Hunton Employment & Labor Perspectives

In a prior post, we set forth the potential liability of employers for collection of debts owed by employees in violation of the bankruptcy stay. To protect themselves from such liability, employers that accrue claims against their employees in the ordinary course of business should implement written protocols designed in consultation with bankruptcy counsel.

However, even employers that do not ordinarily accrue claims against employees must be careful to avoid violating the automatic stay – most notably when complying with creditor garnishment demands under state law.

Consider an example: on August 1, 2016, a California employer receives an Earnings Withholding Order for Taxes (EWOT) from the California Franchise Tax Board (FTB) under California Tax & Revenue Code § 18670. The EWOT requires the employer to answer a questionnaire for the FTB (example question: “Describe any obligations to the taxpayer you expect to incur during the next 12 months”); provide a copy of the EWOT to the employee; and calculate, deduct and pay certain percentages of the employee’s compensation to the FTB (an explanation of the employer’s responsibilities and a calculator to determine withholding is provided by the FTB). Under California Tax & Revenue Code § 18672, the employer must comply with the EWOT, withhold the correct amount, and remit to the FTB, or it becomes personally liable: “Any employer or person failing to withhold the amount due from any taxpayer and to transmit the same to the Franchise Tax Board after service of a notice pursuant to Section 18670 … is liable for those amounts.”

On August 15, 2016, the next payday, the employer properly withholds 25% of the employee’s wages as required by the EWOT. However, on August 16, 2016, before the employer can remit the withheld funds to the FTB, the employee files a Chapter 7 bankruptcy petition – and immediately provides notice to the employer and the FTB. Now, the automatic bankruptcy stay applies. Section 362(a)(1) of the Bankruptcy Code prevents “all entities” from taking any action “to recover a claim against the debtor that arose before the commencement of the case” – such as the unpaid tax debt to the FTB.

Most courts agree that a garnishing creditor (here, the FTB) has an affirmative duty to stop garnishment proceedings when notified of the automatic stay. See e.g. In re Roberts, 175 B.R. 339, 343-44 (9th Cir. BAP 1994) (finding that the FTB must take affirmative steps to lift a wage garnishment post-bankruptcy). If the FTB notifies our employer that it must return garnished funds to the employee and cease future garnishments, then the employer can comply and should be in the clear.

Assume for our purposes that the FTB does not provide any guidance to our employer. Then, on August 30, 2016 - the day before the next payday - the employee sends an email to the human resources department demanding that the employer release the funds it withheld pre-bankruptcy pursuant to the EWOT and refuse to withhold any amounts from the employee’s next paycheck. The employer is faced with a very difficult choice. If the employer complies with the employee’s request, returns withheld wages to the employee, and ceases future withholding under the EWOT, it risks liability to the FTB for the amount that should have been withheld and remitted. Some bankruptcy courts have found that the automatic stay protects a garnishee from a claim by a creditor in this situation, but others disagree. See In re Johnson, 479 B.R. 159, 175-76 (Bankr. N.D. Ga. 2012) (discussing the employer’s dilemma and collecting cases). If the employer refuses to comply, remits withheld wages to the FTB, and continues to withhold, it risks sanctions and punitive damages for violation of the automatic stay. See In re Linsenbach, 482 B.R. 522, 526 (Bankr. M.D. Penn. 2012) (discussing the employer’s dilemma and collecting cases).

As is often the case in bankruptcy cases, the employer’s fate depends greatly on the jurisdiction at issue and the individual judge’s idea of “equity.” It may also depend upon an analysis of the particular type of debt giving rise to the garnishment order – for example, the automatic stay does not apply to garnishments arising from a qualified domestic support order, or for the collection of certain taxes. See e.g. In re Penaran, 424 B.R. 868, 880 (Bankr. D. Kan. 2010) (finding that continued garnishment pursuant to qualified DSO does not violate automatic stay).

We recommend that employers discuss these issues with bankruptcy counsel and implement a written protocol to deal with garnishment issues arising from employee bankruptcies. An employer that has systems in place to quickly identify bankruptcy issues will often be able to resolve matters before they escalate by reaching an agreement with the garnishing creditor, the debtor and/or a bankruptcy trustee.