U.S. Bankruptcy Court Decides WCMSA Funds are Exempt from Chapter 7 Bankruptcy

The United States Bankruptcy Court for the Middle District of Pennsylvania has decided that assets in a Workers’ Compensation Medicare Set-Aside (WCMSA) are exempt property and therefore not available to creditors in a Chapter 7 bankruptcy case (In Re: Jesus Arellano, Debtor Steven M. Carr, Chapter 7 Trustee Objectant v. Jesus Arellano, Respondent. Decided January 5, 2015).

Mr. Arellano sustained a broken hip at his place of work in 2010. In 2011 he received a settlement from his employer and from the Worker’s Compensation Fund for the State of Maryland for a lump sum of $225,000 plus $72,741.88 for a WCMSA. The WCMSA was for the estimated amount of his future medical treatment for his injuries.

Although Mr. Arellano acknowledged in the settlement agreement that he was to only use the funds to pay for his medical expenses, he promptly bought a 2005 Ford F-150 for $17,000, some real property for $85,000 and another piece of real property for $86,000. In 2012 he sold the first property to his brother for $90,000 and took back an installment note, which will pay him $1,200 per month for eight years.

Mr. Arellano then filed for Chapter 7 bankruptcy in March of 2014 and claimed exemptions for the Ford 150, both pieces of real property and the workers’ compensation settlement monies including the WCMSA. He failed to disclose the installment note receivable as income or as an asset.

The bankruptcy trustee, who represents the creditors, objected to these exemptions, claiming that federal bankruptcy law does not allow Mr. Arellano to exempt property that was purchased with the proceeds of a workers’ compensation settlement.

Court’s Discussion
In a well-reasoned 21-page opinion, the court reached the following conclusions:

  • The property was “traceable to payment in compensation of loss of future earnings of the debtor… To the extent reasonably necessary for the support of the debtor and any dependent of the debtor” under 11 U.S.C. §522(d)(11)(E).
  • Because the WCMSA funds were held in an “express trust” for the benefit of medical services related to Mr. Arellano’s workers’ compensation claim, they were not property of his bankruptcy estate.
  • Converting the WCMSA funds to real and personal property does not mean that they were not necessary for the support of the debtor.
  • Whether or not the debtor may have misused the WCMSA funds was not an issue before the Court and in any event the WCMSA funds are not property of the estate.

Court Opinion
The Court decided in favor of the debtor, Mr. Arellano, allowing all of the proceeds from the settlement and all property acquired with those proceeds (including the subsequent installment note receivable) to be exempt from the claims of the creditors in the Chapter 7 bankruptcy.

This case provides some much needed guidance on an often-discussed topic in our industry, namely, what happens to MSA funds in a bankruptcy? Clearly, this court held that MSA funds are exempt from bankruptcy proceedings.

The concept that a WCMSA is an express trust where settlement monies are held for the benefit of medical providers is one that I have not heard before. The purpose of a WCMSA is not to protect the medical providers. They will likely be paid without the WCMSA. The purpose of the WCMSA account is to protect Medicare by making sure that Medicare is secondary to insurance settlement money.

It’s interesting the U.S. Bankruptcy court did not address the issue of the misspent “trust” funds. If these monies were held in trust for the benefit of the future medical providers, then wouldn’t converting them to a truck, real estate and later an installment note receivable be a breach of fiduciary duty? Perhaps that is outside the purview of a bankruptcy court. But, how can you pay a doctor bill with a truck?

Medicare has a severe penalty for the misuse of WCMSA funds, which is the loss of Medicare benefits until the money is restored to the WCMSA account. It would be a tragedy if this claimant were to lose Medicare benefits in the future and not be able to get medical care. This is just another example of why the settling parties should consider professional administration in every WCMSA settlement.


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