Eastern District Federal Court Swats Aside Appeal of Bankruptcy Court Ruling
Can the "penalties" portion of a State of Michigan unemployment benefit "claw-back" claim be discharged in Chapter 13 bankruptcy?
That is the question that the Eastern District of Michigan Federal Court decided this month on appeal from a ruling of the Eastern District of Michigan Bankruptcy Court that said, "NO." And, unfortunately, the appeals court said the same thing. But why, and what does this mean?
Some Debts are Not Dischargeable in Bankruptcy Due to "Fraud"
The first point of note is that some debts that might be discharged otherwise in bankruptcy (unlike child support or recent tax debt or other "non-dischargeable" debt) can be found by the court to be NOT dischargeable if they were incurred by way of some kind of fraud. For example, if you buy 18 laptop computers on a credit card and then try to file bankruptcy 1 week later, that is not going to go well for you! Credit card debt is usually very easily discharged in bankruptcy. However, any debt incurred within 90 days of the filing of a bankruptcy petition is presumed to be fraudulent. And, in example like that one, the court would surely agree that it is fraud if pushed to make that decision by the credit-card issuing creditor. What does this have to do with Michigan unemployment benefits? An unemployment benefit is, at the core, a transfer of money from the State of Michigan to a citizen of Michigan meeting certain criteria. Unemployed workers are eligible for this benefit, yes, by being residents of the State of Michigan—but also only if they meet certain other criteria. One obligation of the extension of unemployment benefits is that you have to agree to be searching for work on a regular basis and to report to the State of Michigan any employment garnered and/or wages earned. When you are re-employed and no longer unemployment—benefits cease. You go back to work. If you were to find employment but fail to report to the State that you did so and thus unemployment funds continued to be extended to you—that would be fraud, the same as the credit card example above. The question is, "Did you mean to fail to report the employment to the State with the intent to defraud?" Or did you just "cross-wires" with the State, reporting the new employment just a day or two after a check had been processed and mailed out to you? Or did you do absolutely nothing wrong at all and the State is incorrectly accusing you of fraud? That is the question that has to be resolved by the Bankruptcy Court when someone files for bankruptcy owing a debt to the Michigan Unemployment Insurance Agency.
What Happens When You Are Accused of Fraud by a Creditor in Bankruptcy Court?
If you file bankruptcy and a creditor accuses you of fraud, they will file a lawsuit against you in the Bankruptcy Court called an "Adversary Proceeding" or ("AP"). If the creditor wins that AP, they will receive a judgment from the Bankruptcy Court that says that the debt in question is fraud-based in some way and is not discharged by the bankruptcy case. The debtor will come out of the bankruptcy process still owing that debt, possibly with interest, penalties, and even attorney fees in some cases. This can happen in either Chapter 7 or Chapter 13 Bankruptcy. The Bankruptcy Code (the Federal law governing the bankruptcy process in the US) defines some sorts of debt that are simply not dischargeable at all (child support, etc.) and then also defines "fraud" in a number of different ways. These definitions vary slightly from Chapter 7 to Chapter 13. For example, it is easier to discharge "marital debt" (post-divorce joint debt ordered to be paid by 1 spouse rather than another in a divorce judgment) in Chapter 13 than Chapter 7.
Kozlowski v. Michigan Unemployment Insurance Agency
The State of Michigan, relying on the use of what sounds like a very buggy computer program, has mistakenly been charging thousands of Michigan residents with "fraud." Nevertheless, despite the now well-known flaws with its computerized fraud determination system, the State routinely files APs in bankruptcy cases to have such debts ruled to be non-dischargeable on the basis of fraud. With unlimited funding for legal services at its fingertips in the form of our tax-dollars, the State has, in this lawyer's experience, filed APs regarding unemployment claim debts for as little as $1,300.00. (Very few commercial creditors would bother with that little at stake.) Such unemployment fraud claims often have massive fees and penalties attached. A small benefit amount extended, say, $1,000, can, over time, develop into a $20,000-$30,000 claim. In the Kozlowski case, the State filed an AP to have an unemployment claim ruled to be non-dischargeable in Kozlowski's Chapter 13 case. Kozlowski and his attorney argued that, due so the differences in the language in Chapter 13 of the Bankruptcy Code from that in Chapter 7, the penalties portion of the State's claim was dischargeable in that Chapter. The Bankruptcy Court disagreed, and, now, on appeal, the Eastern District of Michigan Federal Court has upheld that ruling. Thus, if fraud is determined (unless Kozlowski appeals his case to the Sixth Circuit Court of Appeals), the entire unemployment claim will be held to be NON-dischargeable.
Michigan Unemployment Benefits Fraud Claims: The Upshot
The upshot of this ruling is that, once again, the Eastern District of Michigan Bankruptcy Court is two steps behind everyone else. News outlets and journalists such as Michigan Public Radio have widely publicized the problems with Michigan's unemployment fraud allegations. Lawsuits regarding these claims are widespread in Michigan's court systems, currently, and the State, outside of Bankruptcy Court at least, is beginning (as far as I can tell from clients' reports) to express a willingness to retract some of these fraud accusations and settle the associated claims out. But not in Bankruptcy Court. In Bankruptcy Court, as usual, it's always 3 Years Ago. Thus, if an unemployment fraud claim is your primary purpose in considering bankruptcy, you may want to explore every other option, including the State's appeals process, first. If you are a Michigan resident and would like to explore your options for a Chapter 7 or Chapter 13 bankruptcy with an experienced Michigan bankruptcy attorney, please contact us at (866) 674-2317 or click the button below to schedule a free, initial consultation.
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