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Court of Appeal, First District, Division 3, California.

Eileen Jane BARNHILL, Plaintiff and Respondent, v. ROBERT SAUNDERS & CO., Defendants and Appellants.

Civ. 46636.

Decided: June 19, 1981

J. J. Quill, San Carlos, for defendants and appellants. Division of Labor Standards Enforcement, Louis Giannini, Guy T. Gurney, Charlotte C. Danforth, Richard N. Dinallo, John C. Herbert, Ann Miley, Ramon Yuen-Garcia, C. S. Pedersen & Robert Lotero, San Francisco, for plaintiff and respondent.

The principal question presented here is whether an employer has the right to set off an employee's debt against wages due the employee upon the employee's discharge. We also consider whether an employer who attempted to exercise such a setoff was properly subjected to penalties for wilful nonpayment of wages pursuant to Labor Code section 203.

Respondent Eileen Barnhill was employed by appellant Robert Saunders & Company as a bookkeeper from March 3, 1975, until December 12, 1977. In October 1977 she executed a promissory note in favor of appellant in the amount of $587.50 at 10 percent interest. On its face, the note states “To be paid by payroll deduction or on demand.” Subsequently, the parties orally agreed that appellant would deduct $37.50 from Barnhill's wages every two weeks.

Barnhill was discharged on December 12, 1977, for reasons not relevant herein. On that date, the balance due on the note was $475 plus interest, and Barnhill was owed two weeks wages, or $475. When she went to pick up her check, she was given a stub with a net zero balance indicating various deductions including a $442.46 setoff against the balance owing on the note.

She complained to the Labor Commissioner. After a hearing, an order in her favor was issued. Appellant sought review of that order in superior court. After a trial de novo (see Lab.Code, s 98) judgment was entered in favor of respondent in the sum of $475 for wages, plus $1,096.25 in penalties pursuant to Labor Code section 203.

A. The Setoff

Labor Code section 201 provides in relevant part: “If an employer discharges an employee, the wages earned and unpaid at the time of discharge are due and payable immediately.”

Appellant contends that notwithstanding section 201, it was entitled to set off respondent's debt to it against the wages due her.

The right of setoff has been described as “the established principle in equity that either party to a transaction involving mutual debts and credits can strike a balance, holding himself owing or entitled only to the net difference.” (Kruger v. Wells Fargo Bank (1974) 11 Cal.3d 352, 362, 113 Cal.Rptr. 449, 521 P.2d 441.) The right depends not on statutes authorizing setoff, but on general principles of equity. (Id., at p. 363, 113 Cal.Rptr. 449, 521 P.2d 441.) However, a creditor's right to setoff is not absolute, and may be restricted by judicial limitations imposed to uphold a state policy protecting debtors. (Id. at p. 367, 113 Cal.Rptr. 449, 521 P.2d 441.)

In Kruger a bank's depositor was delinquent in paying her Master Charge bill. At issue was whether the bank could exercise its equitable right of setoff against her checking account, when all monies in that account came from state disability insurance and unemployment compensation, funds exempt from attachment or execution. The court held the deposits immune from setoff, reasoning that to permit setoff would frustrate the Legislature's objectives in providing those benefits and protecting them from seizure by creditors. In support of its conclusion, the court looked to the law of other states, in particular Finance Acceptance Company v. Breaux (1966) 160 Colo. 510, 419 P.2d 955, a Colorado Supreme Court decision which holds that an employer cannot set off the employee's obligations on promissory notes against exempt wages due him. The court cited the Colorado court's conclusion that the general rule is that the right to exemption will be respected and protected without regard to the right of offset, and that the creditor will not be allowed to defeat the exemption with a demand against the debtor's claim, even though such demand would otherwise be good as a counterclaim or setoff. (Kruger, supra, 11 Cal.3d at p. 369, 113 Cal.Rptr. 449, 521 P.2d 441.)

Anticipating the question in this case, the Kruger court added the following footnote: “Several California cases have permitted employers to set off debts owing them by employees against the employee's wages. (McDaniel v. City etc. of San Francisco (1968) 259 Cal.App.2d 356, 365, 66 Cal.Rptr. 384; Patterson v. Henderson T. & R. Co. (1931) 112 Cal.App. 48, 296 P. 304; see Division of Labor Law Enforcement v. Barnes (1962) 205 Cal.App.2d 337, 350, (23 Cal.Rptr. 55); People v. Porter (1930) 107 Cal.App.Supp. 782 (288 P. 22).) Although one-half of wages is exempt from attachment and execution (see Code Civ.Proc., s 690.6), these cases do not discuss the relationship of the state policy providing for this exemption to the employer's assertion of setoff, nor recognize that the majority view in other jurisdictions is that exempt wages are not subject to setoff. (See Finance Acceptance Company v. Breaux (1966) 160 Colo. 510 (419 P.2d 955).) We do not, therefore, regard these decisions as establishing a California rule permitting assertion of setoffs against exempt property.” (Id., at p. 369, fn. 25, 113 Cal.Rptr. 449, 521 P.2d 441.)

