Set Off. Administrative Stay Violation for Freezing Deposit Accounts

A very troubling case for lenders has recently come out from the Bankruptcy Appellate Panel for the Ninth Circuit. If you place an administrative hold on funds on deposit, without moving immediately for relief from the stay to set off (or in cases where you have a direct security interest, to apply the security to the loan), you can and will be held liable for violating the automatic stay.

In the case of Mwangi v. Wells Fargo Bank, N.A. (in re Mwangi) 2010 Bankr. LEXIS 2019 (B.A.P. 9th Cir. June 30, 2010), the BAP ‘”took Wells Fargo Bank to the woodshed” for placing an administrative freeze on Debtor deposit accounts after the filing of a bankruptcy

The facts and all of the holdings of the case are too lengthy to set forth in detail. In essence , Wells Fargo admitted it has a national policy to freeze deposit accounts when a bankruptcy is filed and that as part of its policy it notifies the Trustee of the accounts and seeks instruction from the Trustee on what to do with the funds, instead of just turning them over to the Trustee or the Debtor (if the Debtor demands them as exempt from the Trustee/estate rights).

The BAP found that this policy “put the shoe on the wrong foot” requiring everyone except the Bank i.e. the Debtor and the Trustee, to take action to gain access to the funds. The BAP found that the Bank’s conduct violated the automatic stay. The BAP did not rule on whether the Bank was authorized to request that the Trustee issue instructions on whether the trustee/estate was claiming an interest in the funds. Instead the Court found that the Debtor was allowed to assert stay violation rights because once the Bank did not receive any instructions from the Trustee on the use of the funds, the Bank had no legitimate purpose in holding onto the funds and was violating the stay. The Court found that the Debtor could seek punitive damages.

The BAP did recognize the right of a lending institution to preserve accounts (placing a freeze on the account) that were in its possession for purposes of exercising a right of set off (citing the Supreme Court in Citizens Bank of Maryland v. Strumpf, 516 U.S. at 20, 21, but found that the Bank was not attempting to do this, but was just freezing funds in violation of the stay. If the Bank was seeking to preserve its rights to set off, the BAP recognized that the Bank could have imposed a temporary administrative freeze and then moved for relief from the stay to do so, if it acted quickly (See Mwangi v. Wells Fargo Bank, N.A. (In re Mwangi), 2010 Bankr. LEXIS 2019 (B.A.P. 9th Cir. June 30, 2010), citing in Citizens Bank of Maryland v. Strumpf).

It is interesting to note that the Debtor filed bankruptcy on August 3, 2009 and that after failure of the Bank to release the funds, filed a motion to hold the Bank liable for sanctions on August 27, just 24 days later. This shows that Lenders must act quickly under these circumstances.

There are lots of morals to this story, but the following should be noted:

1. If you don’t have a set off claim (credit unions may have a general right of set off on member share accounts, banks may have a general right of set off as well), then placing an administrative freeze on an account can be held to be a violation of the stay, subjecting you to sanctions
2. If you do have a set off claim or a direct security interest (i.e. CD secured loan etc) on funds in an account, move for relief from stay, quickly. On general set off claims, it may be a race to the courthouse, for you to get there before the Debtor files a motion to hold you liable for violating the stay. Accordingly, you should act quickly. If you intend on asserting set off rights, immediately notify all parties in writing, so they do not beat you to the courthouse with a sanctions motion , seeking to characterize your actions as willful delay.
3. The Court in the Mwangi case has put lenders in a tough position by specifying the specific exemption rights of a Debtor on accounts held by a lender and putting the burden on the lender to determine who is entitled to the funds. While it may be clear in many cases, there may be conflicts and uncertainty and the Lender should act as soon as possible to pay to the proper party. Just holding the funds will not do.
4. Examine your bankruptcy policies to make sure they are clear and do not provide a basis for imposition of liability, as happened in this case.

Please call Scheer Law Group, LLP with questions and to discuss the implications of this case.