditors in Bankruptcy found Constitutional

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Two debtors' IRA assets, challenged in bankruptcy, were considered exempt under a Nevada statute enacted after the debts were incurred wasn't an unconstitutional impairment of the contracts that established the debts. (In re Seltzer (1996, CA9) 1996 US App LEXIS 33336)The Chapter 7 bankruptcy petition, filed in 1992, listed debts exceeding $600,000. The debtors sought to exempt IRAs valued at $28,300 from their bankruptcy estate under a Nevada statute that provided a bankruptcy exemption for IRAs of up to $100,000, effective October 1, 1991. The bankruptcy trustee objected that the state law unconstitutionally impaired the contract rights of creditors because it allowed the debtors to shelter assets in a way not contemplated by the parties when they executed their contracts before October 1, 1991. The bankruptcy court and district court both rejected the constitutional challenge to the exemption under the Nevada statute.

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The Ninth Circuit affirmed.

Although the federal constitution says that no state shall pass any law impairing the obligation of contracts, the Supreme Court narrowly construed the clause in a 1983 case, Energy Reserves Group, Inc. v. Kansas Power & Light Co. The Supreme Court noted that a literal interpretation of the contract clause "would make it destructive of the public interest by depriving the State of its prerogative of self-protection." The Supreme Court said that a substantial impairment of a private contract under state law is constitutional if the impairment is reasonable and necessary to fulfill an important public purpose.

Here, the bankruptcy trustee didn't meet his burden of showing that the retroactive application of Nevada's exemption statute didn't serve a valid purpose. Nevada, like many other states, has recently updated its exemption statutes to shelter retirement assets from debt collection. The Nevada statute reasonably furthers the public policy of protecting retirement plans by limiting the exempt amount to $100,000.

The trustee also argued that the Nevada law unreasonably delegated control of its exemption to Congress by using Code Sec. 408, a federal statute to define the type of retirement account exempted under the state law. The Ninth Circuit also noted that pre-1983 Ninth Circuit decisions invalidating retroactive application of state exemption statutes are inapplicable because they didn't give appropriate deference to state legislative judgments as required by the Supreme Count in Energy Reserves.