United States District Court, D. Connecticut
RULING ON APPEAL FROM BANKRUPTCY COURT ORDER
MICHAEL P. SHEA, U.S.D.J.
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).
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.
of LXEng and the Plan
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.
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.)
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.
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.)
First Discretionary Amendment
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.)
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.
Second Discretionary Amendment
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.
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.)
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.)
Fully Funds and then Terminates the Plan
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.)
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.)
Filing and Claim of Exemption
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.) ...