In re Xiao

          RULING ON APPEAL FROM BANKRUPTCY COURT ORDER

          MICHAEL P. SHEA, U.S.D.J.

         Appellant and bankruptcy debtor Jie Xiao (“Xiao”) appeals from an order by the United States Bankruptcy Court for the District of Connecticut (the “Bankruptcy Court”) sustaining appellee and Bankruptcy Trustee Ronald I. Chorches' (the “Trustee”) objection to Xiao's claim that the funds in the LXEng, LLC (“LXEng”) Pension Plan (the “Plan”) were exempt from his bankruptcy estate and thus protected from his creditors. For the reasons that follow, I affirm the Bankruptcy Court's ruling, which found that the Plan did not satisfy the requirements for exempt retirement funds set forth in the Bankruptcy Code, 11 U.S.C. § 522(d)(12).

         I. Background

         The following facts are drawn from the Bankruptcy Court's findings of fact, the parties' briefs, and the joint stipulation of facts submitted in the Bankruptcy Court, and are undisputed unless otherwise noted. I set forth only those facts relevant to the present appeal.

         Formation of LXEng and the Plan

         Xiao and Michael Little formed LXEng in 2007. (ECF No. 1-1 (Bankruptcy Court's Ruling (“Ruling”)) at 5.) LXEng was an engineering consulting company that sold technology packages and services to its clients. (Id.) Xiao and Little were each initially 50% owners of LXEng. (Id.) After Little died in a plane crash on November 3, 2007, Xiao's wife, Xin Chen, was made a 10% owner of LXEng, and Xiao assumed 90% ownership. (Id.) Xiao became the managing member of LXEng. (Id.)

         The pension plan at issue in this case was formed on December 15, 2007 with an effective date retroactive to January 1, 2007. (Ruling at 5.) At the time of the Plan's adoption, Xiao owned 90% of LXEng and was its managing member; the remaining 10% was owned by Chen. (Id.) Xiao signed the Plan on behalf of LXeng, the Employer and Administrator of the Plan, and Xiao and Chen were listed as the Plan's co-trustees. (Id.) The Plan also listed Keystone Healthcare, LLC (“Keystone”), as a “Participating Employer” under the Plan. (Id.) Keystone was a consulting company Xiao had previously established to provide consulting services in the pharmaceutical industry and in which he had a 100% stake. (Id. at 5-6.) No business relationship existed between Keystone and LXEng other than the fact that Xiao owned both companies. (Id. at 6.)

         As of December 31, 2007, both Xiao and Chen were listed as “highly compensated employees” of LXEng. (Id.) For the calendar year 2007, LXEng reported to the Internal Revenue Service (“IRS”) ordinary business income of $1, 341. (Id.) As of December 31, 2008, Xiao and Chen were still listed as the only two participants in the Plan, and were each 20% vested under the six-year vesting schedule. (Id.) For the calendar year 2008, LXEng reported ordinary business income of $462, 747 to the IRS. (Id.) The IRS issued an opinion letter regarding the plan dated March 31, 2010, which the Bankruptcy Court found addressed only the form of the Plan. (Id.)

         Several professionals were involved in the administration of the Plan. PenServ, Inc. (“PenServ”) acted as the third-party administrator of the Plan. (Id. at 7.) Michael F. Ostuni (“Ostuni”) was the president and sole owner of PenServ. (Id.) PenServ was not a fiduciary of the Plan and was unable to take any action regarding the Plan without direction from LXEng, Xiao as the owner of LXEng, or LXEng's advisors Llyod Cazes (“Cazes”) and Michael Caputo (“Caputo”). (Id.) Cazes was the accountant for Xiao, LXEng, Keystone, and the vast majority of Xiao's other United States entities. (Id.) He filed LXEng's 2007, 2008, 2009, and 2010 tax returns with the IRS at Xiao's direction. (Id.) Caputo was retained by LXEng as a financial planner. (Id.)

         The First Discretionary Amendment

         Initially, the Plan required one year of service and the attainment of age 21 for employees to be eligible to participate in the Plan. (Id.) The beginning date for any prospective participant in the Plan was the earlier of the first day of July or the first day of January coinciding with or following the date on which the participant has met the requirements to participate in the Plan. (Id. at 7-8.) Plan participants would have their benefits vest over a six-year graded period, with 20% vesting after two years and each additional year resulting in an additional 20%. (Id. at 8.) A year of service for vesting meant a twelve-month period beginning on an employee's date of employment or any anniversary of that date during which he or she completed at least 1, 000 hours of service. (Id.)

