Overpayment of Unemployment Benefits: What Should a Debtor Do?

Unemployment insurance benefits provide critical assistance to unemployed individuals and their families.  Often times, it is the only thing that keeps food on the table and the utilities on. It’s an amazing social safety net, but just a small mistake can turn that net into an absolute nightmare.
Michigan Law
Under Section 62 of the MES Act, M.C.L. 421.62, the Unemployment Insurance Agency (UIA) is entitled to recover improperly-paid benefits.  Under Section 54(b) of the MES Act, M.C.L. 421.54(b), the UIA may impose penalties on a person who makes a false statement or representation knowing it to be false, or knowingly and willfully with intent to defraud fails to disclose a material fact, to obtain or increase a benefits payment. Penalties are double the amount of restitution if restitution is less than $500.00, and quadruple the amount of restitution if restitution is $500.00 or more.  What does this mean? It means that if you were overpaid benefits in the amount $1,000.00, the UIA may be coming after you for another $4,000.00 in fraud penalties plus interest!
Bankruptcy as a Solution
If the UIA is pursuing you for thousands of dollars, chances are you don’t have the money and you are already struggling with debt because you were unemployed. Understandably, the solution that most people reach for is bankruptcy.   Chapter 7 , the bankruptcy that allows you to wipe out your debts with no repayment, is the way go, right? It is an option, but it may not be the best option.  Understanding what can be done under Chapter 7 and under Chapter 13 is crucial for deciding how you should resolve overpayment of unemployment benefits.
Section 523 of the Bankruptcy Code provides a list of debts that are not subject to a bankruptcy discharge.  All of the §523 exceptions to discharge apply in a Chapter 7.  Most, but not all, of the §523 exceptions to discharge apply in a Chapter 13.  Generally, debt associated with the overpayment of unemployment benefits can survive a bankruptcy discharge as: (1) debt incurred by fraud and (2) penalties payable to and for the benefit of a governmental unit that is not compensation for an actual pecuniary loss.
Fraud Exception to Discharge
Under §523(a)(2)(A), a debt is nondischargeable if the debt is for money obtained by false pretenses, a false representation, or actual fraud.  Section 1328 of the Bankruptcy Code governs what debts are discharged by a Chapter 13. Section 1328 incorporates 523(a)(2)(A), so the fraud exception to discharge applies in Chapter 7 and Chapter 13. Allegations of fraud typically relate to the actual benefits that were overpaid and the associated interest. What is important to know is that if fraud is established, the debt will survive both a Chapter 7 and a Chapter 13 discharge.
To establish fraud and make the debt nondischargeable, the UIA must file an adversary proceeding. If the UIA makes a determination of fraud prior to a bankruptcy filing, the chances of them filing an adversary proceeding are very high.
If you file Chapter 7 and the UIA files an adversary proceeding seeking to establish fraud, you have the opportunity to litigate the issue. Just because an overpayment was made does not mean there is automatically fraud.  Consulting with an experienced bankruptcy attorney to discuss the facts of the overpayment will give you a better idea of whether you can prevail on this type of issue. However, even if the facts are on your side, litigating this type of issue may be beyond your means.  It is no surprise that people filing Chapter 7 often fail to defend against adversary proceedings. It can be expensive and Chapter 7 debtors usually don’t have the funds to pay an attorney to represent them.
Chapter 13 is often a much better route for people facing allegations of fraud in a nondischargeability action. In Chapter 13 it is possible negotiate the amount of the restitution and interest that will be paid back. Attorneys are also much more inclined to represent their Chapter 13 clients in an UIA adversary proceeding without being paid upfront because their fees can be paid through the Chapter 13 plan payments.
Statutory Penalties as an Exception to Discharge
The statutory penalties assessed by the UIA fall under §523(a)(7) because they are, “a fine, penalty, or forfeiture payable to and for the benefit of a governmental unit, and is not compensation for actual pecuniary loss.”  What is interesting is that §1328 does not include the §523(a)(7) exception to discharge.  This means that the statutory penalties (the debt that can be four times the amount of restitution) survive a Chapter 7 discharge, but are eliminated by a Chapter 13 discharge. In my opinion, this makes Chapter 13 the best option when statutory penalties have been assessed.
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