There are situations where debtors in bankruptcy have received “overpayments” of benefits from the Social Security Administration.  Typically, these benefits are in the form of social security disability sums that the debtor has already received.

The debtor will then get a letter informing him or her that the disability amount was paid out “in error” and that it needs to be recovered.  Obviously, this is not the type of news that is welcome for a distressed debtor, who has enough problems just trying to get back on his or her feet.  The question then arises:  is the debt for social security disability overpayments dischargeable in a bankruptcy?

The short answer is yes.  There is no specific prohibition in the Bankruptcy Code which prevents social security disability overpayments from being discharged in a bankruptcy.  It would be treated as another general unsecured debt.  This was the decision reached in the seminal case of Lee v. Schweiker, 739 F.2d 870 (3d. Cir. 1984).  But this is hardly the end of the story.  Like so many things in the law, there are limitations, exceptions, and qualifiers to this general rule.

1.  Adversary Proceeding.  Even though the social security overpayment may be dischargeable, there is still the possibility that the SSA could claim that the debt was incurred through fraud or false pretenses.  The SSA could bring an adversary proceeding against the debtor in the bankruptcy case under 11 U.S.C. Sect. 523, and try to prevent the debt from being discharged.  However, in practice this seems almost never to happen.  Few, if any, examples of this type of adversary can be found in the legal literature.  Even if such an adversary were brought, it is not easy to show that a debt was incurred by fraud.  It is a high standard for a plaintiff to meet.

2.  Right of Recoupment.  The more common obstacle to discharging a social security disability overpayment will be the theory of recoupment.  Recoupment is a common law doctrine.  It is basically an equitable exception to the automatic stay of bankruptcy.  It is “the setting up of a demand arising from the same transaction as the plaintiff’s claim or cause of action, strictly for the purpose of abatement or reduction of such claim.”  In Re Caldwell, 350 B.R. 182 (E.D. Penn. 2006); see also In Re Mewborn, 367 B.R. 529 (D. N.J. 2006).

Recoupment “does not require a mutuality of obligation, but rather countervailing claims or demands arising out of the same transaction under which the initial claim was asserted.”  In Re Hiler, 99 B.R. 238, 241 (Bankr. N.J. 1989).  See also In Re Irby, 359 B.R. 859 (Bankr. N.D. Ohio 2007). The key phrase here “arising out of the same transaction.”

Both the Hiler and the Caldwell courts stressed that a debtor must accept the burdens of a contract if he wants to continue to receive benefits under it.  If overpayments are made under a contract which provides for recoupment prior to the filing of a bankruptcy petition, the debtor should not be allowed to avoid the reimbursement of money by having them discharged in a bankruptcy while at the same time he continues to receive the benefits under the same contract.

A debtor, basically, cannot assume part of an agreement and reject another.  Recoupment allows for offsetting the amount a person owes from the ongoing benefit received.

If the overpayment is made by the SSA, and the debtor will continue to receive the benefit after the filing of a bankruptcy, then the doctrine of recoupment may not apply and the debtor will continue to receive the benefit.

But if the overpayment was made by your long-term disability under your insurance, then the result may be different.  Under the theory of recoupment, an insurance company may be permitted to “recoup” the amount that was overpaid from ongoing payments under the contract. The debtor will not be personally liable for the overpayment, but the recoupment will be permitted to happen from any future disbursements under the contract.  Why the different results?

The Caldwell case, cited above, gave the reason.  There is a difference between a government “entitlement” and a benefit arising from contract law (i.e., a contract between the parties).  SSA is controlled by a federal social welfare statute that is actually an entitlement, not a contract.  But in Caldwell, the benefit in question arise from a contract between the parties.

But even in this scenario, recoupment only goes on if the benefit is still being received.  If the long term disability benefit stops or has already stopped, then the debt arising from the overpayment will be discharged in the bankruptcy.

3.  Equity has the final say.  As can be seen, these matters can be complicated.  Even if the theory of recoupment does apply (which it often does not), it itself has limitations.  For example, in In Re Beaumont, No. 09-7006 (10th Cir. 2009), the theory of recoupment was ruled to be inapplicable to overpayment claims from the Veterans’ Administration.  In the Mewborn case cited above, the court found that recoupment could apply to unemployment benefits, since they were not clearly recognizable as social welfare benefits, like social security.

But even then, it was clear to state that recoupment is an “equitable remedy” and that a “court must examine each case with particularity.”

In the Western District of Missouri, the a narrow interpretation of recoupment has proven to be very favorable to debtors in bankruptcy.  The case of In Re Terry, 453 B.R. 760, (W.D. Mo 2011) is a great example.  In that case, Judge Venters found that recoupment is “only allowed where it would be inequitable for the debtor to enjoy the benefits of a transaction without also meeting its obligations.”

A creditor’s rights are “not absolute, and must be weighed.”  Judge Venters then went on to state that “the Court finds that permitting recoupment here would impose a hardship on the Debtor and unduly impair the Debtor’s fresh start.”  So, a court can deny recoupment, even if recoupment is theoretically justified under the original contract, if doing so would be a hardship to a debtor.  The final words of Judge Venters are significant:

The Eighth Circuit Court of Appeals and the Bankruptcy Appellate Panel have unequivocally stated that recoupment is an equitable doctrine.  Thus, the Court must look beyond the mere fact that the debt owed to the creditor and the benefits to be enjoyed by the debtor arise from the same transaction.  Looking beyond this fact, the Court finds that it would be inequitable to permit [the creditor] to recoup under the circumstances of this case.

Obviously, the legal analysis around the discharge of overpayment benefits is complicated.  If you have an issue of overpayment of benefits from the Social Security Administration, the Veterans Administration, unemployment benefits, welfare benefits, estates, settlements, or benefits from insurance contracts, you need to contact an attorney familiar with these areas.

Read More:  Secured Debts In Bankruptcy