The object of this article and self-study test is to provide an overview of claims of exemption for judgment debtors. Topics include exemption of funds derived from paid earnings, Social Security or other public funds which can be traced into deposit accounts, the lowest intermediate balance principle, evidence of exemption, and preemption.
In general, all property of a judgment debtor is subject to a money judgment unless it falls within the applicable claims of exemption under California Code of Civil Procedure Sections 704.010-704.210. Ford Motor Credit Co. v. Waters
, 166 Cal. App. 4th Supp. 1 (2008). The rationale behind the exemptions holds that certain types of property should not be taken in order to satisfy a judgment, hence the judgment debtor is allowed to keep all or part of such property for his own protection or that of his family. Id.
Two types of property exempt from money judgment enforcement will be discussed in this article. One, funds derived from paid earnings which can be traced into deposit accounts are exempt. Code Civ. Proc. Section 704.070. Second, deposit accounts containing certain amounts of funds from Social Security and public benefits are also exempt. Code Civ. Proc. Section 704.080.
A judgment debtor must be able to "trace" funds from their exempt source to either a deposit account, cash or its equivalents. Code Civ. Proc. Section 703.080. This article will focus on the evidence which courts have accepted in determining whether funds a judgment debtor has claimed have been sufficiently traced back to exempt sources.
First, the "exemption claimant has the burden of tracing an exempt fund." Code Civ. Proc. Section 703.080(b). Second, "the tracing of exempt funds in a deposit account shall be by application of the lowest intermediate balance principle." Code Civ. Proc. Section 703.080(c). Third, courts have been willing to accept the declarations of persons with personal knowledge of the source of exempt funds in conjunction with corroborating documentation such as bank statements. Fourth, courts should take caution when applying Code of Civil Procedure Section 704.080 insofar as it applies to Social Security benefits. In Lopez v. Washington Mutual Bank FA
, 302 F.3d 900 (9th Cir. 2002) (as amended in 2002 U.S. App. LEXIS 24344), the 9th U.S. Circuit Court of Appeals held that Section 704.080 was preempted by federal law when a bank, pursuant to contract, uses Social Security benefits to reimburse itself for overdrafts and overdraft fees.
As the name suggests, the lowest intermediate balance principle (LIBP) is not a first-in, first-out rule. For insight into how the LIBP operates, we will turn to subdivision (c) of the Legislative Committee Comments which accompany Code of Civil Procedure Section 703.080. While "a legislative committee comment is certainly not conclusive, it is also not without persuasive value." McMullen v. Haycock
, 147 Cal. App. 4th 753 (2007), citing Deutch v. Hoffman
, 165 Cal. App. 3d 152 (1985).
The comment provides: "Under the lowest intermediate balance rule, the exempt fund may not exceed the lowest balance occurring at any time between the deposit of the exempt amount of money and the time of levy. New deposits do not replenish the original exempt fund although new deposits may themselves be exempt."
The comment goes on to provide an example of how the LIBP would operate: "[S]uppose the judgment debtor has a deposit account in which there is a balance of $400 composed of nonexempt fund
. The judgment debtor then makes a deposit of $400 of exempt funds
(leaving a balance of $800) a withdrawal of $600 (leaving a balance of $200), and a deposit of $300 of nonexempt funds
(leaving a balance of $500). The total exempt funds
deposited were $400, but under the lowest intermediate balance rule, the $600 withdrawal reduces first
the nonexempt funds
and then the exempt funds
, leaving $200 of exempt funds
. The final $300 deposit does not affect the exempt funds, which remain exempt in the amount of $200, the lowest intermediate balance, despite the final balance of $500." (Emphasis added.)
We can make at least two observations. First, when there is a withdrawal from an account containing a mixture of exempt and nonexempt funds, nonexempt funds come out first. Second, new deposits, even if exempt, do not replenish the funds of the original exempt fund. For example:
Suppose a deposit account contains a balance of $1,000 of nonexempt funds. The judgment debtor then makes a deposit of $500 in paid earnings (leaving a balance of $1,500), a withdrawal of $1,100 (leaving a balance of $400), a deposit of $600 in Social Security benefits (leaving a balance of $1,000), a withdrawal of $800 (leaving a balance of $200), and a deposit of $300 of nonexempt funds (leaving a balance of $500). Total exempt funds deposited were $500 for paid earnings and $600 for Social Security. Because of the LIBP rule, the judgment debtor now has $0 in exempt paid earnings and $200 in exempt Social Security earnings remaining.
