Unemployment Benefits and Related Claims in a Chapter 7 Bankruptcy Case

Posted by Wesley Scott on April 5, 2022 at 7:30 AM
Wesley Scott

 shutterstock_283550222Job loss is a common reason that people file for bankruptcy. In many cases, when an individual loses their job, they are entitled to certain benefits to help them while they seek new employment. While these types of unemployment benefits are generally “exempt,” meaning legally protected from creditors, there are some exceptions and nuances in the law. Debtors filing for bankruptcy in Minnesota may choose between Federal exemptions and State exemptions to exempt, and protect, their property.

Federal exemptions are those specifically provided for in the Federal Bankruptcy Code. State exemptions primarily consist of exemptions found in the Minnesota State Statutes, but also includes any other applicable Federal laws outside of the Federal Bankruptcy Code. Choosing whether to use Federal or State exemptions is important because it directly impacts how much property the debtor will be able to exempt, and for this reason, it is very prudent for a person to speak to an experienced bankruptcy attorney before filing their case.

In many cases, when a person loses their job they are entitled to Unemployment Insurance (UI) benefits, which is temporary income paid out by the State until the person returns to work. Under the Federal exemptions, the debtor’s right to receive these benefits is completely exempt. However, once the benefits are actually received (i.e. deposited into a bank account), they are no longer exempt.  In most cases, the majority of the received benefits, if not all, are still exempt under the Federal Bankruptcy Code “wildcard” exemption. This exemption is used to protect various types of property, such as cash in the bank, tax refunds, and other types of property that is not specifically exempt under other provisions of the Code. Determining how much of a wildcard exemption a person has to use to protect these types of property is a bit complicated and better elaborated upon in other blogs. If the debtor chooses State exemptions, both the right to receive Unemployment Insurance benefits, as well as proceeds already received, are fully exempt and protected.

Sometimes, a worker may be temporarily out of work due to an injury they sustain on the job. In these cases, they may be legally entitled to collect worker’s compensation.  Worker’s compensation under the Federal exemptions is completely exempt, to the extent the compensation is necessary for the support of the debtor (large amounts of a worker’s compensation in excess of what’s actually needed by the debtor may be considered nonexempt by the court). Worker’s compensation is also fully protected under the State exemptions. Courts have ruled that worker’s compensation benefits are fully exempt whether received before or after the debtor files their bankruptcy case and regardless of whether it is in the form of periodic payments or a one-time lump sum settlement. So long as the debtor can trace the funds in their bank account to the worker’s compensation payout it will be exempt and protected.

Sometimes, a debtor may find themselves out of work due to a personal injury not related to their job. Money that a debtor receives as a result of a personal injury lawsuit may be exempt in some cases. Under State exemptions, a debtor’s right to receive money from a personal injury lawsuit is fully exempt. This means that if a debtor has the legal right to bring a personal injury lawsuit, or is currently engaged in the lawsuit, at the time they file their bankruptcy case, any money they receive from that lawsuit, after filing their case, is fully exempt and protected. However, if a settlement is reached, or money is received, from the personal injury lawsuit prior to the filing of the bankruptcy case, the money is not exempt under State exemptions. This is not the case under the Federal exemptions. Under Federal exemptions, proceeds from a personal injury lawsuit are exempt up to $25,150. This is true whether the funds are received before or after the bankruptcy case is filed. The debtor must only be able to show that the exempt proceeds can be traced to the personal injury claim. The courts have also said that proceeds from a personal injury claim that are for the purpose of compensating the debtor for the loss of future work earnings are exempt even if they would otherwise not be exempt under Federal exemptions.  This is because there is a separate Federal exemption protecting the right to receive, or proceeds already received from, compensation for the loss of future earnings. This exemption would also apply in a case where the debtor has wrongful termination claim against their former employer. In such case, any proceeds received by the debtor that are traceable to compensation for lost future earnings will be fully exempt and protected.

Debtors who become unable to work due to a disability may be able to receive Social Security Disability Income or income from a disability insurance policy. Social Security benefits are absolutely protected regardless of whether the debtor elects Federal or State exemptions. It also does not matter whether the money is received before, or after, the debtor files their bankruptcy case. So long as the money is traceable to Social Security, it will be exempt and protected. If the debtor has a disability insurance policy, and subsequently becomes disabled, their right to receive future payments after filing their bankruptcy case will be completely exempt under the Federal exemptions. Money already received by the debtor before filing is not exempt. This contrasts with State exemptions in that those exemptions protect both the debtor’s right to receive disability insurance income proceeds as well as insurance proceeds already received.


This blog is designed to give a basic overview of how different claims and unemployment benefits are treated in bankruptcy. Before filing for bankruptcy, it is prudent to discuss your particular case with an experienced bankruptcy attorney. See us at LifeBackLaw.com!


Topics: Chapter 7 Bankruptcy, bankruptcy case

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