Katz v. First Nat. Bank of Glen Head

• Decision Date: 21 February 1978
• Docket Number: No. 982,D,982
• Citation: 568 F.2d 964
• Parties: Donald KATZ, Trustee in Bankruptcy of Oakland Foundry Company of Belleville, Illinois, Inc., Plaintiff-Appellant, v. The FIRST NATIONAL BANK OF GLEN HEAD, Defendant-Appellee. ocket 76-7577.
• Court: U.S. Court of Appeals — Second Circuit

Page 964

568 F.2d 964

Donald KATZ, Trustee in Bankruptcy of Oakland Foundry Company of Belleville, Illinois, Inc., Plaintiff-Appellant, v. The FIRST NATIONAL BANK OF GLEN HEAD, Defendant-Appellee.

No. 982, Docket 76-7577.

United States Court of Appeals Second Circuit.

Argued May 2, 1977.

Decided Oct. 17, 1977.

Certiorari Denied Feb. 21, 1978.

See 98 S.Ct. 1250.

David J. Letvin, East St. Louis, Ill. (Joel A. Kunin, and Cohn, Carr, Korein, Kunin & Brennan, East St. Louis, Ill.; Murray S. Lubitz, and Kazlow & Kazlow, Scarsdale, N. Y., on the brief), for plaintiff-appellant.

Michael L. Cook, New York City (William M. Goldman, Lenard H. Gorman, and Weil, Gotshal & Manges, New York City; Goldman, Horowitz & Cherno, Mineola, N. Y., on the brief), for defendant-appellee.

Before TIMBERS and VAN GRAAFEILAND, Circuit Judges, and OWEN, District Judge. ^*

TIMBERS, Circuit Judge:

Donald Katz, trustee in bankruptcy of the Oakland Foundry Company of Belleville, Illinois, Inc. (Oakland), sued The First National Bank of Glen Head (the Bank) in the Eastern District of New York to recover $108,732.07 which the trustee alleged constituted a voidable preference under § 60 of the Bankruptcy Act, 11 U.S.C. § 96 (1970). ¹ The district court, George C. Pratt, District Judge, in an opinion filed October 19, 1976 granted the bank's motion for summary judgment and dismissed the trustee's complaint. From the judgment entered accordingly on October 22, 1976, the trustee has appealed.

The district court, in granting the bank's motion for summary judgment, assumed for purposes of the motion that the depositor in fact was insolvent at the time of the deposits and later set-offs, and that the bank had reasonable cause to believe it to be insolvent. Thus the narrow holding of the court below was that, since the bank had obtained the funds of the bankrupt by setting off money on deposit with the bank in the bankrupt's checking account, in conformity with § 68(a), 11 U.S.C. § 108(a), ² there was no "transfer" and, absent a transfer, no preference that could be avoided by the trustee.

We reverse and remand for trial in order to resolve certain issues of fact which we shall discuss more fully below. In reversing and remanding we are mindful of the traditional rule that in order to prove a voidable preference the trustee must show complicity or understanding on the part of the bank. This is in accordance with a long line of authority that a bank is entitled to set off deposits which were accepted in good faith and in the regular course of the bank's business. This rule in turn is premised on practical commercial considerations; it has survived the test of time; and, absent compelling reasons for doing so, it should not be disturbed. Within this framework, we hold that the district court misinterpreted the law and erroneously applied its interpretation to the allegations of the complaint, thus foreclosing a jury's resolution of such critical issues of fact as whether, in view of the build-up and real nature of the Glen Head account, the bank acted in good faith in accepting the deposits or whether the account in fact was a general deposit account. To resolve these and other issues of fact we reverse and remand.

I.

The course of events which lead to the bank's exercise of its asserted right of set-off began on January 16, 1969 when the bank made a $125,000 loan to Oakland. This loan was obtained for Oakland by its president and chief executive officer, Herman Brede. Oakland was a wholly-owned subsidiary of Electronic Cabinets, Inc., all of whose stock was owned by Brede and his wife. Oakland's indebtedness to the bank was guaranteed personally by the Bredes, as required by the bank, and was secured by a pledge of all the Bredes' stock in Electronic Cabinets, Inc. and all of their stock in another company wholly owned by the Bredes. When Oakland's indebtedness to the bank later was converted to a demand note in June 1970, the Bredes gave the bank additional security in the form of a second mortgage on their home. Pursuant to the bank's usual practice, Oakland opened a general checking account with the bank when the loan was first made.

Oakland had been having financial difficulties even before it obtained the loan from the bank. Its financial condition deteriorated until it virtually ceased doing business in March 1971. By June 1971 Oakland had either ceased making or reduced significantly office and factory payroll.

