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Overdraft Protection For Direct Deposit Accounts In Question

by Mary Beth Guard, Esq.

Congress had on its protective "parent" hat when it wrote two statutes which protect social security and SSI benefits from claims of creditors. Under 42 U.S.C. Sections 407(a) and 1383d(1), a recipient of such benefits is precluded from transferring or assignment any right to his future payments, and the moneys, once received, are not subject to execution, levy, attachment, garnishment, or other legal process, or to the operation of any bankruptcy or insolvency law.

Nursing Home Claims
Most of the cases interpreting these two statutes, until recently, have involved nursing homes trying to grab Social Security benefits from institutionalized patients' hospital accounts to pay for the cost of their care, or prison officials attempting to glom on to inmates' government benefits to satisfy overdrafts on an inmate's prison trust accounts.

In 1998, however, the Tenth Circuit court of appeals handed down a decision in Tom v. First American Credit Union which disallowed a credit union's right to exercise a right of setoff to apply Social Security benefits in a checking account to satisfy the depositor's loan obligation. In reaching its decision, the Court held that the setoff constituted "other legal process" as that term is used in Section 407. I reasoned that it would not make sense for Congress to choose to protect Social Security beneficiaries from creditors who utilized the judicial system and then choose not to protect those beneficiaries from creditors who use nonjudicial methods (such as setoff) to collect debts.

In essence, the Tenth Circuit believed there was no real difference between attachment and execution and the banker's setoff in terms of the effect on the account holder, so this "self-help" remedy to collect a debt was barred just like a garnishment would be. That didn't seem like too much of a stretch in reasoning to me, and it raised few banker's eyebrows, so far as I know.

Overdrafts and Fees
The latest case interpreting these statutes has bankers' tongues wagging, however. The 9th Circuit Court of Appeals in Lopez v. Washington Mutual Bank, Inc. ruled that a bank violated Section 407(a) and 1383d(1) of Title 42 by utilizing funds from social security direct deposits to reimburse the bank for overdrafts it had covered for benefits recipients. The case was brought by several recipients of direct deposit Social Security and SSI benefits. Each had signed a deposit agreement that had language allowing the bank to pay overdrafts and impose a fee, and a promise to immediately pay the overdraft amount to the bank.

This case has spawned a large number of questions. Here are some of the most important questions, along with answers.

QUESTION: Does this directly affect my bank? We're in the fifth circuit. Has my circuit had any similar, or better yet dis-similar cases that you know of? We allow many of our customers with direct deposit to overdraw their accounts. This basically says that if they are overdrawn when that deposit arrives, somehow the system should make the direct deposited funds available and the OD amount should stay the same.

ANSWER: The only other circuit court of appeals to come close to addressing the issue was the Tenth Circuit. (Its ruling dealt with a slightly different fact situation. The financial institution was exercising its right of setoff to satisfy the depositor's loan obligation, rather than using it to cover an overdraft.) No other Circuit has handed down a decision on the overdraft issue or the loan setoff issue.

Decisions of federal circuit courts of appeals (CCA) outside your circuit are considered persuasive authority, rather than controlling authority. That means your CCA is free to reach a different conclusion.

In determining whether you should conform your practices to the guidelines set forth in the Lopez decision, however, consider the fact that two CCAs have basically ruled the same way. With two circuits ruling that way and none ruling differently, the odds favor this being the outcome in future court actions.

I think your analysis of the case's bottom line is correct - that if the customer is overdrawn, and the SS or SSI direct deposit arrives, the system should make those funds available and the OD amount should stay the same.

QUESTION: We're not in the 9th Circuit. Can we just ignore this court decision unless and until our Circuit hands down its own decision? What are the risks of ignoring it?

ANSWER: The risks are numerous. Don't assume that the worst that could happen is that an individual benefits recipient would raise objection and you would have to recredit that individual's account. Instead, as in this case, the SS recipient could try to sue you (on behalf of himself and a similarly situated class, perhaps) for an unfair or deceptive practice or for conversion. In the Lopez case, the plaintiffs are seeking punitive damages. I doubt they will get them, since this was a case of first impression and I think it would be difficult to win punitive damages against the bank when it was not well-established prior to the case that this activity was impermissible. But once the Lopez ruling is on the books, other banks that act contrary to it would be at more risk for punitives. There's no penalty built into the two sections of federal law, but as with any other violation of law, you could be cited for the violation by examiners and the regulatory agencies could pursue action against you for engaging in an unsafe or unsound practice.

As the judge pointed out in the concurring opinion, Congress needs to correct this problem.

QUESTION: Maybe the Court just didn't realize that this would negatively impact the ability of these customers to have overdraft protection. What do you think?

ANSWER: I think the Court fully understood the consequences. In his concurring opinion, one of the judges agreed with the decision, but stated, "Holding that a bank cannot touch a directly deposited Social security check, we make overdraft protection virtually impossible for Social Security recipients...Whenever a Social Security beneficiary overdraws his account and the bank pays it, the bank runs the risk of running afoul of Section 407(a) if the bank covers its loss when the customer's overdrawn account is replenished by a direct deposit. Faced with this risk, banks may not give overdraft protection to direct depositors of Social Security."

As the judge pointed out in the concurring opinion, Congress needs to correct this problem.

Copyright © 2002 Bankers' Hotline. Originally appeared in Bankers' Hotline, Vol. 12, No. 3, 4/02

First published on 04/01/2002

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