Can Unemployment Overpayment Debt Be Discharged in Bankruptcy?

Written by: leonora  |  Published on: October 7th, 2010  |  Category: Blog

Yes, it will likely be discharged like any other unsecured debt, absent a showing of fraud. Therefore, if it was a clerical error on the part of California EDD,

However, one thing to be careful about is the equitable right of recoupment.

What is RECOUPMENT and how does it apply to employment overpayment?

In English – it means that if Ann has to repay Betty $200, Betty then breaks Ann’s bike costing $50, Ann can repay $50 less to Betty, or $150, based on the concept of Recoupment. It doesn’t make sense for Ann to have to pay $200 to Betty and then for Betty to repay Ann $50.

Similarly, there is a concern that while this overpayment owed to California is discharged in bankruptcy, if the unemployment benefits are still being paid to the debtor, California EDD can argue that this is not collection, but is rather Recoupment, which unlike other “collections” doesn’t violate the Discharge Order or Automatic Stay, because the bankruptcy estate is subject to these equitable recoupment rights.

The law is clear that if the Debtor is receiving the unemployment payments reduced due to the overpayment, such reduction can continue through the bankruptcy if the overpayment debt and the claim for unemployment is a result of one transaction.

What about if the Debtor has to reapply for unemployment after bankruptcy? For example, the Debtor is employed and has overpayment debt, he files for bankruptcy, the debt is discharged and then he loses employment and has to reapply. Will his unemployment be reduced to recoup the overpayment, despite the bankruptcy?
Will the filing of the bankruptcy not only get rid of this unemployment overpayment debt, but also prevent the California EDD from reducing future unemployment benefits if they become necessary in the future due to a different loss of employment? It is unclear.

On the one hand, I will propose that in the 9th Circuit (California), there is a strong likelihood that the Court will likely find that this will be a separate event that would not entitle the unemployment insurance to equitable recoupment of the previously discharged debt. In fact, any attempt would be deemed a violation of the Discharge based on Bankruptcy Rule 524. While there is no case directly on point regarding unemployment overpayment in the bankruptcy context, there is a similar case out of California dealing with long-term disability overpayment case. In In re. Madigan, 270 B.R. 749 (Bankr. 9th Cir. 2001), the court considered the issue whether Aetna can recoup money that it overpaid Mr. Madigan prior to the bankruptcy, from his post-bankruptcy long-term disability claim. In re. Madigan, 270 B.R. 749 (Bankr. 9th Cir. 2001). The facts are complicated. Mr. Madigan was overpaid disability benefits. He then obtained employment and Aetna tried to collect the overpayment. Mr. Madigan then filed for bankruptcy. He included the overpayment debt in his bankruptcy petition. After the bankruptcy Mr. Madigan had to apply for disability benefits through Aetna. Aetna tried to withhold benefits and reduce his future benefits to recover the money it initially overpaid Mr. Madigan. Both the Bankruptcy Court and the Appellate Panel held that it was a separate disability claim, therefore recoupment would not apply and it would violate the discharge injunction. Id.

On the other hand, the Court in In re. Madigan distinguished the facts of overpayment of long-term benefits by a private company, like Aetna, from overpayment of VA Benifits, by a government agency. The court in dicta states that “[o]ur case does not concern a federal government creditor whose public policy concerns compete with the Bankruptcy Code’s fresh start policy.” In re. Madigan, 270 B.R. 749, 761, referring to United States v. Keisler (In re Keisler), 176 B. R. 605, 607 (holding that VA had the right to recoup).

Exception to discharge of overpayment of unemployment benefits – Fraud

If the overpayment of the unemployment benefit was a result of fraudulent misrepresentation by the debtor then it will be non-dischargeable like any other debt obtained through fraud. See Section 523(a)(2) of the Bankruptcy Code.

In summary:

Employment benefit overpayment by California EDD will likely be dischargeable as long as not a result of debtor’s fraud. Therefore, if bankruptcy is filed when your wages are being garnished for overpayment of unemployment debt, the garnishments will have to stop. However, it may be recouped if future unemployment payments are to be paid out or if the debtor is still receiving unemployment.

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