Bohlen Enterprises, Ltd., In re

• Citation: 859 F.2d 561
• Decision Date: 17 February 1989
• Docket Number: Nos. 87-2413,87-2442,s. 87-2413
• Parties: 19 Collier Bankr.Cas.2d 986, 18 Bankr.Ct.Dec. 672 In re BOHLEN ENTERPRISES, LTD. d/b/a Central Office Equipment, Debtor. Thomas G. McCUSKEY, Substitute Trustee for Wesley B. Huisinga, Appellant, v. The NATIONAL BANK OF WATERLOO, Appellee.
• Court: United States Courts of Appeals. United States Court of Appeals (8th Circuit)

Page 561

859 F.2d 561

19 Collier Bankr.Cas.2d 986, 18 Bankr.Ct.Dec. 672

In re BOHLEN ENTERPRISES, LTD. d/b/a Central Office

Equipment, Debtor.

Thomas G. McCUSKEY, Substitute Trustee for Wesley B.

Huisinga, Appellant, v. The NATIONAL BANK OF WATERLOO, Appellee.

Nos. 87-2413, 87-2442.

United States Court of Appeals, Eighth Circuit.

Submitted May 13, 1988.

Decided Sept. 30, 1988.

Rehearing and Rehearing En Banc Denied Feb. 17, 1989.

Thomas G. McCuskey, Cedar Rapids, Iowa, for appellant.

George Keith, Waterloo, Iowa, for appellee.

Before HEANEY and McMILLIAN, Circuit Judges, and HILL, Senior District Judge. ^*

IRVING HILL, Senior District Judge.

In this opinion we reverse a judgment of the district court in a bankruptcy case because it erroneously applied the doctrine of "earmarking" to justify rejection of a claim that a transfer of funds to a pre-existing creditor was a voidable preference.

FACTS

Bohlen Enterprises Ltd. ("debtor") was a retail office equipment business in Waterloo, Iowa. Mr. William F. Bohlen was its president. In late April 1986 the debtor owed two separate obligations to the National Bank of Waterloo, Iowa ("bank"). One obligation was a short-term inventory loan dating from November, 1985, in the principal amount of $189,000. The other obligation was a long-standing arrangement for an open line of credit in the principal amount of $125,000. Both obligations were secured by a single security agreement.

In late April, 1986 the bank was insisting that the $189,000 obligation, which was overdue, be repaid by the end of that month. Mr. Bohlen went to the John Deere Community Credit Union ("credit union") in Waterloo and applied for a $200,000 loan. He disclosed to the credit union the debtor's $125,000 obligation to the bank but failed to disclose its $189,000 obligation. Mr. Bohlen told the credit union that if it provided the $200,000 loan, $125,000 of the proceeds would be used to repay the $125,000 obligation to the bank and the rest would be used for miscellaneous purposes. The credit union agreed to those arrangements.

Although the credit union's formal approval of the loan did not occur until May 1, 1986, it apparently determined on April 30, 1986 that the loan would be granted. On that date the credit union opened a share draft account ¹ in the debtor's name and gave Mr. Bohlen some blank share drafts to use in drawing on the share draft account.

The opening of the share draft account on April 30, the day before the approval and funding of the loan, is a critical fact in the rather bizarre series of transactions which followed that event. The transcript does not disclose why the share draft account was opened in advance of the loan's being approved and funded, or why the borrower was given the blank share drafts before there was any money in the account.

In any event, Mr. Bohlen on April 30, 1986, purported to utilize and draw upon the share draft account despite the fact that on that date it had nothing in it. That day he issued a share draft on that account in the sum of $192,000 payable to the bank, which he then deposited in the debtor's checking account at the bank. He then immediately wrote three checks on the debtor's checking account at the bank totalling $191,777.27. All three checks were payable to the bank.

The three checks collectively constitute the transfer which is alleged to be the voidable preference. One was for $189,000 to repay the entire principal of the debtor's larger loan obligation. The second was for $1,708.77 which paid the interest on that obligation to date. The third check was for $1,068.50 which paid the interest on the The conclusion is inescapable that Mr. Bohlen on his own had decided to pay off the $189,000 obligation to the bank, which he was being pressured to retire at once, and to leave the $125,000 obligation unpaid. The conclusion is likewise inescapable that Mr. Bohlen expected his $192,000 share draft to be made good by the credit union's depositing the entire $200,000 of loan proceeds in the share draft account so that he could freely draw upon the account as he saw fit. But the credit union did not put the entire proceeds of the loan at Mr. Bohlen's disposal. Instead it deposited only $74,931.50 of the loan proceeds in the share draft account. It funded the rest of the loan on May 1, 1986 by issuing a check for $125,068.50 ² jointly payable to the debtor and the bank.

debtor's $125,000 obligation to date. The principal of the $125,000 loan obligation remained unpaid.

