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The bankruptcy court found that funds withheld from employees' wages become plan assets (and trust funds) immediately upon being withheld rather than at the time the employer was required to segregate and transfer them to the plan. The court also noted that ' 403 of ERISA states that “the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants in the plan and their beneficiaries.” However, the court also found that a trust should only be imposed on the employees' contributions, not on the employer's assets, despite the fact that some of the contributions had been commingled with corporate assets. The court required the Labor Department to demonstrate a nexus between the funds withheld from the participants and the funds held by the bankruptcy trustee. Because the DOL failed to provide sufficient evidence of such a nexus, the court denied its summery judgment motion, but did find that since “the nexus requirement is less exacting than tracing, a nexus would be shown if the Plaintiff were able to trace the escrowed funds to the funds currently being held by the Trustee.”

401(k) Contributions Not Subject to Security Interests

The Bankruptcy Court for the District of Delaware has ruled that 401(k) contributions that Chapter 7 debtors withheld from its employees' paychecks but never sent to the plan administrator are not property of the bankrupt estate and therefore are not subject to the security interests of creditors. The court also held, however, that a trust should be imposed only on the employees' actual contributions and not on the debtors' assets, despite the fact that the funds had been commingled. It is the burden of the Labor Department to show a nexus between the contributions and the funds on which it seeks to impose a trust. Chao v. Lexington Healthcare Group Inc. (In re Lexington Healthcare Group Inc.), No. 03-11007 (December 15, 2005).

The debtors sponsored an ERISA qualified 401(k) plan for their employees. The plan allowed participants to withhold money from their wages to be contributed to the plan on their behalf. The debtors were responsible for withholding the employees' contributions, segregating them from the debtors' general assets, and transferring them to the plan administrator. Unfortunately, both pre- and post-petition there were contributions that were withheld from the employees but never transferred to the plan administrator. Approximately 9 months after the debtors filed their petition, and 6 to 12 months after the contributions had been withheld from the employees, the debtors' accounting manager established an escrow account with the debtors' attorney into which the debtors deposited funds, which were to be used only for payments to employee benefits plans, including the 401(k). Although the secured creditors' liens on the Debtors' assets predated the contributions in question the Secretary of Labor filed a complaint asserting that a trust is imposed on the general assets of the debtors for the benefit of the 401(k) plan pursuant to ' 1103(a) of ERISA, which provides that “all assets of an employee benefit plan shall be held in trust … ”

The bankruptcy court found that funds withheld from employees' wages become plan assets (and trust funds) immediately upon being withheld rather than at the time the employer was required to segregate and transfer them to the plan. The court also noted that ' 403 of ERISA states that “the assets of a plan shall never inure to the benefit of any employer and shall be held for the exclusive purpose of providing benefits to participants in the plan and their beneficiaries.” However, the court also found that a trust should only be imposed on the employees' contributions, not on the employer's assets, despite the fact that some of the contributions had been commingled with corporate assets. The court required the Labor Department to demonstrate a nexus between the funds withheld from the participants and the funds held by the bankruptcy trustee. Because the DOL failed to provide sufficient evidence of such a nexus, the court denied its summery judgment motion, but did find that since “the nexus requirement is less exacting than tracing, a nexus would be shown if the Plaintiff were able to trace the escrowed funds to the funds currently being held by the Trustee.”