Three Against Two: on the Difference Between Property and Contract and the Example of Deposit Accounts in Bankruptcy
| Publication year | 2019 |
Three Against Two: On the Difference Between Property and Contract and the Example of Deposit Accounts in Bankruptcy
Jeanne L. Schroeder
David Gray Carlson
In Citizen's Bank v. Strumpf, 516 U.S. 16 (1995), Justice Scalia announced that deposit accounts are not "property." Five years later, the Uniform Commercial Code was amended to make deposit accounts collateral for the depositary bank maintaining the account, thereby crowding the field previously occupied by the common law right of setoff. Security interests attach to personal "property." Security interests attach to deposit accounts. Deposit accounts, by syllogistic logic, are property. Does this mean that the U. C.C. has overruled the Supreme Court? We argue not. A deposit account is a mere contract in the two-person universe that contract law presupposes. A deposit account is property in a universe of three or more persons. We argue that Justice Scalia can be vindicated by the text of the Uniform Commercial Code and that the 2000 amendments do not overrule the Supreme Court. The investigation reveals the proper vector spaces that contract and property logically inhabit.
In music, composers occasionally contrast 3-4 rhythm in one line against 2-4 rhythm in another, producing a jerky unstable rhythm. In law, property and contract bear this same uncomfortable rhythmic structure. Property involves (at a minimum) a three-person universe. Contract keeps pace in a two-person world. Suppose A and B enter into a contract. "Property" implies a relation between A and B with regard to a third—a "thing". If B were to assign his rights against A to C, then A's obligations become a thing in this three-party universe of property. However, where the question is simply A's duty to B (or B's duty to A), the "thing" aspect of the relationship falls out of the equation and we remain in the two-party universe of contract.
In Citizens Bank v. Strumpf,1 the Supreme Court relied on this distinction between the two-person universe of contract and the three-person universe of
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property to solve an alleged puzzle in bankruptcy law: the "banker's dilemma."2 In Strumpf, the Court ruled that a bank's administrative hold on a bankrupt customer's deposit account does not violate the "automatic stay" in the customer's bankruptcy. Bankruptcy Code § 362(a)(3) prohibits "any act to . . . exercise control over property of the estate . . . ."3 According to Justice Scalia, a bank's obligations under a checking account is not "property." Rather, the depositary bank's refusal to honor checks is mere breach of contract and the automatic stay does not prohibit breaches of contract.
Since the Strumpf decision, Article 9 of the Uniform Commercial Code (U.C.C.) has been amended to enable a bank security interest in a deposit account maintained by the bank for a customer who is also debtor with the very same bank. In other words, Article 9 now treats a depositary bank's obligation to pay on demand as a "thing" as to which its own security interest, good against the world (more or less), could attach. That is, the modern U.C.C. now treats bank accounts as "property."
As bankruptcy lawyers know, federal bankruptcy law is interstitial law. According to the standard view, the Bankruptcy Code has no definition of "property."4 The bankruptcy courts must instead take their definition of "property" from state law. The usual citation for this proposition is that tired warhorse, Butner v. United States, in which the Supreme Court stated:
Unless some federal interest requires a different result, there is no reason why such interest [i.e., property interest created under state law]
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should be analyzed differently simply because an interested party is involved in the bankruptcy proceeding.5
If Butner stands for the proposition that federal law has no definition of "property," then perhaps one could argue that Strumpf has been overruled. State law now makes it clear that bank accounts are property.
Alternately, could one argue that, despite Butner, might there now be a federal law of property as least for the purposes of § 362(a)(3)? If so, the U.C.C. would be incapable of overruling Strumpf s holding that the bank account is not "property of the bankruptcy estate."
We argue in this Article that neither is Strumpf overruled nor does Strumpf articulate a federal property principle. Rather, Justice Scalia's theory of the bank account is both correct as a matter of federal property law and as a matter of the state common law of property. In short, the U.C.C. does not make contractual performance into "property" in a two-person universe. It only does so in a three-person universe. Indeed, this must be the case, or otherwise all breaches of contract by nondebtors would violate the automatic stay—a radical change in bankruptcy law.
