Circuit Split on Wage Garnishments Underpins a Certiorari Petition

October 3, 2017

If a creditor obtains a wage-garnishment order long before bankruptcy, can a trustee mount a successful preference action to recover wages actually garnished within 90 days of bankruptcy?

Circuits answering the question will remain split unless the Supreme Court grants the petition for certiorari filed last week in Tower Credit Inc. v. Schott, 17-444 (Sup. Ct.).

In Tower Credit, a test case involving $1,750, the Fifth Circuit interpreted Local Loan v. Hunt, 292 U.S. 234 (1934), and Barnhill v. Johnson, 503 U.S. 393 (1992). Combining the two high court authorities, the appeals court concluded that a worker does not have an interest in wages until she or he has performed services.

Since Section 547(e)(3) provides that a transfer for preference purposes does not occur until the debtor acquires an interest in the property, the New Orleans-based appeals court sided with the Sixth Circuit and held that wages garnished within three months of bankruptcy are recoverable preferences because the debtor did not earn wages until performing the underlying services, regardless of how much earlier the garnishment order was entered.

In three cases decided in the 1980s before Barnhill, the Second, Seventh and Eleventh Circuits ruled to the contrary and held that the transfer occurred outside of the preference period, on entry of the garnishment order.

The Fifth Circuit sided with the Collier treatise and said that the decisions from those three circuits did not survive Barnhill, which established the principle that federal law prescribes the time of a transfer even though state law determines a debtor’s interest in property. For preference purposes, Barnhill held that federal considerations prescribe the time of the transfer as being the date when a check is honored by the drawee bank, not the date when the debtor drew or delivered the check.

The lender’s certiorari petition in Tower Credit argues in substance that the lower courts have gone too far in interpreting Barnhill. The petitioner believes that the Fifth and Sixth Circuits upset “the careful balance between state and federal law established by the U.S. Constitution, the Bankruptcy Code, and [the Supreme Court’s] precedents.” In other words, the petitioner is appealing to conservative justices, hoping they will be more deferential to state law rather than follow a policy supposedly underlying the Bankruptcy Code.

The argument is not without appeal. Although Local Loan involved garnished wages, the Supreme Court held that the “fresh start” principle prevents a garnishment order from riding through bankruptcy, thus allowing a worker to earn wages after bankruptcy unencumbered by garnishment. Tower Credit, on the other hand, allows a trustee to recover pre-petition wages and has nothing to do with the debtor’s “fresh start” and post-petition wages.

The petitioner contends that the Supreme Court has already begun backing off from Local Loan. The lender says that the high court has not cited that case since the adoption of the Bankruptcy Code regarding the existence of property rights. To the contrary, the lender argues that a 1994 Supreme Court precedent requires a “clear and manifest” federal statutory mandate before departing from state regulation.

The lender therefore believes that the Fifth Circuit’s decision conflicts “with the constitutional separation between federal and state interests.”

The odds favoring a grant of certiorari seem slim because the split may be dissolving. The Seventh Circuit arguably disavowed its own precedent when it questioned whether the Eleventh Circuit case survived Barnhill. The odds in favor of Supreme Court review improved because the Tower Credit certioraripetition is succinct, intelligible and persuasive about the need for review because it ends by explaining the real-world significance of the issue. The petitioner says that 7.2% of Americans had wages garnished in 2013, implying that many of them filed bankruptcy, thus laying the groundwork for thousands of preference suits annually.

The certiorari petition did not reach the Supreme Court earlier because the lender filed a petition for rehearing en banc, which the circuit denied in late June.

The date for the justices to hold a conference and consider the Tower Creditcertiorari petition will not be scheduled until the bankruptcy trustee has responded. In the event of a “grant,” the high court could hold oral argument this term unless there is a delay in considering the petition. The case will not be heard this term if the justices ask the Solicitor General for his views about the petition.

To read ABI’s discussion of the Fifth Circuit’s Tower Credit opinion, click here.

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