Smith, Matter of

• Decision Date: 13 July 1992
• Docket Number: No. 91-1519,91-1519
• Citation: 966 F.2d 1527
• Parties: , 27 Collier Bankr.Cas.2d 754, Bankr. L. Rep. P 74,750, 20 UCC Rep.Serv.2d 228 In the Matter of Joseph D. SMITH, doing business as J.D. Management Services and G.L. Properties, Debtor. Appeal of David R. BOYER, Trustee.
• Court: U.S. Court of Appeals — Seventh Circuit

Page 1527

966 F.2d 1527

61 USLW 2110, 27 Collier Bankr.Cas.2d 754,

Bankr. L. Rep. P 74,750, 20 UCC Rep.Serv.2d 228

In the Matter of Joseph D. SMITH, doing business as J.D. Management Services and G.L. Properties, Debtor Appeal of David R. BOYER, Trustee.

No. 91-1519.

United States Court of Appeals Seventh Circuit.

Argued Nov. 1, 1991.

Decided July 13, 1992.

Douglas Reed Adelsperger, argued, Beckman, Lawson, Sandler, Snyder & Federoff, Fort Wayne, Ind., for David R. Boyer.

William I. Kohn, argued, Seth D. Linfield, Scott M. Keller, Barnes & Thornburg, South Bend, Ind., for Baker & Schultz, Inc., Joseph D. Smith and G.L. Properties.

Before CUDAHY and FLAUM, Circuit Judges, and FAIRCHILD, Senior Circuit Judge.

CUDAHY, Circuit Judge.

In this bankruptcy case we must decide whether a debtor's payment to a creditor within the 90-day pre-petition period is avoidable as a preferential transfer when the payment was achieved by means of provisional credit supported only by the debtor's deposit of a bad check. Through what appears to be a simple check-kiting scheme, the debtor managed to pay off a single creditor well within the 90-day preference period. Because the debtor had deposited into his account a check (which eventually failed to clear), the bank honored the check presented by the creditor, although the debtor's account contained almost nothing in actual funds. So the creditor received its full payment; the issue we must resolve is whether that payment was a transfer of the debtor's property.

I.

In February of 1987, Baker & Schultz loaned $105,000 to Joseph Smith, doing business as J.D. Management Services and G.L. Properties (the Debtor). In satisfaction of this loan, the Debtor, on September 22, 1987, delivered to Baker & Schultz a check (number 1141) in the amount of $121,345.11 drawn on the Debtor's checking account with Fort Wayne National Bank (FWNB or the Bank). On the same day, the Debtor deposited with FWNB another check (number 1100) in the amount of $125,000, and his account was credited with that amount. Baker & Schultz deposited check number 1141 at the First State Bank of Decatur. On September 23, 1987 FWNB honored check number 1141 when it was presented for payment by the First State Bank of Decatur. When FWNB made payment on check number 1141, the Debtor's checking account contained only $163.58 of the Debtor's funds other than the $125,000 amount credited the previous day.

On September 28, 1987, FWNB learned that check number 1100 (the Debtor's $125,000 deposit) had failed to clear. The Bank then debited or "charged back" the provisional credit to the Debtor's checking account, creating an overdraft of $121,290.53. The Bank was unable to obtain a return of the overdraft amount from Baker & Schultz, which insisted that the Bank's payment on check number 1141 constituted "final payment" under Indiana Law (specifically Ind.Code § 26-1-4-213).

On December 10, 1987, FWNB filed an involuntary Chapter 7 bankruptcy petition against the Debtor. On July 22, 1988, the Trustee filed a complaint for recovery of preferential transfer pursuant to 11 U.S.C. § 547(b). The Trustee's complaint sought to recover the entire $121,345.11 paid to Baker & Schultz on the Debtor's check number 1141. Both the Trustee and Baker & Schultz filed motions for summary judgment.

The bankruptcy court found that the Debtor's payment to Baker & Schultz was a preference avoidable under section 547(b), rejecting Baker & Schultz's argument that the payment made on check number 1141 was property of the Bank rather than of the Debtor. Because the Debtor had dominion over the provisionally credited $125,000 and paid off a selected creditor, the bankruptcy court reasoned, the Debtor's property had been transferred and the estate thereby diminished. The court ordered Baker & Schultz to return the $121,345.11 to the Trustee as a preferential transfer.

The district court reversed, granting summary judgment in favor of Baker & Schultz and limiting the Trustee's preference recovery to $163.58. 123 B.R. 605 (Bkrtcy.N.D.Ind.1991). The district court emphasized that the provisional credit of $125,000 never became final, so the Debtor was never entitled to it as of right; since the Bank was not required to honor check number 1141 but nevertheless did so, the transfer to Baker & Schultz was in reality a transfer of the Bank's property, and there was no diminution of the bankrupt's estate.

