The federal banking agencies (the agencies) recently announced a proposed guidance for the banks they supervise titled "Garnishment of Exempt Federal Benefit Funds." The guidance addresses the recurring problem of banks garnishing accounts exempt from judgment execution under federal law, such as a deposit account funded only by social security benefits, and provides best practices for banks to follow when a creditor attempts to garnish an exempted account (see note at the end of this article). The agencies published the guidance because garnishment of these exempt accounts imposes severe hardship on the type of customers most likely to have them, namely, retirees receiving social security. The agencies' request for comment makes this an appropriate time to review recent court cases that highlight the circumstances under which courts have allowed banks to exercise their right of setoff against a customer account that receives social security benefits.
Generally speaking, bank accounts funded only by social security benefits are exempt from execution because of the anti-assignment provision in section 207 of the Social Security Act. This section provides:
(a) The right of any person to any future payment under this title shall not be transferable or assignable, at law or in equity, and none of the moneys paid or payable or rights existing under this title shall be subject to execution, levy, attachment, garnishment, or other legal process or to the operation of any bankruptcy or insolvency law.
(b) No other provision of law, enacted before, on, or after the date of the enactment of this section , may be construed to limit, supersede, or otherwise modify the provisions of this section except to the extent that it does so by express reference to this section.
(c) Nothing in this section shall be construed to prohibit withholding taxes from any benefit under this title, if such withholding is done pursuant to a request made in accordance with section 3402(p)(1) of the Internal Revenue Code of 1986  by the person entitled to such benefit or such person's representative payee.
The agencies' guidance, which is designed to help implement section 207 and other federal laws protecting federal benefits from execution, is directed to the fairly common issue of a bank receiving legal process from a third-party creditor against a customer bank account that receives social security benefits. That issue is subject to a bright-line rule: if the account is funded only by social security benefits, section 207 prevents the creditor from attaching it unless another federal law specifically provides for attachment of social security benefits.1 But recent court cases have carved out a new exceptionwhen a bank exercises its right of setoff against a deposit account that receives social security benefits to pay a delinquent bank debt that arises out of that account, such as an overdraft or overdraft fees.
The Right of Setoff
Setoff is a self-help right of a creditor holding a delinquent debt to obtain payment from assets of the debtor in the creditor's possession. For example, if a bank has a customer who is in default on a car loan, and the customer also maintains a deposit account with the bank, the bank can exercise its right of setoff against the deposit account to obtain payment on the car loan debt. But in light of the broad prohibition on assignment of social security benefits in section 207 of the Social Security Act, the question arises whether banks can legally attach an account receiving social security benefits as a setoff against a debt of that customer.
In light of recent court decisions, the answer appears to be that the bank can exercise the right of setoff against an account receiving social security benefits if the debt to the bank arises out of the account. For example, in the recent case of Wilson v. Harris Bank N.A., 2007 U.S. Dist. LEXIS 65345 (N.D. Ill. Sept. 4, 2007), a customer's checking account was overdrawn because of allegedly unauthorized debit card transactions. The bank also assessed overdraft fees because the transactions exceeded the balance in the account.
The customer notified the bank that transactions were unauthorized, but the bank rejected the customer's claim after conducting an investigation. When the customer's social security benefits were deposited, the bank offset the negative balance in the account against the deposit. The customer sued the bank, alleging, among other things, that the bank violated the anti-assignment provision of section 207 of the Social Security Act. However, the court rejected the customer's claim that the bank violated section 207, noting a distinction between attachment of a protected account for an independent debt and attachment to pay a debt arising from the protected account. The court upheld the right of the bank to exercise its right of setoff against the social security benefits because the debt to the bank being offset arose from that account.
The United States Court of Appeals for the Ninth Circuit reached a similar conclusion in Lopez v. Washington Mutual Bank, 302 F.3d 900 (9th Cir. 2002).2 Lopez concerned a class action against Washington Mutual Bank (Wamu) alleging violations of section 207 because Wamu was using social security benefits deposited to checking accounts to obtain repayment of overdrafts and overdraft fees incurred in those accounts. The Ninth Circuit rejected the plaintiffs' claims, finding that
the plaintiffs voluntarily opened an account with the bank and executed an account holder agreement which outlined the terms and conditions of the bank's overdraft policies. They also established a direct deposit for their benefits (an agreement to which Washington Mutual was not a party). The plaintiffs remained free at all times to close their account or change their direct deposit instructions. Because they did not do so, Washington Mutual argues, each deposit to the account after an overdraft should be treated as a voluntary payment of a debt incurred. We agree.
It is important to emphasize that the cases approving the right of setoff concerned an obligation arising from the account being offset. However, a different rule has been applied for setoffs in the context of a debt unrelated to the account receiving social security benefits. For example, in Tom v. First American Credit Union, 151 F.3d 1289 (10th Cir. 1998), the United States Court of Appeals for the Tenth Circuit held a credit union liable for conducting an offset against a customer account receiving social security benefits to pay delinquent loans of the account holder unrelated to the deposit account.3
The trial court in Marengo v. First Massachusetts Bank, 152 F. Supp. 2d 92, 93 (D. Mass. 2001) reached a similar conclusion. The plaintiffs in that case were retirees who were delinquent on their unsecured line of credit with their bank. To collect payment on the delinquent account, the bank conducted an offset against their deposit account, which only received social security benefits.
The couple sued the bank for violating the Social Security Act's anti-assignment provision. The court ruled for the customers, finding that setoff was not an exception to section 207 of the Social Security Act. But the court also stated that the outcome might be different if evidence were presented that the customer had signed an agreement allowing the bank to offset the account for the customer's other indebtedness to the bank.
It should be noted that the United States Court of Appeals for the Third Circuit, which has jurisdiction for appeals from federal courts and agencies in Pennsylvania, New Jersey, and Delaware, has not yet specifically addressed the issue of whether a setoff is permissible against a social security account to cover a debt arising from that account.
However, it appears from these cases that banks are generally prohibited from allowing levy or garnishment of customer accounts funded only by social security benefits when the garnishment is from a third-party creditor or when the debt is owed to the bank but is unrelated to the account receiving the social security benefits. One example is attempting to pay a customer's delinquent credit card debt by a setoff against the deposit account for social security benefits. But some recent cases have recognized an exception when the bank is performing an offset against a protected account because of a delinquency in the account, typically an overdraft or an overdraft fee. The lesson for banks is that they should proceed cautiously in this area and review their policies and procedures to ensure that they are in compliance with state and federal law.
Banking Agencies Propose Best Practices When Exempt Federal Benefit Funds Are Garnished
The agencies are seeking public comment on their proposed "best practices" for financial institutions to follow when a creditor garnishes a customer's account that receives benefits exempt from garnishment or other legal process under federal law. To lessen the hardships from garnishment, the agencies propose these best practices:
Banks are encouraged to submit comments on the proposed best practices. The rulemaking notice contains contact information for all of the agencies and is available online.
The views expressed in this article are those of the author and are not necessarily those of this Reserve Bank or the Federal Reserve System.