The "Banker's Dilemma"

This dilemma has just been resolved in the banker's favor by the Supreme Court. The dilemma was whether to violate the automatic stay in bankruptcy or allow Debtor to empty the bank account. The dilemma was shared by other creditors with offsetting debts to bankruptcy Debtor. In counseling creditors and debtors about Chapter 11 reorganization, our office often observes that early action is useful, and this case shows why.

       Suppose Debtor has $1,000 on deposit with Bank, and owes Bank $2,000 on a loan. Debtor files bankruptcy. Bank freezes the deposit balance. Can Bank do that before obtaining relief from the automatic stay in bankruptcy? Yes. Citizens Bank of Maryland v. Strumpf,___ U.S.___, 1995 WL 633458 (U.S.), 95 Daily Journal D.A.R. 14562, November 1, 1995 (U.S. Supreme Court, No. 94-1340, October 31, 1995). [Decision below: In re Strumpf, 37 Fed.3d 155 (4th Cir. 1994)].

       A debtor wishing to reorganize in Chapter 11 should review non-bankruptcy alternatives. However, Debtor's outlook in Chapter 11 is immensely improved if Debtor does not wait until cash is practically gone before filing. If Debtor counts on cash in Bank, and Bank takes the cash, Debtor is weakened early.

       Under Strumpf, Bank need only intend to seek relief from the automatic stay when it freezes Debtor's deposits. With that intent, under Justice Scalia's opinion for a unanimous Court, Bank has not made a setoff because Bank's withholding funds is not permanent and absolute, but only temporary and conditional, until resolution of its motion for stay relief. [A creditor's setoff permitted under non-bankruptcy law is permitted in bankruptcy, provided, however, that stay relief is obtained.] This decision favors creditors over debtors in timing strategically important to both.

       Another recent decision compounds Debtor's difficulties in connection with offsets. On September 26, 1995, a Bankruptcy Court in the Ninth Circuit decided that IRS may offset a refund first against its general unsecured claim and second against its oldest priority claim. In re Lawson, 187 B.R. 6 (Bankr. D. Idaho, 1995). In dictum, the court hypothesized the very bank scenario actually presented in Strumpf, and said that Bank may set off, for example, the $1,000 it is holding against its $2,000 unsecured claim. The court extended the hypothetical, saying that if Bank had, in addition, a $1,000 fully-secured claim, Bank would have a choice. Bank's best course: apply its offset to its unsecured claim, and receive its remaining $1,000 secured claim through the plan. On this reasoning, the court held that IRS may apply its offset to its non-priority claim first.

       Adding Lawson to Strumpf helps creditors and hurts debtors. Strumpf and Lawson both arose in Chapter 13 but their principles apply in Chapter 11.


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Jerome S. Cohen

Attorney At Law -- (213) 388-8188