In re New York City Shoes, Inc.
| Decision Date | 05 October 1987 |
| Docket Number | Bankruptcy No. 87-03426S. |
| Parties | In re NEW YORK CITY SHOES, INC., Debtor. |
| Court | United States Bankruptcy Courts. Third Circuit. U.S. Bankruptcy Court — Eastern District of Pennsylvania |
Edward C. Toole, Jr., Mary F. Walrath, Katherine McAlice, Philadelphia, Pa., for Debtor.
Dinah Bogart Engel, Asst. Counsel, Bala Cynwyd, Pa., for Germantown Savings Bank.
The Motions brought before us by Germantown Savings Bank (hereinafter referred to as "the Bank"), in the instant relatively large Chapter 11 bankruptcy case involving a chain of retail women's shoe stores cause us to consider the rather complex interplay among various sections of the Bankruptcy Code on the attempt of a bank to "administratively freeze" funds deposited with it against delinquent loan balances owed to the Bank by the Debtor. We hold, consistent with Cusanno v. Fidelity Bank, 29 B.R. 810 (E.D.Pa.1983), aff'g sub nom. In re Cusanno, 17 B.R. 879 (Bankr.E.D.Pa.1982), that such an "administrative freeze," at least under controlling Pennsylvania law, constitutes a setoff. Hence, considering only 11 U.S.C. § 362(a)(7), we would not believe that such a freeze can be legally effected in light of the presence of the automatic stay.
However, we further hold that a bank's apparent right to set off the funds in a debtor's bank account renders its claim secured or at least quasi-secured as to the amount of funds deposited by the debtor pre-petition. Hence, in a Chapter 11 case, or any other case where a debtor is authorized to operate a business, we find that 11 U.S.C. § 363(c) comes into play, and the debtor may remove pre-petition deposits from a bank account only upon the condition that it provides adequate protection to the bank's interest in the pre-petition deposit pursuant to 11 U.S.C. § 363(e). Therefore, we conclude that the "administrative freeze" imposed by the Bank here was a permissible means of protecting its cash collateral, but in the amount of the pre-petition deposits only. We shall consequently order the Bank to release the Debtor's post-petition deposits, allow the Debtor to seek damages against the Bank for holding these funds, and deny the Bank's request for relief from the stay to set off the pre-petition funds deposited merely to give the Debtor a chance to provide adequate protection to the Bank's interest in the pre-petition deposits.
On July 7, 1987, the Debtor filed the instant bankruptcy case. The first of the two Motions before us, a Motion for Relief from the Automatic Stay (hereinafter "the Stay Motion"), was filed by the Bank on July 24, 1987. The Debtor opposed the Stay Motion in an Answer filed August 12, 1987. On August 19, 1987, the Bank filed the second of the Motions before us, a Motion to Prevent Debtor from Using Cash Collateral Without Complying with 11 U.S.C. § 363(c)(2) (hereinafter "the Cash Collateral Motion"). We allowed expedited consideration of the Cash Collateral Motion in order that it could be heard together with the Stay Motion on August 27, 1987. The Debtor answered the Cash Collateral Motion on August 25, 1987, and the hearing on the two Motions was ultimately continued to September 3, 1987.
On September 3, 1987, the parties presented a rather comprehensive Stipulation of Facts to us, incorporating a Deposition of Beth K. Greenberg, the Bank's commercial services supervisor. On September 3, 1987, the Bank adduced brief additional testimony from Margaret Conway, a Vice-President in charge of the Bank's department which places "holds" on depositors' accounts.
The facts are basically undisputed. On June 1, 1987, the Debtor restructured an installment loan arrangement of July, 1986, with the Bank by executing a note in its favor in the amount of $86,377.50, payable in sixteen monthly installments of $5,000.00 and a final installment of $6,377.50. The Debtor made only one $5,000.00 payment prior to its bankruptcy filing on July 7, 1987.
On the date of the bankruptcy filing, the Debtor had $4,404.90 deposited in seven separate accounts with the Bank. Additional post-petition deposits brought the total balance of the seven accounts to $9,429.38.
Since February, 1987, the Bank had imposed a "do not pay hold" on the Debtor's accounts, due to a number of the checks having been returned for insufficient funds. On July 10, 1987, the Debtor requested that the Bank continue the "do not pay hold" because one of its former officers, Terry Rakoff, was believed to be attempting to cash unauthorized checks drawn on the accounts. However, upon learning about the bankruptcy filing from newspaper accounts, the Bank placed its own "administrative freeze" on the accounts on or about July 14, 1987.
