United States: "U Can't Touch This": When A Garnished Employee Goes Bankrupt

Seyfarth Synopsis: Employers increasingly find themselves in the difficult position of deciding whether to continue garnishing an employee's wages pursuant to a garnishment order when the employee files for bankruptcy. On one hand, the employer risks penalties for failing to withhold wages; on the other hand, the employer risks sanctions for violating the automatic stay generated by a bankruptcy filing. Below we discuss this dilemma and employers' options.

MC Hammer filed for bankruptcy, claiming over $15 million in debt even though he was reportedly worth more than twice that only a few years earlier. As American household debt continues to climb, many less talented individuals may be following the Hammer's funky footsteps and seeking bankruptcy relief. If these people are also employees subject to garnishment orders, employers may face the dilemma of (a) withholding wages in violation of the automatic stay in bankruptcy or (b) risking penalties for failing to withhold wages.

Making 'Em Sweat

In California, once an employer is served with an earnings withholding order (an "EWO"), an employer must withhold the amounts required by the EWO from all earnings of the employee during any pay period within the withholding period. California law also sets forth a priority scheme for withholding in the event an employer has been served with multiple EWOs. Wages withheld should be paid to the levying officer, for ultimate payment to the creditor, on a monthly basis not later than the 15th day of each month. The employer's obligation to withhold continues until the employer is served with a notice of termination of the EWO.

Employers should know that service of an EWO creates a lien upon the earnings of the employee and also upon the employer's assets up to the amount required to be withheld. If an employer fails to withhold or pay amounts subject to an EWO, the creditor is entitled to bring a civil action against the employer to recover those amounts: failing to withhold wages properly may make the employer liable for the entire amount the employee owes to the creditor. Additionally, the employer potentially can be hit with contempt sanctions andfor an EWO concerning child supportcivil penalties.

Stop! Hammer Time

Notwithstanding California law, an employee's bankruptcy filing triggers an automatic stay that stops creditors' collection efforts and enforcement actions (subject to some exceptions). That means an employer faces the daunting task of determining whether to continue to comply with California law on garnishments or whether to halt withholding in compliance with the automatic bankruptcy stay.

In the Ninth Circuit (which includes California), a garnishing creditor has an affirmative duty to stop garnishment proceedings when notified of the automatic stay. But not all garnishment actions are subject to the automatic stay. Some garnishmentssuch as collecting on certain domestic support obligations of the employee or on certain taxes owed by the employeeare 2 Legit 2 Quit and are not stayed by the employee's bankruptcy. In those circumstances, if the employer stops withholding, the employee's creditor may seek to hold the employer liable for failing to comply with the garnishment order. Meanwhile, the employee's bankruptcy counsel may threaten the employer with possible sanctions for allegedly violating the automatic stay.

I Told You Homeboy

Whether to stop withholding wages is typically not a clear cut decision and requires careful analysis of federal bankruptcy and state garnishment laws. The employer cannot simply cease withholding funds upon learning of the employee's bankruptcy filing. The proper course of action may also be informed by the amount of potential penalties and liabilities that may result from noncompliance with either the automatic stay or the relevant EWO.

Rather than just throw up its hands in despair and Pray, at an absolute minimum, the employer should:

  • Provide written notice to the garnishing creditor of the employee's bankruptcy filing and notify the creditor of its affirmative duty to stop the garnishment.
  • Send a copy of the written notice to the employee and employee's bankruptcy counsel to encourage their intervention.
  • Notify both the creditor and the employee of any funds that have been garnished but not yet turned over to the creditor. The creditor and employee likely will assert competing ownership interests in those withheld funds, and the employer should avoid favoring one or the other.

Remember, an employer's clear communication with all parties, and also perhaps a request to the bankruptcy court for guidance, is paramount to safeguarding the employer from liability.

Workplace Solutions: Given the overlap of federal and California law and the risks facing employers, the next time an employee files for bankruptcy and then points to his paycheck and starts to sing You Can't Touch This (oh-oh oh oh oh-oh-oh), follow MC Hammer's sage advice: "Stop! [Lawyer] time!" Immediately contact your favorite Seyfarth attorney or the authors of this post for advice on how best to proceed.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

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