In the district court proceedings the trustee sought to show that Oakland's deposits in its Glen Head account constituted preferences by comparing the activity in that checking account with the activity in Oakland's checking accounts in an Illinois bank. The trustee also sought to prove that practically all of Oakland's banking activity was carried on through two accounts in the Illinois bank, while the Glen Head account remained substantially inactive from July 1970 until March 1971. During this period Oakland made only a few deposits in and withdrawals from the Glen Head account and the balance never rose above $5,800. Beginning April 20, 1971 this pattern changed markedly. From April 20 to June 30 Oakland built up the balance in its Glen Head account from $865.09 to over $100,000. During this period no withdrawals were made. The first reduction in the balance occurred on June 30 when the bank set off the sum of $108,783.91 against the $125,000 which Oakland owed on the loan.

The trustee also sought to prove that Anthony D. Famighetti, the bank's president and the officer primarily concerned with the Oakland loan, was aware of Oakland's worsening financial condition and that he was aware that the Glen Head account was being built up in anticipation of Oakland's impending bankruptcy, thus to be available for a set-off by the bank. On June 29, 1971 Brede called Famighetti to apprise him of Oakland's difficulties. Brede told Famighetti that he would try to work something out with Oakland's creditors. Famighetti immediately placed a freeze on Oakland's account. On June 30 the bank executed the set-off and applied it against the outstanding $125,000 loan. On July 15 an involuntary petition in bankruptcy was filed in the Eastern District of Illinois against Oakland which was adjudicated a bankrupt on August 18.

For purposes of the bank's motion for summary judgment the district court correctly accepted as undisputed the essential facts summarized above to the extent that they were asserted by the bank in support of its motion and admitted by the trustee in his answering papers. On the basis of the undisputed facts the court concluded that Oakland's Glen Head deposits were not made in the regular course of Oakland's business. The court nevertheless dismissed the complaint on the ground that "(t)he test (for determining whether a 'deposit' really is a 'transfer') is not whether the deposits were made in the depositor's regular course of business, but instead, whether they were accepted by the bank in its regular course of business."

We hold that the legal standard articulated by the district court was erroneous. We further hold that, whether under the standard articulated by the district court or under the correct standard, the bank's motion for summary judgment should have been denied because there remained triable issues of fact, including whether the bank was aware of Oakland's intentional build-up of its account as reflected in the bank's acceptance of the deposits other than in the bank's regular course of business.

II.

Section 60(a) defines a preference in terms of six key elements. ³ Only one is of concern here. The district court assumed that elements (2)-(6) of § 60(a) were present. We likewise assume that the trustee, if afforded the opportunity at trial, could prove elements (2)-(6) in Oakland's series of deposits in its Glen Head account. The only remaining issue is the requirement of element (1) that there be a "transfer" ⁴ of the debtor's property. ⁵

The district court concluded that there had been no transfer because Oakland deposited its funds in an ordinary checking account from which it could make withdrawals, until the bank imposed the freeze on June 29, 1971. In view of this factor, and because the court concluded that the trustee could not prove any agreement or complicity between Oakland (Brede) and the bank with regard to building up the account, the court concluded that the relationship between Oakland and the bank did not differ from an ordinary debtor-creditor relationship. This was the predicate for its conclusion that Oakland's deposits were not transfers within the meaning of § 60. ⁶

It is well settled that deposits in an unrestricted checking account, made in the regular course of business, do not constitute transfers within the meaning of the Bankruptcy Act. New York County Bank v. Massey,192 U.S. 138, 145 (1904); Jensen v. State Bank of Allison, 518 F.2d 1, 4 (8 Cir. 1975); Farmers Bank v. Julian, 383 F.2d 314, 324 (8 Cir.), cert. denied, 389 U.S. 1021 (1967); Joseph F. Hughes & Co. v. Machen, 164 F.2d 983 (4 Cir. 1947), cert. denied, 333 U.S. 881 (1948); Cusick v. Second National Bank, 115 F.2d 150, 151-52 (D.C.Cir.1940); Frankford Trust Co. v. Comber, 68 F.2d 471, 472 (3 Cir. 1933); Citizens' National Bank of Gastonia v. Lineberger, 45 F.2d 522, 526-27 (4 Cir. 1930). The theory of these cases is that a deposit creates a debt owed to the depositor by the bank and does not constitute a parting with property by the depositor. As the court said in Lineberger, supra, 45 F.2d at 527:

"A deposit in a bank . . . does not deplete the estate of the depositor, but results in substituting for currency, bank notes, checks, drafts, and other bankable items a corresponding credit with the bank, which may be checked against . . . . A deposit of funds differs from a payment in the essential particular that it is withdrawable at the will of the depositor."

All of the courts that have relied on a...