The Fifth Circuit handed down an important garnishment decision on March 13 following the Collier treatise and saying that opinions from three other circuit courts were either wrongly decided or did not survive Barnhill v. Johnson, 503 U.S. 393 (1992).
The case involved a judgment creditor who served a garnishment order on a debtor’s employer before the debtor filed bankruptcy. The bankruptcy court awarded a preference judgment to the trustee for recovery of wages garnished within 90 days of bankruptcy.
The district court affirmed, and so did the Fifth Circuit in an opinion by Circuit Judge James L. Dennis.
Do not be surprised if there is a petition for certiorari. The appeal was a test case because it entailed the recovery of a $1,750 preference.
Judge Dennis explained that a preference resulting from garnishment is governed by two subsections in Section 547.
First, Section 547(e)(2)(B) provides that a transfer is “perfected” when a creditor on a simple contract could not obtain a lien superior to the interest of the transferee. Because the garnishment order was served on the employer before bankruptcy, the creditor argued that no other creditor could acquire a judicial lien superior to the garnishor’s interest.
Judge Dennis said that would be true, except for the fact that it ignores the second relevant subjection, Section 547(e)(3), which says that the debtor must have an interest in the property before a transfer can occur.
On that topic, the Supreme Court ruled in Barnhill that the time of a transfer is governed by federal law, not state law.
The Supreme Court had ruled earlier in Local Loan v. Hunt, 292 U.S. 234 (1934), that the earning power of an individual is not “translated into property” until the earnings come into “existence.”
Thus, Judge Dennis said that the Sixth Circuit was correct when it said in In re Morehead, 249 F.3d 445 (6th Cir. 2001), that a debtor cannot obtain rights in future wages until the services have been performed. Therefore, the Sixth Circuit held that garnished wages earned during the preference period are recoverable preferences.
Judge Dennis agreed with the Sixth Circuit. He went on to say that contrary decisions from the Eleventh, Seventh and Second Circuits were all decided before Barnhill and are therefore no longer good law. He noted that the Seventh Circuit has disavowed its pre-Barnhill case, which had held that wages garnished before bankruptcy are not preferential.
Those three cases, Judge Dennis said, have been “roundly criticized” by the Sixth Circuit in Morehead and by lower courts. He noted that the Collier treatise says those three circuit cases are “wrong.”
In short, Judge Dennis said, there is no property a creditor can garnish or that a debtor can transfer until wages are earned. Therefore, the “creditor’s collection of garnished wages earned during the preference period is an avoidable transfer made during the preference period even if the garnishment was served prior to that period.”