         The Plan was amended on March 1, 2009, effective retroactively to January 1, 2009 (the “2009 Amendment”). (Id.) The Bankruptcy Court found that PenServ prepared the 2009 Amendment at the direction of LXEng and that it was a discretionary amendment elected by LXEng. (Id.) Xiao signed the 2009 Amendment on behalf of LXEng, as the Employer and Administrator of the Plan, and, with Ms. Chen, as co-trustee. (Id.) As of January 1, 2009, LXEng had eleven employees in addition to Xiao and Chen, but the Plan's only participants were Xiao and Chen. (Id.) The 2009 Amendment excluded from Plan participation non-owner employees who were highly compensated employees. (Id.) The 2009 Amendment also increased the years of service to become eligible for participation to two years and provided for 100% vesting immediately for all current Plan participants. (Id.) Xiao and Chen became fully vested in the Plan as a result of the 2009 Amendment, but the effect of the amendment was to extend the participation requirement for LXEng's remaining employees to two years. (Id. at 9.) The Bankruptcy Court found that PenServe would not have advised LXEng, or any other client, to adopt an amendment similar to the 2009 Amendment. (Id.)

         The Second Discretionary Amendment

         On December 15, 2009, the Plan was amended effective January 1, 2010 (“2010 Amendment”). (Id.) The 2010 Amendment froze participation in the Plan for employees who were not already participants as of January 1, 2010, as well as benefits accrual. (Id.) The practical effect of the 2010 Amendment was to exclude all then-present LXEng employees and any future LXEng employees from participating in the Plan and to prevent their accrual of benefits under the Plan, with the exceptions of Mr. Xiao and Ms. Chen. (Id.) The 2010 Amendment was offered to LXEng as an option by PenServ based upon information PenServ received from LXEng, Xiao, Cazes, and Caputo that adverse business conditions had arisen and that the Plan had become too costly. (Id. at 10.) Xiao signed the 2010 Amendment on behalf of LXEng, as the Employer and Administrator of the Plan, and, with Ms. Chen, as co-trustee. (Id.) As of January 1, 2010, Xiao and Chen were still listed as the only two participants in the Plan. (Id.) Several of LXEng's employees would have been participants in the Plan by 2010 or 2011 if not for the 2009 and 2010 Amendments. (Id.)

         At the time of the 2010 Amendment, LXEng's business appears to have been growing. Its taxable income grew from $462, 747 in 2008 to $989, 384 in 2009 to $1, 601, 481 in 2010. (Id.) In 2010, LXEng recognized revenue in excess of $4 million and had received a payment of $6 million on one of its contracts. (Id.) At the same time, LXEng still had a $3 million receivable, and it had access to a $2.9 million legal reserve fund. (Id.)

         The Mandatory Amendments

         On January 26, 2009 and December 4, 2009, PennServ prepared amendments to the Plan pursuant to regulatory requirements, which it advised LXEng were mandatory. (Id. at 11.) PenServ was not aware whether LXEng executed these amendments, because executed copies were never provided to PenServ by LXEng. (Id.) In 2010, PenServ prepared a further amendment, pursuant to the Economic Growth and Tax Relief Reconciliation Act (“EGTRRA”). (Id.) The Plan was amended and restated as of December 15, 2011 to comply with EGTRRA. (Id. at 11.) The EGTRRA restatement of the Plan did not have any effect on the applicability of the 2009 and 2010 discretionary amendments. (Id. at 12.)

         LXEng Fully Funds and then Terminates the Plan

         In September 2010, after the 2010 Amendment, LXEng deposited $38, 849 into the Plan to fully fund the Plan for the calendar year 2009, the last year before the Plan was frozen. (Id.) At the time, the minimum funding requirement was $23, 058, which LXEng had already met. Thus, Xiao was not obligated to deposit the additional $38, 849 into the Plan. (Id.). Xiao authorized the $38, 849 payment in a conversation with Cazes. (Id.)

         LXEng terminated the Plan effective January 15, 2011, by a resolution dated January 1, 2011. (Id.) Xiao signed the resolution as the “Principal” of LXEng and solely acknowledged receipt of the resolution on behalf of the Plan as co-trustee. (Id.) Xiao and Chen were the only participants in the Plan at the time it was terminated. (Id.) The plan was in operation for approximately four years prior to termination. (Id.)

         Bankruptcy Filing and Claim of Exemption

         On July 30, 2013, the Petition Date, Xiao filed for voluntary bankruptcy relief under Chapter 7 of the Bankruptcy Code. (Id. at 13.) As of the Petition Date, Xiao was the sole participant and the sole beneficiary of the Plan, as Xiao and Chen had obtained a divorce and Chen's interest in the Plan had been transferred to Xiao as part of the judgment of divorce. (Id.) ...