In re Moreira, Bankruptcy No. 94-43553-JFQ. Adv. No. 94-4278.

• Decision Date: 04 November 1994
• Docket Number: Bankruptcy No. 94-43553-JFQ. Adv. No. 94-4278.
• Citation: 173 BR 965
• Parties: In re Sandra L. MOREIRA, Debtor. Sandra L. MOREIRA, Plaintiff, v. DIGITAL EMPLOYEES FEDERAL CREDIT UNION, Alan Prindel, Vice President, and Brian W. Ducharme, Collection Manager, Defendants.
• Court: U.S. Bankruptcy Court — District of Massachusetts

173 B.R. 965 (1994)

In re Sandra L. MOREIRA, Debtor.

Sandra L. MOREIRA, Plaintiff, v. DIGITAL EMPLOYEES FEDERAL CREDIT UNION, Alan Prindel, Vice President, and Brian W. Ducharme, Collection Manager, Defendants.

Bankruptcy No. 94-43553-JFQ. Adv. No. 94-4278.

United States Bankruptcy Court, D. Massachusetts.

November 4, 1994.

Helene B. Page, Worcester, MA, for Sandra L. Moreira.

Peter C.L. Roth, Bingham, Dana & Gould, Boston, MA, for Digital Employees' Federal Credit Union.

OPINION

JAMES F. QUEENAN, Jr., Chief Judge.

This case raises three questions: Is it a violation of the automatic stay for a credit union to "freeze" a debtor's deposit account for the purpose of preserving the credit union's claimed right of setoff against the debtor's loan indebtedness? May the account now be set off against the entire debt balance even though at the filing the debtor was current on her monthly payments and the credit union had made no attempt to accelerate the debt? Finally, what is the effect upon postpetition setoff rights of a large deposit made shortly before bankruptcy? Complicating the second question is the disputed validity of a clause in the note accelerating the debt in the event of the debtor's bankruptcy. Complicating all three is another clause in the note purporting to grant the credit union a "lien" on the deposit account.

Before the court are three pleadings: (i) the complaint of Sandra L. Moreira (the "Debtor") seeking a mandatory injunction requiring the defendant Digital Employees Federal Credit Union (the "Credit Union") to turn over the balance of the Debtor's deposit account, (ii) the Credit Union's motion to dismiss the complaint, and (iii) the Credit Union's motion for relief from the automatic stay in order accomplish the setoff. I decline to issue the injunction or grant relief from stay, but I do allow the motion to dismiss unless the Debtor amends her complaint to seek relief concerning the prepetition deposit.

I. FACTS

The Credit Union is a creature of federal law established for the benefit of the employees of Digital Equipment Corporation ("DEC"). The Debtor worked for DEC for sixteen and one-half years. On January 21, 1994, while so employed, she obtained an unsecured loan of $15,459.41 from the Credit Union. The note calls for monthly payments over five years with interest at 14½% per annum. It authorizes payments through charges to the Debtor's deposit account with the Credit Union. The note states the Debtor will be "in default" upon the occurrence of various events which include the filing of a bankruptcy petition, and upon default it gives the Credit Union the right to "demand payment of the unpaid balance."

In July of 1994, the Debtor lost her job with DEC as part of a general reduction in force. She was also divorced from her husband in the same month. DEC paid her approximately $7,000 as severance pay, which was deposited with the Credit Union on August 4th.

The Debtor filed her bankruptcy petition under chapter 7 on August 10th. She was then current on her monthly payments under the note. Having received notification of the filing from the court, the Credit Union wrote to the Debtor on August 23rd stating that because of the bankruptcy it had "frozen" the Debtor's deposit account. The account then had a balance of $7,871.23, far less than the balance of the note. A few weeks later, the Credit Union filed a motion for relief from the automatic stay seeking permission to make the setoff.

In freezing the account, the Credit Union refuses to honor requests for withdrawals. It has not, however, made an entry on its books applying the account balance against the loan. The deposit account therefore continues to earn interest.

II. FREEZE AND THE AUTOMATIC STAY

The Debtor contends the freeze violates the automatic stay in several respects. The freeze, says the Debtor, is a "setoff" within the meaning of section 362(a)(7), an "act to . . . exercise control over property of the estate" within the meaning of section 362(a)(3), an "act to . . . enforce a lien" within the meaning of section 362(a)(4), and an "act to collect . . . a claim" within the meaning of section 362(a)(6).

The Code's provisions imposing the automatic stay must be read in light of two other sections of the Code — section 542(b) and section 363.

