October 2011 #1. BANK ACCOUNTS AND SAFE DEPOSIT BOXES:.

• Author: by Nicholas C. Dreher

Hawaii Bar Journal

2011.

October 2011 #1.

BANK ACCOUNTS AND SAFE DEPOSIT BOXES:

Hawaii State Bar JournalOctober 2011BANK ACCOUNTS AND SAFE DEPOSIT BOXES: .Issues Raised by the MWANGI Case and One district'sby Nicholas C. DreherCreative solution,

When one of its depositors files bankruptcy, a bank is often faced with a dilemma - what to do with the funds in the account? This dilemma arises because of section 542 of the Bankruptcy Code, which provides as follows:

(a) Except as provided in subsection (c)...an entity ...in possession, custody, or control,...of property... shall deliver to the trustee, and account for, such property or the value of such property, unless such property is of inconsequential value to the estate. (b) Except as provided in subsection (c).. .an entity that owes a debt that is property of the estate...shall pay such debt to, or on the order of, the trustee, except to the extent that such debt may be offset under section 553... (c) [A]n entity that has neither actual notice nor actual knowledge of the commencement of the case con- cerning the debtor may transfer property of the estate, or pay a debt owing to the debtor, in good faith...to an entity other than the trustee, with the same effect as to the entity making such transfer or payment as if the case under this tide concerning the debtor had not been commenced. 11 U.S.C. §542.

Many banks do not have their own systems in place to monitor bankruptcy filings. Except in cases where a bank is owed money by its depositor and therefore has a right of setoff against the account, ignorance of the bankruptcy filing can be a blessing. It means that the bank does not have to worry about whether it is the depositor or a bankruptcy trustee who is entitled to the funds in the account and the bank can honor checks and other instructions from the depositor as if no bankruptcy had been filed. This is because section 542(c) of the Bankruptcy Code protects a bank from liability for paying out funds so long as the bank is acting in good faith and without notice or actual knowledge of the bankruptcy filing.

If the bank is owed money by the debtor, even if it does not have its own monitoring system, it should receive the ofBcial notice of the bankruptcy filing from the clerk's office and should then be able to impose an "administrative freeze" on the account (or what's left in it) and seek relief from the automatic stay either by stipulation or by motion to exercise its right of setoff under the authority of section 553(a) of the Bankruptcy Code and the Supreme Court's Strumpf decision which validated this procedure.(fn1)

Some banks, however, are not content to leave well enough alone, and insist on monitoring bankruptcy filings to see if their customers have filed.(fn2) Once they do this, the banks are stuck with the knowledge of the bankruptcy case. This can leave them in the unenviable position of knowing that one of their depositors has filed, but, not being a creditor and therefore having no rea- son to exercise setoff against the account, being burdened with the worry about incurring hability for the depositor's misappropriation of the funds in the account. What should this hapless bank do now?

Here are some possible courses of action that the bank could take:

* Do nothing - allow the bank account to be used by the debtor just as if no bankruptcy had been filed. * Close the account and turn the proceeds over to the debtor. * Close the account and turn the proceeds over to the bankruptcy trustee (or debtor-in-possession). * Don't close the account but turn the proceeds over to the debtor. * Don't close the account but turn the proceeds over to the bankruptcy trustee (or debtor-in-possession). * Hire a lawyer to file a motion with the Bankruptcy Court seeking authority to close the account and turn the proceeds over to the trustee (or the debtor). * Freeze the account and prompdy notify the debtor and/or the trustee and ask for instructions from the debtor and/or trustee as to the disposition of the account and then follow the debtor and/or trustee's instructions.

Each of these courses of action presents its own costs and risks. Doing nothing exposes the bank to potential claims from the trustee if the debtor misappropriates the funds. Closing the account could be found to be a violation of the automatic stay, since the ability to use a bank account, especially a checking account, could itself be found to be a property interest of the debtor and could open the bank to claims by the debtor. Turning the proceeds over to the debtor could result in a trustee's claim, especially if the amount...