I am very frequently asked the question: “What do you consider to be the biggest common weakness of most asset protection plans?” The answer to that ― in my opinion at least ― is that the plan fails to provide for a protected stream of income to a debtor in the event that a creditor obtains a judgment against them. As a creditor-debtor litigator who both attacks and defends asset protection plans, the failure of asset protection planners to provide for the debtor to have a revenue stream upon which to live usually creates tremendous leverage for creditors while putting such debtors under tremendous pressure.
At the same time, there are lots of folks out there who have debts that they cannot pay, usually so-called consumer debt because they have over-extended themselves, and which end up in judgments. These debtors, for whom asset protection didn’t make any sense in the first place, also have to worry about their wages being garnished to pay their debtors.
A wage garnishment is quite possibly the most used remedy of creditors, competing with bank levies (i.e., a creditor tapping a debtor’s bank account) for that honor. Where the debtor is a W-2 employee, the process is simple: In most states, a creditor holding a judgment will have the court clerk issue a Writ of Garnishment which is delivered to either the sheriff or a process server, and the Writ of Garnishment is then served on the employer. After receipt of the Writ of Garnishment, the employer starts withholding a portion of the debtor’s wages, which are then remitted to the sheriff (who passes it on to the creditor) until the judgment is paid.
This is how garnishments work generally, but every state has its own garnishment laws (except for a few states such as Texas where garnishments are not allowed under the state constitution) and those garnishment laws are all over the board. In 2016, the Uniform Law Commission adopted the Uniform Wage Garnishment Act (UWGA) which was promptly adopted by nobody, not a single state or territory, and which emphasizes better than anything else the local concerns that go into wage garnishments, meaning the interrelationships between creditors, the court, the sheriff’s office, employers, and ultimately the debtor.
If you are wondering why most states still use a Writ to accomplish a garnishment, the answer is simply bureaucratic inertia: A Writ of any kind is an anachronism dating back to medieval England and is nothing more than an order compelling somebody to do something. In the case of garnishments, the court orders the sheriff to serve the Writ, and the sheriff orders the employer to withhold the debtor’s wages. So, if it makes it easier to read, simply substitute “order” in place of “Writ” wherever it appears. There are, of course, other types of Writs than orders in other circumstances, but that is outside of today’s discussion. Also note that in some states, such as Arizona, what would otherwise be called levies (where the sheriff grabs other assets than wages) are called “garnishments” for similarly anachronistic reasons if not to just utterly confuse everybody about the process.
Once the Writ of Garnishment has been served on the employer, the employer must respond to the Writ by providing a return to the sheriff which basically confirms, or not, that the debtor is indeed employed by the employer and usually giving the wages that are paid to the debtor. At this stage in the proceeding, either the employer or the debtor may object to the Writ of Garnishment with whatever defenses they have, such that too much of the employee’s wages are to be garnished.
All of this brings me to today’s discussion of the Federal Wage Garnishment Law, 15 USC §§ 1671 through 1677, and known by its acronym the FWGL, and which is part of the Consumer Credit Protection Act.
Like many statutes, some of the most important stuff in the FWGL is found in the definitional section, so we’ll stop there first. There are three definitions to be understood, or else the rest of the FWGL will not make much sense.
First, the term earnings is defined as any compensation to the debtor for “personal services”, i.e., the fruits of the employee’s labor. If the compensation doesn’t arise from the debtor’s personal services, then it is not earnings for purposes of the FWGL. So, for example, if an employee is injured on the job and the employer pays a settlement, that was not compensation for personal services and would not be protected under the FWGL (although it probably would be exempt under some other state statute). The definition of earnings also makes clear that it doesn’t matter how the compensation is titled, since earnings expressly includes “wages, salary, commission, bonus, or otherwise”. This is the duck test: If it walks like compensation and quacks like compensation, it is probably compensation not matter what else one might call it. Finally, compensation also includes “periodic payments pursuant to a pension or retirement program” or, in other words, if the employer is diverting moneys periodically into a pension or retirement plan, those payments would also be included in the definition of earnings.
Second, having defined earnings, we now come to disposable earnings which basically means what the debtor is paid after mandatory withholdings by the employer, i.e., federal and state tax withholding, FICA taxes, etc. This is a very important definition, as we shall see, because the FWGL legislates on the basis of disposable earnings and not gross earnings.
Third, we finally get to the definition of garnishment, which basically means any court procedure through which a debtor’s earnings may be grabbed for the benefit of creditors.
With all this fresh in mind, let’s now look at what the FWGL actually does.
Fundamentally, the FWGL in § 1673 sets an upper limit on the amount of a debtor’s disposable earnings that may be garnished. There are two limits to be applied, but in any event the debtor gets the most favorable limit, i.e., the limit that allows the debtor to receive the most money and the sheriff to get less.
The first ―and by far more common ― limit to understand is in § 1673(a)(1) and simply provides that a garnishment may not exceed 25% of the debtor’s disposable earnings for any given week. In other words, the employer will first calculate and deduct the amount of mandatory withholdings from the debtor’s pay, and then the debtor gets a check for 75% of the remainder and the sheriff gets a check for 25% of the remainder. Easy-peasy.
The limit that is only rarely applied is found in § 1673(a)(2) which basically says that disposable earnings is calculated by the amount by which the debtor’s weekly compensation exceeds the federal minimum wage (29 USC § 206(a)(1)) multiplied by 30 hours. As of the writing of this article, the federal minimum wage is only $7.25 per hour, which means that an employer would be required to remit to the sheriff everything that the debtor makes over $217.50 per week.