Section 542(b) provides in pertinent part:

An entity that owes a debt that is property of the estate and that is matured, payable on demand, or payable on order, shall pay such debt to, or on the order of, the trustee, except to the extent that such debt may be offset under section 553 of this title. . . . (emphasis supplied).¹

Congress seems to be saying in section 542(b) that if there is a valid right of setoff, a party owing indebtedness to the estate need not pay its debt. The phrase "may be offset" indicates approval of action withholding payment short of setoff. This is authorization for the Credit Union's freeze.

The validity of the freeze is also supported by section 363. Under section 363, the estate is prohibited from using "cash collateral" unless an entity having an interest in the collateral consents or the court authorizes the use.² Section 363(a) defines "cash collateral" to include a deposit account, and section 506(a) treats the right of setoff as the equivalent of a security interest. Thus if the Credit Union were to honor its payment obligation it would be permitting a violation of the obligations owed it concerning use of its cash collateral.

I conclude from this statutory scheme that the Credit Union's action in freezing the deposit account is not a violation of the automatic stay if it has the right to set off the account against the note obligation. Although a freeze, like a setoff, denies use of the account, there is technically no setoff until the Credit Union makes an entry on its books applying the account against the debt.³ Without such an entry, the account continues to bear interest, so there is an economic difference between a freeze and setoff. A number of courts adopt this reasoning and permit the freeze.⁴ They are impressed with the dilemma a financial institution finds itself in due to the conflict between potential loss of the benefit of setoff and the command of the automatic stay against setoff. Realizing the right of setoff may be lost without immediate action, these courts permit a freeze because they regard the freeze as a preservation of the status quo rather than action taken which improves the creditor's position.

Other courts view a freeze differently. Because the freeze denies a debtor use of funds as effectively as setoff, some regard the freeze as a setoff under another name.⁵ Some recognize the technical difference between freeze and setoff but hold the freeze is an exercise of control over property of the estate prohibited by section 362(a)(3).⁶

The Eleventh Circuit takes a compromise approach. It requires a bank lender to honor a check drawn on the debtor's account unless, prior to its midnight deadline, the bank files a motion seeking an order denying the estate use of the account and deposits the balance of the account into the registry of the bankruptcy court.⁷ This is not very practical. The midnight deadline applies only to checks received from other banks.⁸ A bank has no such grace period with respect to a check presented for payment at the counter.⁹ More basically, this approach fails to give sufficient recognition to a bank lender's rights under sections 363(c)(2) and 542(b).

The freeze is nevertheless proper only if it preserves a valid right of setoff. I now turn to the question of whether the Credit Union has that right.

III. CREDIT UNION'S RIGHT OF SETOFF

A. Prepetition Lack of Mutuality

Section 553(a) provides that the Bankruptcy Code "does not affect any right of a creditor to offset a mutual debt owed by such creditor to the debtor. . . ."¹⁰ The Debtor contends this language makes the Credit Union's postpetition right of setoff dependent upon its setoff rights under Massachusetts law immediately prior to the filing. At that time, nothing was presently due the Credit Union. In contrast, the entire indebtedness owed by the Credit Union under its deposit account agreement was due upon demand of the Debtor. Under Massachusetts law, the Credit Union could not have then set off the account because the variation in due dates of the debts deprived them of the mutuality necessary for setoff.¹¹ In Massachusetts, a financial institution may set off a deposit account against debt owed but not yet due only if the depositor is the subject of an insolvency proceeding.¹² This is in contrast to the law of many states, under which the debtor's insolvency, even without a formal insolvency proceeding, is sufficient to dispense with the requirement of mutuality of due dates.¹³ The Debtor was involved in no insolvency proceeding prior to her present bankruptcy. Thus the Credit Union had no prepetition right of setoff.

B. The Proper Test — Mutuality of Due Dates After the Filing

The Debtor is incorrect, however, in her contention that the requirement of mutuality of due dates must be met prior to the bankruptcy filing.

Section 68 of the prior Bankruptcy Act contained this command: "In all cases of mutual debts or mutual credits between the estate of a bankrupt and a creditor the account shall be stated and one debt shall be set off against the other, and the balance only shall be allowed or paid."¹⁴ In applying this statute, courts approved postfiling setoff even though at the petition filing date one of the debts was not presently due.¹⁵ Setoff was also permitted even though one debt was liquidated and the other not.¹⁶

Section 553(a) is worded differently than section 68 of the Act. It imposes no command for postpetition setoff of mutual debts. Instead, section 553(a) provides in part as follows: "This title does not affect any right of a creditor to offset a mutual debt owing by such creditor to the...