By Jon Hill

Law360 (April 22, 2020, 10:23 PM EDT) -- The Trump administration could score a double victory for consumer advocates and the banking industry by exempting coronavirus stimulus payments from private garnishment, a move that would help assuage concerns about seizure of these funds and help banks avoid getting caught between debt collectors and an angry public.

For weeks, pressure has been mounting for federal action to keep debt collectors away from the stimulus funds that the U.S. Treasury Department and IRS began disbursing last week as part of the $2.2 trillion coronavirus relief package enacted in late March.

Although Congress specifically restricted federal and state agencies' ability to garnish these so-called economic impact payments, the lack of equivalent restrictions on private debt collectors means some struggling consumers might see their pandemic aid diverted to paying off old debts rather than being made available to cover food, housing and other living expenses.

A growing number of states has responded to this uncertainty by instructing debt collectors to keep their hands off the stimulus money, and consumer groups, banking trade associations and others are pushing for these funds to be federally shielded from private garnishment, too, much as other government benefits already are.

But while the latest coronavirus relief legislation passed by senators on Tuesday did not include such language, financial services attorneys told Law360 that Treasury can still act to clarify the status of these payments nationally so that consumers don't miss out and banks aren't left to shoulder the reputational and legal risks of complying with garnishment orders during a pandemic.

"Banks are caught between a rock and a hard place on this issue," said Lori Sommerfield, of counsel at Ballard Spahr LLP. "They have to obey a state garnishment order, but they also know this is much-needed money for their customers. That's why this clarification is really critical."

Federal law has long deemed Social Security, disability and other federal benefit payments off-limits to private debt collectors, and the Treasury Department years ago adopted regulations to help banks parse out which funds in an account are protected after a garnishment order is served.

Under those rules, Treasury uses special codes to mark the protected status of a payment when electronically depositing it into a beneficiary's bank account, but the Treasury didn't give the same treatment to the coronavirus stimulus funds that started being disbursed earlier this month.

That's because the relief bill, known as the CARES Act, "doesn't exempt any of these economic impact payments from court-ordered garnishment to pay creditors or debt collectors," Sommerfield said. "Private debt collection can in theory proceed, and creditors and debt collectors do have access to those EIPs because there's nothing in the law that prohibits that."

Some have speculated that the act's silence on garnishment was just an oversight. But whatever its origins, New York and several other states have reacted by making their own determinations. In guidance issued on Friday, for example, New York Attorney General Letitia James told debt collectors and state-chartered banks that the coronavirus stimulus payments qualify as exempt from garnishment under New York law and warned she "will aggressively prosecute" attempts to go after these funds.

For its part, the debt collection industry has bristled at the idea that debt collectors are looking to swoop in and scoop up the stimulus payments. ACA International, a top trade association for the industry, made that point in a letter last week to Treasury, writing that its members aren't targeting the funds and dismissing consumer advocates' concerns to the contrary as "harmful and unwarranted."

The reality, according to ACA, is that debt collectors can't know what money is in a debtor's bank account when they're pursuing garnishment, nor could they plausibly start trying to get new garnishment orders to go after the stimulus payments when so many courts are closed or delaying cases because of the virus. And garnishment is typically only a last resort for creditors anyway, ACA said.

"Any problems for consumers that arise could be more easily solved through a conversation, rather than in complex legislation," ACA wrote. "In the rare event that stimulus funds are garnished, consumers have ample opportunity to have those funds returned, particularly if they have been directly impacted by COVID-19."

But consumer groups like the Center for Responsible Lending and industry organizations like the American Bankers Association told congressional leaders in a letter on Tuesday that consumers may not always know the state-law nuances around garnishment orders or have the resources needed to challenge them at this time.

"The lack of clear, self-executing protection for the stimulus payments imposes a significant burden for some families facing unprecedented circumstances," the letter said.

Not only could federal-level action go further to protect the payments, it could help speed up their disbursement by incentivizing the use of direct deposits, which banks can more easily set aside as exempted thanks to the way the government electronically flags them, according to the consumer and industry groups.

Consumer benefits aside, the banking industry has other reasons to want federal clarity on garnishment exemption. For one, Debevoise & Plimpton LLP partner Courtney Dankworth said a state-by-state approach could lead to legal headaches for national banks over whether a given state attorney general's guidance on this issue applies to them or is federally preempted.

While that guidance has generally been aimed more at debt collectors, Dankworth said that's no guarantee they will be the only targets if states bring enforcement actions over garnishment. Already, for example, New York's James has threatened to use the Dodd-Frank Act to go after anyone who provides "substantial assistance" in garnishing a stimulus payment.

"Even if we don't see a state cause of action against a national bank right now, I would not take that to mean an AG wouldn't pursue it," Dankworth said.

Financial services attorneys who spoke to Law360 said extending a federal garnishment exemption to the stimulus payments could also spare banks from the public relations nightmare of having to obey a court's garnishment order and take aid money from a customer in the middle of the COVID-19 crisis.

"Banks have to follow the law, but they're obviously concerned about how it would look if they were to allow private garnishment to proceed," Sommerfield said. "There's a tremendous reputational risk to banks in following the law without this clarification from Treasury or Congress."

Tuesday's letter from the consumer and industry groups pushed for Congress to intervene, and Democratic lawmakers including Sens. Sherrod Brown of Ohio and Elizabeth Warren of Massachusetts have expressed support for legislatively exempting the stimulus payments.

But the CARES Act did empower Treasury to issue rules and guidance as needed to carry out the stimulus program's mission. Since then, consumer advocates, state attorneys general from both parties and policymakers have urged Treasury Secretary Steven Mnuchin to use this authority to classify the stimulus payments as protected like other federal benefits.

So far, those calls have not yielded such guidance from Mnuchin's agency, which has been stretched thin amid various ongoing coronavirus response efforts, including implementation of the $349 billion small business relief loan program that is poised for a $310 billion expansion in the coming days.

Treasury representatives did not respond when asked by Law360 whether the agency might declare the stimulus payments exempt from private garnishment, but The Washington Post reported earlier this week that agency lawyers have been exploring the possibility.

Still, Sommerfield described it as "perplexing" that Treasury hasn't moved more quickly to address the status of the stimulus payments, saying it would have been relatively straightforward for the agency to extend protection to the funds when the direct deposits first started going out.

"All Treasury would have had to do is issue a simple set of guidance saying these payments will be coded as federal benefits so that they are not subject to garnishment by private parties," Sommerfield said. "Or the agency could have issued guidance saying that it would treat these as federally protected benefit payments, for purposes of a one-time payment to taxpayers, because they're really being issued as tax credits."

And even though an initial wave of tens of millions of stimulus payments has already been sent to consumers, Sommerfield said banks could still benefit from federal action on the private garnishment issue.

"The banking industry and financial institutions urgently need guidance from Treasury or a legislative fix so that they have clarity on this issue," Sommerfield said.

Dankworth said she would not be surprised if Treasury ultimately steps up to resolve the uncertainty and keeps the stimulus money out of private debt collectors' reach.

"The administration itself will want to get credit for putting money in people's pockets, so to the extent that this [uncertainty] would detract from that, I think they may be interested in cleaning it up themselves," Dankworth said.

"It would be extremely helpful to give guidance to national banks and state-licensed actors," she added. "It would avoid a lot of litigation if there was a federal rule that made it more clear."

--Editing by Brian Baresch and Michael Watanabe.

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