We conclude, from the language of the court in Kruger, that an employer is not entitled to set off debts owing by the employee against the entirety of that employee's wages. The policy underlying the wage exemption is to insure that regardless of the debtor's improvidence, the debtor and his or her family will retain enough money to maintain a basic standard of living, so that the debtor may have a fair chance to remain a productive member of the community. (Perfection Paint Products v. Johnson (1958) 164 Cal.App.2d 739, 741, 330 P.2d 829.) Permitting appellant to reach the exempt portion of respondent's wages by setoff would let it accomplish what neither it nor any other creditor could do by execution or garnishment, and would defeat the legislative policy underlying the exemption.

Since we conclude the employee's right of immunity from setoff of his earnings is derived from the statutes exempting employees' earnings from execution of judgment, it necessarily follows that the extent of that immunity is no greater than the exemption provided under those statutes. At the time of respondent's discharge, Code of Civil Procedure section 690.61 provided in relevant part: “One-half or such greater portion as is allowed by statute of the United States of the earnings of the debtor received for services rendered at any time within 30 days next preceding the date of a withholding by the employer shall be exempt from execution without filing a claim for exemption.” (Emphasis added.) Because federal law prohibits garnishment of more than 25 percent of a debtor's disposable earnings,2 section 690.6 provided in substance that at least 75 percent of a debtor's earnings were automatically exempt from execution, without any claim for exemption by the debtor. (Raigoza v. Sperl (1973) 34 Cal.App.3d 560, 563, 110 Cal.Rptr. 296.)

Accordingly, at least 75 percent of respondent's wages should have been absolutely immune from setoff, despite her debt to appellant, and the trial court's refusal to allow a setoff was correct, at least with respect to that portion of the wages.

Respondent argues that none of her wages are subject to setoff because when the Legislature authorized the Labor Commissioner to investigate employee complaints and hold hearings in wage disputes, it by implication excluded such proceedings from the reach of Code of Civil Procedure section 431.70, the setoff statute.3 We are unpersuaded by that argument. Whether or not section 431.70 applies to proceedings before the Labor Commissioner is irrelevant. That section and its predecessor, former section 440, merely establish a procedure for asserting a setoff under the code pleading system of the state. The statutory setoff provisions emanate from equitable principles, and do not alter the substantive law of setoff. (Kruger, supra, 11 Cal.3d at p. 362, 113 Cal.Rptr. 449, 521 P.2d 441; see also Jess v. Herrmann (1979) 26 Cal.3d 131, 142, 161 Cal.Rptr. 87, 604 P.2d 202.) Moreover, the principle of setoff is not limited to judicial proceedings. (Murchison v. Murchison (1963) 219 Cal.App.2d 600, 605, 33 Cal.Rptr. 285.) Appellant's right to setoff was not dependent on the applicability of Code of Civil Procedure section 431.70.

However, former Code of Civil Procedure section 690.6, subdivision (b), provided that all earnings of the debtor received for services rendered within 30 days preceding the date of a withholding by the employer were exempt “if necessary for the use of the debtor or debtor's family” unless the debts were incurred for the common necessaries of life.4 To establish entitlement to the latter exemption in the event of a garnishment, the debtor was required to file a claim of exemption promptly after a levy. If the creditor opposed the claim, a hearing was held, at which the debtor had the burden of proof. (Code Civ.Proc., s 690.50.) The Raigoza court summarized the state's statutory system for wage garnishment as a system whereby “a judgment creditor can garnish up to 25 percent of a judgment debtor's wages, which amount may be returned to the debtor, if he seeks an exemption and proves that he meets the statutory requirements for the exemption.” (34 Cal.App.3d at p. 564, 110 Cal.Rptr. 296.)

Accordingly, 75 percent of the wages due respondent were automatically exempt from execution, and the remaining 25 percent might have been. If appellant were a judgment creditor of respondent, it could have garnished 25 percent of her wages, but she would have been allowed an opportunity to claim and prove her entitlement to the full exemption. Allowing appellant to assert its right of setoff against that 25 percent without giving respondent an opportunity to prove that all her wages were necessary for her support would also frustrate the policies underlying the statutory exemptions. Consequently, to be consistent with the exemption scheme, we conclude that appellant was entitled to assert its right of setoff against 25 percent of the wages due respondent, but that she could then have claimed that even those wages were immune in proceedings before the Labor Commissioner, at which she should have borne the burden of proof. As the matter was heard de novo by the trial court, this question could have been resolved by that court as well.

B. The Penalty

The trial court awarded respondent $1,096.25 in “waiting time penalties” pursuant to Labor Code section 203 ($43.18 per day for 25 days). That section provides in relevant part: “If an employer willfully fails to pay, without abatement or reduction, in accordance with Sections 201, 201.5 and 202, any wages of an employee who is discharged or who quits, the wages of such employee shall continue as a penalty from the due date thereof at the same rate until paid or until an action therefor is commenced; but such wages shall not continue for more than 30 days.”

