Nothing inspires people to consider filing for bankruptcy than the threat of a garnishment. The possibility of losing 25% of your paycheck to a judgment creditor is more than any average household budget can bear.
What if the garnishment has already begun?
The filing of a Chapter 7 or Chapter 13 bankruptcy will stop a garnishment instantly. The Federal “automatic stay” injunction that is triggered by the filing of a bankruptcy requires that all collections activity cease upon filing of a bankruptcy.
The cessation of a garnishment is one of the most immediate benefits of the filing of a bankruptcy. Depending upon the amount of the money saved by the quashing of a garnishment, the bankruptcy filing can often nearly pay for itself.
However, a bankruptcy filing can deliver a further benefit: the requirement that a creditor return some or all of the money garnished prior to the filing of the Chapter 7 or 13 bankruptcy case.
GARNISHED FUNDS RECOVERY IN BANKRUPTCY: HOW & WHEN?
Whether garnished funds can be recovered after a bankruptcy filing is both a fact- and Chapter-specific question.
That said, the rules for pre-filing garnishment recovery is that a debtor in bankruptcy can recover funds garnished only in the 90 day period of time directly prior to the date of filing of the bankruptcy case—and only if the amount garnished is $600 or more.
So, if $599 is garnished from your paycheck the week before you file, it will not be recoverable.
If $601 is garnished from your paycheck 91 days prior to the date you file your bankruptcy case, it will not be recoverable.
This 90-day pre-filing period is known as the “preference period,” and it is a period of time during which payments made to a single creditor in the amount of $600 or more are recoverable by a bankruptcy Trustee. Read more about preferential transfers here.
A provision of the US Bankruptcy Code—the Federal statute that governs the bankruptcy process—allows the debtor to “stand in the shoes” of the Trustee to demand return of such funds.
However, unless the Debtor has disclosed the “preference payment” (garnished funds) along with their other assets in the bankruptcy petition and fully exempted it, the right to demand return of the funds belongs to the bankruptcy Trustee alone.
Thus, the further requirement for recovery of the funds is that the garnished be properly disclosed and exempted.
The need to properly list, describe, value, and exempt your assets is a primary reason why you should retain an experienced bankruptcy attorney to represent you.
Further, the final step in garnished fund recovery is the need to demand it back from a creditor. Just filing paperwork properly drafted will not cause a check to show up in your mailbox. When the demand comes from a well-known bankruptcy attorney, the creditor holding your funds is far more likely to jump quickly into action.
GARNISHED FUNDS RECOVERY IN CHAPTER 7 BANKRUPTCY
There is also a difference in the likelihood of recovery between the filing of a Chapter 7 bankruptcy and a Chapter 13 bankruptcy.
In a Chapter 7 bankruptcy, the creditor must turn garnished funds directly over to the debtor when properly exempted and demanded. It is in a Chapter 7 bankruptcy that the debtor may truly stand in the shoes of the Chapter 7 Trustee, whose duty it is otherwise to liquidate the non-exempt assets of the Debtor.
In a Chapter 7, when an asset is fully exempted, it is removed from the jurisdiction of the Chapter 7 Trustee entirely.
GARNISHED FUNDS RECOVERY IN CHAPTER 13 BANKRUPTCY
In a Chapter 13 bankruptcy, the situation can be more complicated. The Bankruptcy Code requires that the Debtor commit all of his or her “disposable income” to the Chapter 13 payment plan for the duration of the 3-5-year bankruptcy proceeding.
There is no real question that, regardless of Chapter 13 vs. Chapter 7, a creditor does not get to keep garnished funds meeting the above requirements.
However, because of this “disposable income” requirements, many creditors take the position that such funds should not be turned over to the Debtor but to the Chapter 13 Trustee for redistribution to the Debtor’s creditors via the Chapter 13 payment plan. Many Chapter 13 Trustees take the same position.
Depending upon the goals and structure of the individual Debtor’s Chapter 13 plan, this may be something that the Debtor is okay with, particularly relative to the hourly cost of attorney fees for further aggressive action in response to that position.
For example, if the purpose of the Chapter 13 Plan is to fully repay non-dischargeable income tax debt, the more money fed into the Plan, the faster it is concluded.
Thus, in a Chapter 13, the recovery of funds garnished pre-filing is as much art as science, often a matter resting on a bankruptcy attorney’s professional ability to make life tedious for the other players involved, with results never a guaranteed matter.
RECOVERY OF GARNISHED STATE TAX REFUNDS
A final point of discussion here is the particular matter of garnished State of Michigan tax refunds. There is no question that $600 or more garnished from a bank account or paycheck within the 90-day preference period must be turned over by a garnishing creditor.
However, when it comes to a garnished State of Michigan tax refund, the question is murkier.
There is local case-law holding that a Notice of Intent to Garnish a State tax refund filed and not responded to outside of the 90-day preference period constitutes the perfection of a lien on the State tax refund which is not avoidable by the bankruptcy’s filing.
That is, the automatic stay doesn’t affect it. Any funds garnished from the refund even, then, within the 90-day preference period need not be returned. (The garnishment must always cease upon filing, however.)
Or so the argument goes.
More recent case-law has decided otherwise, but, depending upon the judge assigned to the particular bankruptcy case, there remains a reasonably strong likelihood that a creditor will refuse to turn over funds garnished from a State of Michigan tax refund.
GARNISHED FUNDS & MICHIGAN BANKRUPTCY: THE BOTTOM LINE
The bottom line is that, if you are considering filing for bankruptcy and are facing garnishment or have had funds garnished, you need to retain an experienced bankruptcy attorney to assist you.
The Law Offices of Walter A. Metzen & Associates offers free consultations for those interested in the bankruptcy process and is experienced advising as to the recovery of garnished funds and dealing with the creditors who garnish them.