Again, the debtor gets the advantage of the highest exemption, i.e., whichever of these limits puts the most money in his pocket and the sheriff gets the least. Because the second limit (excess of FMW x 30) would likely only ever be less than the first limit ((gross earnings minus withholdings) x 25%) in the case of a part-time employee for whom it usually doesn’t make economic sense for a creditor to bother pursuing in the first place. Thus, it is the first limit that almost always applies in garnishment cases.
The bottom line is that in the vast majority of cases, a creditor will get no more than 25% of the debtor’s disposable income and 75% of that disposable income is thus protected under the FWGL. Now we get to the three statutory exemptions found in § 1673(b).
The first exception of the FWGL relates to a support order (alimony or child support) and, depending upon the circumstances, the amount taken pursuant to the support order may not exceed 50% of the debtor’s net disposable income if the debtor is also supporting another family, or up to 60% if they are not. Note that this is an aggregate maximum limit which includes both support order creditors and general garnishment creditors. For example, if a debtor with a family is already paying 50% of her income towards a support order, a credit card creditor who attempts to garnish the debtor’s wages later will simply not collect anything until the support order has been satisfied, because the 50% maximum has already been reached.
The second exception goes to payment order under a Chapter 13 bankruptcy plan. I’ll leave that one to the bankruptcy folks to explain.
The third exception is a very important one, being that the FWGL does not apply to federal or state judgments for unpaid taxes. The law relating to unpaid taxes have their own rules as to the maximum amount that may be garnished, and it will be those rules which apply and not the FWGL.
Except for these three exceptions, the FWGL trumps all other competing federal and state laws. As stated in § 1673(c): “No court of the United States or any State, and no State (or officer or agency thereof), may make, execute, or enforce any order or process in violation of this section.” However, the FWGL specifically allows states, in § 1677(1), to enact their own laws to give even greater protection to a debtor’s wagers than provided in the FWGL (and some do).
Note also that the FWGL limits apply in the aggregate to all creditors. If three creditors each attempt to garnish the debtor’s wages, the first to have the employer served will get the 25% of disposable income, the second creditor to serve will have to wait until the first creditor’s judgment is satisfied before receiving anything, and the third will have to wait on the second. This is closely analogous to lien priority.
One more benefit of the FWGL is that is also protects a debtor from being fired as a result of a debtor’s employer receiving a wage garnishment — an employer that does this risks a $1,000 fine or up to a year in prison.
There is one big thing that the FWGL does not protect, however, and that is the wages once they have been received by the debtor and deposited into a debtor’s bank account. However, most states have exemptions for funds received by a debtor. Often this is accomplished by a creditor exemption statute that provides basically the same benefits as the FWGL, but then also there will be a tracing statute that continues to exempt the funds so long as they are not commingled or used to purchase some other non-exempt asset. This is why debtors will often open so-called wage accounts or earnings accounts to receive and hold their wages in a way that they are no comingled with the debtor’s other funds that might be available to creditors.
That in a nutshell describes the FWGL and what it does. Now, let’s return to one of my initial points above which is how this relates to asset protection planning.
When creditors enforce a judgment, the first questions to a debtor will often include: “How are you getting money to live on? Where are you getting money to pay your utility bills? Where are you getting money to pay your credit card bills?” and the like. The debtor’s answers will usually lead to other assets, and often fraudulent transfers previously made by the debtor. Even if there are no new such leads, however, the debtor’s answers give creditors a roadmap by which they can start sealing off the debtor from his sources of income and thus cutting deeply into the debtor’s quality of life. Creditors may even be able to terminate the debtor’s ability to pay for quality legal counsel. This will cause the debtor to start playing all sorts of the familiar games to try to get access to money, and then the debtor’s asset protection planning becomes at risk of alter ego and similar claims, not to mention the conspiracy and Civil RICO theories that can take even the best asset protection plans down hard.
The vast majority of asset protection plans claim to protect the assets of debtors, yet they give little or no consideration to the cash flow needs of a debtor while the creditor is enforcing the judgment. A debtor who has been cut off from access to income can become very miserable in short order, thus creating all sorts of leverage for the creditor. By contrast, a really good asset protection plan will also provide for wages of some sort or another to be paid to the debtor, with the idea that although the creditor may take 25% of it, the debtor can comfortably live off the balance. Like everything else in asset protection planning, this must be arranged and in place before any actual claim arises — and it has to be real and not some sham arrangement — or else the new arrangement will smell to high heaven and creditors with the assistance of judges will start looking for ways to get around it. Yet, very rare is the asset protection plan that I review or must defend in litigation which makes such a provision. While planners come up with all sorts of gimmicks to try to overcome these problems, such as distributing money from a trust to a beneficiary who then loans or gifts it back to the debtor, these are precisely the sort of ideas that look really good in a conference room but very bad in a courtroom and end up backfiring more often than they succeed.
A final consideration is that one of the best arguments that a creditor has is that the debtor isn’t paying anything on a judgment, but if the debtor has wages that are being garnished, this argument is largely deflated. It allows somebody like me to tell the court, “Your Honor, the creditor is being paid exactly what they are allowed under the law, which is 25% of the debtor’s net disposable income.” The creditor might not like that the amount received is relatively small in relation to the judgment, but that is a concern for Congress and not the court.
Note that for some debtors, such as professionals like physicians, their biggest asset may be their future earnings potential. In that event, they may decide that bankruptcy is better than allowing their wages to be garnished for a considerable period. Except under Chapter 13, as mentioned above, bankruptcy cuts off all dischargeable debts as of the date of filing and no more wage garnishment is allowed going forward. But that is for another day.
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