II.

We review the district court's grant of summary judgment de novo. Anderson v. Liberty Lobby, Inc., 477 U.S. 242, 255, 106 S.Ct. 2505, 2513, 91 L.Ed.2d 202 (1986). Summary judgment is appropriate only if, drawing all reasonable inferences in favor of the nonmoving party, we conclude that there exists no genuine issue of material fact and the moving party is entitled to judgment as a matter of law. Hohmeier v. Leyden Community High Schools Dist. 212, 954 F.2d 461, 463 (7th Cir.1992). The facts of this case are not disputed, and we are presented with a pure question of law.

Under the Bankruptcy Code's preference avoidance provision, 11 U.S.C. § 547, a bankruptcy trustee may recover certain transfers of property made by the debtor within 90 days before the date on which the bankruptcy petition was filed. ¹ The present dispute concerns only one element of a preferential transfer: the transfer of "an interest of the debtor in property." It is undisputed that the other elements required under the statute are present.

The Supreme Court recently addressed the Bankruptcy Code's treatment of checks as preferential transfers in Barnhill v Johnson, --- U.S. ----, 112 S.Ct. 1386, 118 L.Ed.2d 39 (1992). The Court held that for purposes of the 90-day preference period under section 547(b), a transfer made by check occurs on the date the check is honored rather than the date it is delivered to its recipient. The case before us presents a different issue. In Barnhill there was no question that there had been a transfer of the debtor's property; the question was when that transfer occurred. Here the issue is not one of timing, but of whether there has been a transfer of the debtor's interest in property at all. The Supreme Court's decision turned on a construction of the term "transfer," which is a matter of federal law. ² Id. 112 S.Ct. at 1389. The definition of "an interest in property," in contrast, is generally a matter of state law. Id.

A.

Since our primary concern is with interests in property, we begin with state law. We have found no Indiana authority directly addressing the property status of a check honored on the basis of provisional credit that is subsequently revoked. The Uniform Commercial Code as adopted in Indiana does address, however, the general rights of parties when a bank extends provisional credit. In order to facilitate efficiency and rapid check processing, the Commercial Code gives protection to banks that extend provisional credit to customers on the basis of a deposited item. While the proceeds of the provisional credit are in a customer's account, the bank is given the right of "chargeback," which is a "claim or lien against the customer's account." Yoder v. Cromwell State Bank, 478 N.E.2d 131, 135, 41 U.C.C. 173 (Ind.App.1985); Ind.Code § 26-1-4-212. ³ When, however, the customer has "withdrawn or applied" the provisionally credited funds, the bank's interest rises to a security interest in the item or proceeds thereof. Ind.Code § 26-1-4-208(1). ⁴ The Trustee argues that under the Indiana Code (and the U.C.C.) something must exist to which a security interest may attach once the customer uses provisionally credited funds: "That something is the ability to control disposition which is an interest in property." Trustee Br. at 9. Indiana, like other states, emphasizes control of disposition in defining the contours of property rights. See, e.g., State v. Ensley, 240 Ind. 472, 164 N.E.2d 342, 348-49 (1960).

In response, Baker & Schultz places emphasis on a different statutory provision--that governing final credit. Section 26-1-4-213 of the Indiana Code, as correctly noted by Baker & Schultz, provides that provisionally credited funds do not become available for withdrawal as of right until the provisional credit becomes final (that is, until the item supporting the provisional credit clears). ⁵ Here, of course, it is undisputed that the provisional credit never became final. Five days after the Bank honored check number 1141, it revoked the Debtor's provisional credit and exercised its right of charge-back. Baker & Schultz's point is that since the Debtor's credit never became available for withdrawal as a matter of right, the Debtor never had a property interest in the "funds" in his account; those funds were a "mere bookkeeping entry." Further, the Bank was not required to honor check number 1141 when it was presented for payment; the Bank could have (and presumably should have) waited until the Debtor's check number 1100 cleared. Therefore, argues Baker & Schultz, the Bank simply assumed the risk that the Debtor's provisional credit would not become final, and it transferred its own property when it made payment on check number 1141.

Baker & Schultz's position has a certain plausibility, but it is only a superficial plausibility. The Bank's obligations under the statute are not the relevant issue. The fact that the Debtor did not have a statutory right to withdraw the provisionally credited funds does not entail that he had no "interest in property." Statutes are not the only source of property interests; agreements also give rise to such interests. See Department of Financial Institutions v. Holt, 231 Ind. 293, 108 N.E.2d 629, 634 (1952). One has a property interest, for example, in a certain amount of interest on savings in a savings account, but the amount of that interest is in reality a matter of bank policy, embodied in one's agreement with the bank, and not a matter of statute. Similarly, a bank's credit policy...