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IRA Pledged as Security for Future Debt Exempt from Bankruptcy Creditors

Deitz, Shields & Freeburger, L.L.P. Jan. 21, 2021

In the case of In re Daley, the Sixth Circuit Court of Appeals reversed the decisions of the bankruptcy court and the district court and held that the debtor’s IRA was still entitled to an exemption from creditors in bankruptcy proceedings even though the debtor had signed an agreement granting Merrill Lynch lien access to the IRA in order to satisfy future debts.

Background of The Case

The debtor had an IRA with Merrill Lynch. When the account was opened the debtor signed a Client Relationship Agreement, which contained a boilerplate lien provision stating that the debtor pledged his IRA as security for any future debts to Merrill Lynch.

The debtor never became indebted to Merrill Lynch. He did not borrow from his IRA or use it as collateral for any loans.

Procedural History

Two years after opening the account with Merrill Lynch, the debtor filed for Chapter 7 bankruptcy and sought protection under the Bankruptcy Code for the $66,000 on deposit in his Merrill Lynch IRA. The bankruptcy trustee filed an objection and argued that the IRA was no longer entitled to an exemption as a result of the debtor’s Client Relationship Agreement granting the lien to Merrill Lynch. Both the bankruptcy court and the district court sustained the trustee’s objection. The debtor filed an appeal with the Sixth Circuit.

The Sixth Circuit’s Ruling

The Sixth Circuit debtor cited statutory presumptions under federal tax law and the Bankruptcy Code that the debtor’s IRA is exempt from both tax collectors and creditors in bankruptcy. The court noted that an IRA can lose its exempt status if the owner engages in certain prohibited transactions, including the direct or indirect lending of money or other extension of credit between the IRA and the owner. The court found, however, that the debtor did not use the IRA to obtain credit from Merrill Lynch. While actual use of the agreement might have disqualified the IRA from exempt status, in this case, the debtor never incurred any debt with Merrill Lynch. The court stated that the lien provision was “naked” and “stripped of any connection to a credit transaction” and contingent upon an event that never occurred. Since there was no direct or indirect extension of credit between the debtor and the IRA, the account did not lose its exemption under bankruptcy law.

Individuals facing debt problems or bankruptcy should seek the advice of competent legal counsel experienced in such matters to assist them in the protection of their legal rights.