One aspect of the Bank's defense was attempting to convince us that, since there was already a "do not pay hold" on the accounts prior to the imposition of the "administrative freeze," the latter was basically cumulative and hence relatively insignificant. The Bank failed in this endeavor. It is apparent to us that the February, 1987, "do not pay hold" merely required a check with supervisors to be sure that the account contained adequate funds before a payment was made, and that the July 10, 1987, "do not pay hold" merely required a check with supervisors to be sure that unauthorized checks were not being presented. These "holds" would apparently be released as soon as the Debtor established that an authorized check was being presented against a legitimate account balance.
However, the "administrative freeze" required consultation with the Bank's counsel before any funds would be released, as evidenced by the refusal of the Bank to release funds to undisputably authorized agents of the Debtor on August 3, 1987, and August 18, 1987, despite remonstrances from the Debtor's counsel as early as July 20, 1987. Thus, the "administrative freeze" was an unconditional and unilateral assertion by the Bank that it would retain all funds on deposit until it saw fit to do otherwise.
Few areas of the law involve as many apparent conflicts of applicable Code provisions and hence as clear a split of authorities as the area of bank setoffs. As is indicated in the first paragraph of this Opinion, our district court, affirming a decision of this Court, has rendered one of the best known holdings in this area nationally in the Cusanno decisions. There, our district court held, in the context of a Chapter 13 consumer case, that an "administrative freeze" of a debtor's bank account to offset a loan owed to the bank by the debtor was a setoff, and its imposition violated 11 U.S.C. §§ 362(a)(3) and (a)(7).1 Holding that the bank account was not cash collateral, which undoubtedly was correct in that case because 11 U.S.C. § 363(c)(2) restricts a debtor's use of cash collateral only "if the business of the debtor is authorized to be operated," the district court speaks in perhaps overly-broad terms in stating as follows:
Even if the bank had possessed a right of setoff against the Cusannos, the bank forfeited this right by failing to seek timely relief in the Bankruptcy Court. The bank\'s conduct would have been in error in either a Chapter 7, a Chapter 11, or a Chapter 13 case. Here, however, in a Chapter 13 case involving individual debtors of modest means who may require the bank account funds to meet daily expenses for food, clothing and shelter, the bank\'s actions in disregard of court authority are especially troublesome. 29 B.R. at 813.
We have only had one occasion to address the issue of bank setoffs, and we did so by way of dictum. In emphasizing our view that the concept of set off should be "applied restrictively in bankruptcy proceedings," we stated, in In re Lessig Construction, Inc., 67 B.R. 436, 441 (Bankr.E. D.Pa.1986), that, in Cusanno, "this court properly severely limited the right of a bank to set off a deposit of a debtor-customer against a debt owed by the customer to the bank."
The view that a bank's "administrative freeze" of a debtor-customer's account is a setoff subject to at least 11 U.S.C. § 362(a)(7) has been adopted by numerous other courts. See In re Wildcat Construction Co., 57 B.R. 981, 984-85 (Bankr.D.Vt. 1986); In re Rio, 55 B.R. 814, 817-18 (Bankr.M.D.Ala.1985); In re LHG Resources, Inc., 34 B.R. 202, 203-04 (Bankr. W.D.Tex.1983); In re Executive Associates, Inc., 24 B.R. 171, 172-73 (Bankr.S.D. Tex.1982); and In re Nelson, 6 B.R. 248, 250, 251 (Bankr.D.Kan.1980).
However, the Cusanno decision has also been the specific target of criticism in two articles co-authored by two of the giants of bankruptcy, Benjamin Weintraub and Professor Alan N. Resnick in Freezing as Preservative —The Debtor's Bank Account, 101 BANKING L.J. 3 (1983); and Freezing the Debtor's Account: A Banker's Dilemma Under the Bankruptcy Code, 100 BANKING L.J. 316 (1982).
The "dilemma," which is itself never defined in these articles, arises, as we see it, from the fact that, on one hand, the holding that an "administrative freeze" places the bank in jeopardy of acting in contempt of the automatic stay if it does not allow withdrawals from the debtor's accounts and, on the other hand, if it does allow withdrawals, subjecting it to the following adverse consequences: (1) If it has actual notice or knowledge of the bankruptcy, and pays on withdrawals, it may be liable for improperly transferring property of the estate. See 11 U.S.C. § 542(c), codifying the result in Bank of Marin v. England, 385 U.S. 99, 103, 87 S.Ct. 274, 277, 17 L.Ed.2d 197 (1966); (2) It will lose the "banker's lien" which otherwise arises in its favor to give it a priority right to the deposited funds only so long as it retains them in its possession. See Lowden v. Iowa-Des Moines Nat'l Bank & Trust Co., 10 F.Supp. 430, 433 (S.D.Iowa 1935), aff'd, 84 F.2d 856 (8th Cir.), cert. denied, 299 U.S. 584, 57 S.Ct. 109, 81 L.Ed. 430 (1936).
A substantial body of caselaw rejects the reasoning of Cusanno and the cases consistent with it cited at pages...
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