Strumpf entails the law of deposit accounts in bankruptcy, which remains surprisingly untheorized and misunderstood in practice. In particular, there remains substantial unresolved issues regarding a bank's traditional right of setoff against a customer's account. In Strumpf, Justice Scalia contrasted a setoff that is prohibited under § 362(a)(7) with a permissible administrative hold or "freeze" without explaining to how to distinguish a freeze from a true setoff. Also untheorized are the differences between a setoff and a security interest of a bank in its customer's account, as well priority disputes between a banker's setoff rights and security interests or judgment liens claimed by third party creditors.
In this Article we tackle a number of these issues. We start first in Part I with some philosophical remarks on the nature of contract and property. In Part II, we examine the modern U.C.C.'s treatment of deposit accounts to show that the U.C.C. adopts the same three-against-two theory that Justice Scalia expresses in Strumpf. Finally, in Part III we examine the context in which the Strumpf case arose. This Part exposes a great many paradoxes that eluded Justice Scalia in
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Strumpf, even as he righty saw that, in context, deposit accounts are not property of the bankruptcy estate.
A. Can a Bank Have Property in its Own Contractual Obligation?
In Strumpf, Justice Scalia insisted that the depositary bank's obligation to its customer is contractual and that deposit accounts are not "property" within the meaning of § 362(a)(3). Does this position require the view that a depositary bank cannot possibly take a security interest in the deposit accounts it maintains for its customer and borrower? After all, U.C.C. § 1-201(a)(35) defines a security interest as "an interest in . . . property."6 If the depositary account is capable of serving as "collateral"7 for the depositary bank, then the depositary account is "property," contrary to Justice Scalia's declaration. It would then seem to follow that the 2000 amendments to the U.C.C. have overruled the Supreme Court's Strumpf opinion (assuming the U.C.C. is capable of doing so).
Over the years, a few courts8 and commentators9 have suggested that it is logically impossible for a depositary bank to take a security interest in its own
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contractual obligation to pay to the order of its customer. Perhaps relevant to this issue is Grant Gilmore's famous "fan dancing" remark. In his classic Security Interests in Personal Property, Professor Gilmore commented on old U.C.C. 9-104(l), which excluded setoffs from Article 9. Gilmore's remark is significant because the U.C.C., then and now, was designed to govern any security interest on personal property "regardless of form."10 The drafters obviously feared that a court might rule that the provisions of Article 9 would govern setoffs. Professor Gilmore scoffed with disdain:
(I) to any right of set-off. This exclusion is an apt example of the absurdities which result when draftsmen attempt to appease critics by putting into a statute something that is not in any sense wicked but is hopelessly irrelevant. Of course a right of set-off is not a security interest and has never been confused with one: the statute might as appropriately exclude fan dancing. The bank's right of set-off against a depositor's account is often loosely referred to as a "banker's lien," but the "lien" usage has never led anyone to think that the bank held a security interest in the bank account. Banking groups were, however, concerned lest someone, someday, might think that a bank's right of set-off, because it was called a lien, was a security interest. Hence the exclusion, which does no harm except to the dignity and self-respect of the draftsmen.11
It is not likely, however, that the learned Professor Gilmore believed it nonsense for a depositary bank to take a security interest in its own obligation to honor checks. One exclusion in old Article 9 that never drew comment was § 9-104(l): Article 9 would not apply "to a transfer of an interest in any deposit account (subsection (1) of U.C.C. § 9-105), except as provided with respect to proceeds (U.C.C. § 9-306) and priorities in proceeds (U.C.C. § 9-312)."12 This provision was not dismissed by Gilmore as superfluous for the obvious reason that it was not incoherent for a third party lender to take a security interest in a
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deposit account as original collateral. One learns from the Official Comment that "deposit accounts are often put up as collateral. Such transactions are often quite special, do not fit easily under a general commercial statute and are adequately covered by existing law."13 Thus, Gilmore may have thought that (1) setoffs are not security interests, and (2) a bank can take a security interest in its own obligation to pay, but this would have to be done pursuant to the common law rules of assignment for security (as...
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