The exemption claimant has the initial burden of proving that the funds in a deposit account derive their origin from an exempt source. ITT Commercial Fin. Corp. v. Tech Power Inc.
, 43 Cal. App .4th 1551 (1996). The party bearing the burden of proof must offer evidence so that the trier of fact may have a basis for finding in his favor. Id.
Courts have been willing to accept declarations from individual exemption claimants within which funds in deposit accounts are traced back to exempt sources. McMullen
. The exemption claimant may also provide bank statements to substantiate the origin of exempt funds. See, e.g., Ford Motor Credit Co.
Lastly, a declaration from a company's controller in conjunction with corroborating documentation has been accepted as sufficient to meet the claimant's burden of production. ITT Commercial Fin. Corp.
, the judgment debtor prior to judgment, moved funds from a private retirement plan (which is fully exempt from execution) into an individual retirement account (IRA) (which is subject to diminished immunity from execution). The judgment debtor submitted a declaration within which he could trace all funds in the rollover IRA back to funds distributed to him from his retirement plan with his former employer. The court held that "under the tracing statute [Code Civ. Proc. Section 703.080(a)], the exempt private retirement plan funds retained their full exemption ... after being rolled over into the IRA."
In Ford Motor Credit Co.
, the judgment debtor's bank account, comprising wages paid by her employer, was levied upon by a judgment creditor. The judgment debtor provided bank statements to demonstrate that she received direct deposits from her place of work, and deposits were credited to her account within 30 days of the date of levy. Based on this, the court held that the judgment creditor was only entitled to 75 percent of the paid earnings existing in the balance on the date of levy.
Moreover, in ITT Commercial Fin. Corp.
, a third-party claimant joined a lawsuit alleging that it had perfected security interest in all funds within the defendant's bank account that derived their origin from the sale of the defendant company's inventory. In support of its claim, the third-party claimant submitted the declaration of the former controller of the defendant company within which the controller maintained that all funds in the bank account were derived from, among other things, proceeds from the sale of the defendant company's inventory. In addition the third-party claimant also submitted documents listing all deposits made to the bank account over a two-month period. The court held that the third-party claimant successfully traced proceeds from the sale of the defendant company's inventory to the defendant's bank account.
Any state law, even if within a state's acknowledged sphere of power, which interferes with or is contrary to federal law, must yield. Witkin Summary of California Law 10th Edition Constitutional Law 98. Code of Civil Procedure Section 704.080 provides that deposit accounts containing certain amounts of funds from Social Security benefits are exempt from judgment execution. In Lopez
, the 9th circuit held that at least under certain circumstances the California law has been preempted by federal regulations promulgated by the federal Office of Thrift Supervision (OTS).
, all named plaintiffs were recipients of Social Security benefits. Each had an account with defendant Washington Mutual. All accounts were subject to a contract which allowed the bank to honor checks even if there were insufficient funds in an account. An overdraft would be created, in addition to an overdraft fee. Washington Mutual maintained the practice of using subsequent direct deposit Social Security benefits to first satisfy overdraft amount, then overdraft fees. Plaintiffs sued alleging violation of federal law and Code of Code of Civil Procedure Section 704.080. The court stated that within 12 C.F.R. Section 557.11, the OTS provides examples of state laws that are preempted. For example, "state laws purporting to impose requirements governing ... checking accounts ... savings account orders of withdrawal and service charges and fees." The court then held that Code of Civil Procedure Section 704.080 is preempted by federal regulations because it "imposes requirements governing 'checking accounts,' 'funds availability,' and 'service charges and fees.'"
It is unclear just how applicable Lopez
would be to a traditional judgment debtor judgment creditor relationship. In Lopez
, the bank was simply reimbursing itself for overdrafts; no judgment had been sought, nor rendered. Given this, perhaps Lopez
is limited to its facts. Namely, that when a bank attempts to use Social Security benefits pursuant to contract, to cover overdrafts and overdraft fees, federal regulatory law preempts state law.