The credit union obviously intended the joint payee check to be endorsed to the bank to pay off the $125,000 obligation as Mr. Bohlen had promised. If Mr. Bohlen endorsed that check and turned it over to the bank, the bank would clearly use it as repayment of the $125,000 loan and this would leave Mr. Bohlen without funds to cover the unauthorized payment already made of the $189,000 obligation. Mr. Bohlen was apparently unable to solve that dilemma and the joint payee check was never negotiated. ³

So on the morning of May 2, 1986, Mr. Bohlen realized that his attempt to pay off the $189,000 obligation to the bank without ever disclosing that obligation to the credit union would fail because the full $200,000 had not been put at his disposal. Only $75,000 was available to him to pay the $192,000 share draft he had written. The remaining $125,000 of new proceeds were embodied in the joint payee check and not available to him. He needed another $125,000 to cover. So on May 2, 1986, at 8:05 A.M., utilizing a drive-thru window at the credit union, Mr. Bohlen purported to deposit into the debtor's share draft account at the credit union, a check for $125,000 which he wrote on the debtor's checking account at the bank. That check, having been written on an account with no funds in it, was eventually dishonored. It seems clear that that check was written in a desperate check-kiting scheme in which Mr. Bohlen was playing for time.

In the meantime, during the night of May 1, 1986, the share draft of $192,000 was presented to the credit union for payment by the normal electronic process. It cleared electronically, i.e., it was honored and paid. The next morning, May 2, 1986, a clerk in the operations department of the credit union noted the electronic clearance but took no action because of Mr. Bohlen's deposit in the share draft account that morning of the debtor's $125,000 check drawn on the bank account. The clerk was also apparently relying on the approximately $75,000 of the loan proceeds which the credit union was transferring into the share draft account that day. The two sums together would cover the $192,000 share draft.

As of Monday, May 5 then, the picture was as follows: The credit union and the debtor had made a deal for a new $200,000 loan to the debtor with the credit union stipulating that $125,000 of the proceeds be used to retire the debtor's $125,000 obligation to the bank, the only obligation of the debtor to the bank known to the credit union. Through the share draft account, the credit union had advanced $192,000. None of that money had been used to pay the $125,000 obligation. Instead, the bulk of the money was used to pay the $189,000 obligation which was still unknown to the credit union.

The debtor filed a Chapter 11 bankruptcy petition on July 21, 1986. On August 19, 1986, the bankruptcy trustee commenced this adversary proceeding against the bank. The trustee asserted that the three checks written by Mr. Bohlen on April 30, 1986, totalling $191,777.27 in favor of the bank, constituted a voidable preference and that the said sum should be disgorged by the bank and made a part of the debtor's estate.

The bank contended that the entire sum of $191,777.27 was protected from treatment as a voidable preference by the doctrine of earmarking. It alternatively argued that it could keep the entire payment under 11 U.S.C. Sec. 547(b)(5) because it did not thereby receive a greater sum than it would have obtained in a Chapter 7 liquidation. This alternative claim was premised on an assertion that as to the entire $191,777.27, the bank (1) was a secured creditor on the date of payment by virtue of a lien derived from its security agreement and/or (2) had a right of setoff under 11 U.S.C. Sec. 553.

Following a trial, the bankruptcy judge ⁴ in a lengthy written opinion, held that $125,068.50 of the $191,777.27 was not a voidable preference because of earmarking. He rejected all of the bank's other claims and theories and ordered the bank to disgorge the remainder, $66,708.77.

Both sides appealed the bankruptcy court's decision, 78 B.R. 556, to the district judge, ⁵ who affirmed the bankruptcy court in all respects. 91 B.R. 486.

Both sides have appealed to us from the judgment below. The trustee argues that the application of the earmarking doctrine to any of the funds in issue is an error of law. The bank contends that the lower court's application of the earmarking doctrine was legally correct but did not go far enough. The bank argues that the doctrine should be extended to protect the entire $191,777.27. Alternatively, if the doctrine is held not to protect some or all of the transfer, the bank maintains that it nonetheless has a right to retain the entire sum under Section 547(b)(5) because it would have received at least an equal sum in a Chapter 7 distribution. In making this latter assertion, the bank on appeal no longer presses its claim of lien. The assertion is solely premised on the alleged right of setoff.

THE MERITS

The prerequisites for a voidable preference are set forth in 11 U.S.C. Sec. 547(b). Section 547(b) begins with a threshold requirement that a voidable preference must involve a "transfer of an interest of the debtor in property ..." If such a transfer is involved, the transfer must also be:

(1) to or for the benefit of the creditor,

(2) for or on account of an antecedent debt,

(3) made while the debtor was insolvent,

(4)...