Appellant contends that penalties should not have been imposed, because it had a good faith defense to respondent's wage claim. The purpose of section 203 is to compel the prompt payment of earned wages; the section is to be given a reasonable but strict construction. (Oppenheimer v. Sunkist Growers (1957) 153 Cal.App.2d Supp. 897, 898-899, 315 P.2d 116.) As used in the statute, the term “willful” does not mean that the refusal to pay wages must necessarily be based on a deliberate evil purpose to defraud workmen of wages which the employer knows to be due. “Willful” merely means that the employer intentionally failed or refused to perform an act which was required to be done. (Davis v. Morris (1940) 37 Cal.App.2d 269, 274, 99 P.2d 345.)

In Manford v. Singh (1919) 40 Cal.App. 700, 702-703, 181 P. 844, the court said with respect to a predecessor of section 203: “(T)he statute should have reasonable construction. Its design is to protect the employee and to promote the welfare of the community But it is to be observed that the most formidable objection to the statute derives its principal force from the supposed hardships of a hypothetical case wherein the employer is without fault or the employee is guilty of culpable conduct. The statute is not subject to such reproach. It contemplates that the penalty shall be enforced against an employer who is at fault. It must be shown that he owes the debt and refuses to pay it. He is not denied any legal defense to the validity of the claim.” (Emphasis added.) An honest dispute between the parties, or uncertainty on the part of the employer, as to the amount of unpaid wages due, has been held to constitute a valid defense to an action for statutory penalties for nonpayment. (Annot. (1963) 90 A.L.R.2d 606, 632.)

This dispute was not over the amount of wages respondent had earned prior to her discharge; the parties agreed as to the amount of those unpaid wages. Instead, they disagreed as to whether appellant could exercise its equitable right of setoff against that sum. However, language in Oppenheimer v. Sunkist Growers, supra, 153 Cal.App.2d Supp. at page 899, 315 P.2d 116 suggests that penalty wages are inappropriate in these circumstances as well: “ ‘Statutes of the character under discussion are intended to compel the employer to pay promptly the regularly earned wages of an employee who was either discharged or who quit of his own accord; they must be given a reasonable, although necessarily strict, construction, and their literal enforcement, it has been held, may yield to strong equitable defenses.’ (56 C.J.S. Master and Servant s 156 p. 761.)”

Here although we have concluded that appellant is entitled to a possible setoff of only 25 percent of the wages due respondent, there is no contention that appellant did not entertain a good faith belief that it was entitled to a setoff against all those unpaid wages. The fact that he did not have that absolute right of setoff was not the clear state of the law. Surely if several courts of appeal were of the view that such setoffs were proper (see Kruger fn. discussed supra at p. 673), appellant cannot be faulted for its similar belief. We conclude that given the uncertain state of the law, appellant's attempt to exercise its right to setoff was not wilful nonpayment of wages within the meaning of Labor Code section 203, and the imposition of penalties was inappropriate.

The judgment is reversed and the cause remanded for a determination of appellant's right of setoff as to 25 percent of respondent's wages and with further direction to enter judgment denying the imposition of penalties. Each party to bear their own costs.


1.  Section 690.6 has been superseded by the Employees' Earnings Protection Law (Code Civ.Proc., s 723.010 et seq.). Section 723.050 provides: “The amount of earnings of a judgment debtor exempt from the levy of an earnings withholding order shall be that amount provided by federal law in 15 U.S.C. Sec. 1673.” (Stats.1978, ch. 1133, s 7, operative Jan. 1, 1980.)

2.  Federal law limits garnishment to 25 percent of the debtor's disposable earnings or the amount by which disposable earnings exceed 30 times the federal minimum wage, whichever is less. (15 U.S.C. s 1673.) “Disposable earnings” are those earnings remaining after all amounts required by law to be withheld are deducted. (15 U.S.C. s 1672.)

3.  Code of Civil Procedure section 431.70 provides in part: “Where cross-demands for money have existed between persons at any point in time when neither demand was barred by the statute of limitations, and an action is commenced by one such person, the other person may assert in his answer the defense of payment in that the two demands are compensated so far as they equal each other.” (Emphasis added.)

4.  Superseded section 690.6 subdivision (b), is essentially unchanged by Code of Civil Procedure section 723.051 which provides: “Except as provided in Section 723.052 , the portion of the judgment debtor's earnings which the judgment debtor proves is necessary for the support of the judgment debtor or the judgment debtor's family supported in whole or in part by the judgment debtor is exempt from levy unless the debt is incurred for personal services rendered by any employee of the judgment debtor or is incurred by the debtor, or his or her spouse or family for the common necessaries of life.”

SCOTT, Acting Presiding Justice.