By Michael L. Moskowitz and Melissa A. Guseynov

Weltman & Moskowitz has previously reported on noteworthy cases regarding possible violations of the automatic stay with respect to actions taken by lenders relating to debtors’ deposit accounts. In a recent decision of interest, District Judge Kenneth M. Karas, sitting in the Southern District of New York, held that the automatic stay does not prohibit a bank from imposing a temporary administrative hold on a debtor’s bank account. In re Weidenbenner, 15-244 (S.D.N.Y. April 25, 2019).

In Weidenbenner, the bank had an internal policy which permitted an individual debtor to withdraw funds from an account if the account held less than $5,000 as of the petition date. However, if an account held more than $5,000, the bank would place an “administrative pledge” on the account, effectively freezing all prepetition funds. Once the funds were pledged, it looked exclusively to the trustee to control payment of the account balance that constituted property of the debtor’s estate.  

In Weidenbenner, debtors’ accounts held more than $5,000. Consistent with their internal policy, the bank placed a temporary freeze on the account as of the petition date. The bank then notified both the debtors and chapter 7 trustee of the hold and sought instructions from the trustee with respect to disposition of the funds. When the trustee instructed the bank to release the funds to debtors, the bank promptly complied.

Subsequently, debtors moved to hold the bank in violation of the automatic stay pursuant to section 362(a) of the Bankruptcy Code. They also sought an award of damages, arguing the “administrative pledge” constituted an improper seizure of exempt funds. Ruling in favor of debtors, the Bankruptcy Court concluded the bank violated the automatic stay by exercising control over property of the estate. The bank appealed and Judge Karas reversed the Bankruptcy Court’s ruling.   

Judge Karas explained that section 542(b) which requires an entity owing a debt that is property of the estate to pay it to or for the benefit of the trustee, and section 362(b)(3), which prohibits exercise of control of estate property, are clearly “in tension.” The Court cited to Citizens Bank of Maryland v. Strumpf, wherein the Supreme Court determined a bank did not violate the stay when it placed an administrative freeze on a debtor’s account, to the extent the bank held a valid right of setoff. Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 19 (1995). Judge Karas noted courts have since applied Strumpf to temporary freezes placed on accounts even where a bank does not have a setoff right. 

Finally, Judge Karas sought guidance from In re Mwangi, a Ninth Circuit case which held that a bank’s post-petition administrative freeze on debtor’s bank account did not constitute a violation of the automatic stay. In re Mwangi, 764 F. 3d 1168 (9th Cir. 2014). The Mwangi Court explained there was no stay violation prior to the deadline for objecting to exemption claims because debtor had no right to possess the funds. There was also no stay violation after the objection deadline because the account was exempt and no longer constituted property of the estate.  

In conclusion, Judge Karas determined that by placing a brief hold and seeking direction from the trustee, the bank “did not withhold estate property from the estate.” On the contrary, the bank substantiated that the funds were estate property and asked the trustee for further instruction regarding distribution.  

This case emphasizes yet again how vital it is for lenders to consult with experienced counsel prior to freezing or disbursing funds with respect to an account where a borrower has filed for bankruptcy protection. The attorneys at Weltman & Moskowitz help their clients make informed decisions every day to avoid costly mistakes. Feel free to reach out to our attorneys with your bankruptcy questions.

About Weltman & Moskowitz, LLP, A New York and New Jersey Business, Bankruptcy, and Creditors’ Rights Law Firm:

Founded in 1987, Weltman & Moskowitz, LLP is a highly regarded business law firm concentrating on creditors’ rights, bankruptcy, foreclosure, and business litigation. Michael L. Moskowitz, a partner with the firm, focuses his practice on business and bankruptcy litigation, as well as creditor’s rights, foreclosure, adversary proceeding litigation, corporate counseling, M&A, and transactional matters. Michael can be reached at (212) 684-7800, (201) 794-7500 or mlm@weltmosk.com. Melissa Guseynov is an associate of the firm. Melissa can be reached at mag@weltmosk.com.