Kaufman v. First National Bank of Opp, Alabama

• Decision Date: 08 August 1974
• Docket Number: No. 73-1857.,73-1857.
• Citation: 493 F.2d 1070
• Parties: Samuel KAUFMAN, As Trustee in Bankruptcy of A-OK Motor Lines, Inc., Plaintiff-Appellee, v. The FIRST NATIONAL BANK OF OPP, ALABAMA, Defendant-Appellant.
• Court: U.S. Court of Appeals — Fifth Circuit

493 F.2d 1070 (1974)

Samuel KAUFMAN, As Trustee in Bankruptcy of A-OK Motor Lines, Inc., Plaintiff-Appellee, v. The FIRST NATIONAL BANK OF OPP, ALABAMA, Defendant-Appellant.

No. 73-1857.

United States Court of Appeals, Fifth Circuit.

May 10, 1974.

Rehearing Denied August 8, 1974.

Frank J. Mizell, Jr., Montgomery, Ala., for defendant-appellant.

Samuel Kaufman, L. Wayne Collier, Montgomery, Ala., for plaintiff-appellee.

Before GODBOLD, SIMPSON and INGRAHAM, Circuit Judges.

GODBOLD, Circuit Judge:

Within four months of the bankruptcy of A-OK Motor Lines, Inc., the Bank, in order to reduce a debt due it by A-OK, set off against the debt funds on deposit in two A-OK accounts, known respectively as the "A-OK COD account" and the "A-OK escrow account."¹ The bank claims the benefit of § 68 of the Bankruptcy Act, 11 U.S.C. § 108, which in certain circumstances permits setoff of mutual debts between the estate of a bankrupt and a creditor.

The crux of the controversy is whether the COD and escrow accounts were of such character that the bank was entitled to make the setoff. The District Court found deposits in the accounts were trust funds not subject to setoff. We affirm, but remand for consideration by the District Court of a limited issue discussed infra.

In a nonbankruptcy context, the right of a bank to a lien against money deposited with it and the right to set off a deposit against the depositor's indebtedness to the bank are part of the law merchant. 5A Michie, Banks & Banking, § 114 p. 300. The courts have had considerable difficulty in this area with both concepts and terminology. The right to make a setoff requires determining the character of the deposit and the bank's knowledge or notice of its character. The legal status of the depositor — individual, trustee, public officer, etc. — may be relevant as evidence of the character of the deposit or notice to the bank or both. Necessarily, concepts from the law of trusts may be applicable. The banking law of general versus special deposits is to be considered as well. The right of the bank to mingle with its assets general deposits but not special deposits may be fed into the analysis. The application of these several legal concepts, and the special jargon of each, has produced a body of law not entirely consistent and certainly without the corners neatly fitting together.²

The right of the bank exists only where with respect to both debt and deposit the bank and the depositor are in debtor-creditor relationship, and there must be mutuality of demands. Id. § 115c, p. 309. The debts must be between the same parties and in the same "right" or capacity, so that, for example, the bank (having notice of the character of the deposit) cannot set off against a depositor's individual debt a deposit made by him in his capacity as a public officer or as executor or administrator. Id. at p. 310.

From the trust law approach, it is clear that the right to set off does not extend to funds held in trust by the depositor and (with notice to the bank of their character) received on deposit. In re Goodson Steel Corp., 488 F.2d 776 (CA5, 1974) (bankruptcy case); Restatement of Trusts, Second § 324i.³

From the special deposit approach, stated broadly, funds deposited for a special purpose known to the bank, or under special agreement, cannot be set off by the bank. 5A Michie, Banks & Banking, § 129, p. 352.⁴ A deposit is special rather than general when there is specific direction, or agreement express or implied, that it be special or where there are circumstances sufficient to create a trust by operation of law. 5B Michie, Banks & Banking, § 328, pp. 263, 266-267. The consequence of a deposit's being special in the sense that it cannot be subject to setoff is at times described in trust terms. "Where the deposit is made for a special purpose, known to the bank — as, for example, to be paid to creditors — the money is held as a trust fund and hence the bank is without lawful right to appropriate the deposit to its own use as a set-off." 4 Collier, Bankruptcy, § 68.16, pp. 925-26.⁵

However, if a trustee deposits trust funds in his name as such, the deposit is general and a debtor-creditor relationship is created. The bank does not become a trustee of the funds, and it may mingle the funds with its general assets. V Scott, Trusts § 527, p. 3671. The bank is not bound to supervise the use or application which the fiduciary depositor makes of the trust funds, and, therefore, it is not liable for misapplication merely because the funds are identified as trust monies. This must be distinguished from the situation in which the bank, with notice that a deposit is of trust funds, seeks to set them off against individual indebtedness of the depositor to it. The bank, with an interest in the transaction, is then seeking to profit from a misapplication of trust funds, which it will not be permitted to do. IV Scott, Trusts (3d ed.) § 324.3-4, pp. 2525-33; V id. § 527, p. 3674.

Thus it is seen that the general-special deposit approach does not quite fit with the trust approach, and neither of these approaches fits with the analysis that focuses on whether funds are subject to mingling.⁶ As pointed out above, a deposit of trust funds may be "general" yet setoff may be barred by lack of "mutuality of debts."⁷

We turn to the facts concerning the two accounts in question. There is little dispute concerning the nature of the COD account. In January 1970 a hearing was held before the Alabama Public Service Commission (APSC) in response to complaints that A-OK was not properly handling funds that had been collected from consignees of COD shipments and were the property of consignors.⁸ Both Bank and carrier were represented by counsel at the hearing. The Bank was then pledgee of all of A-OK's stock. Following the hearing the APSC entered an order pointing out that pending the closing of a prospective sale of the company, the Bank was supervising its operations, and that respective counsel for the Bank and A-OK had represented to the Commission that COD consignees were remitting by checks payable directly to the shippers and that funds collected for COD shipments would not be deposited in A-OK's bank account. The Commission then ordered that the case be continued,

with the understanding that operations ... will be supervised until further notice to this Commission by the First National Bank of Opp, Alabama, and upon the assurance that no Collect-On-Delivery monies are now being deposited to the general bank account of Respondent .... (emphasis added)

The next day, January 20, 1970, the COD account was opened, and under the Bank's own supervision COD collections, and only COD collections, were deposited therein until February 9, 1970. It is obvious that this arrangement was a means of setting aside COD funds that were collected by A-OK rather than remitted directly to the consignors by consignees, and of assuring compliance with the Commission's understanding that such collections were not placed in A-OK's general bank account.⁹

On February 9 the Bank notified the APSC that it had sold all the stock of A-OK, that the purchasers had taken over control and management, that as of that date A-OK was depositing COD funds in an account for payment to the proper parties, and that the Bank would no longer exercise supervisory control. After February 9 some of the COD collections, but not all, were deposited in the COD account.¹⁰

In May an SBA-guaranteed loan, discussed below, was closed and $35,000 of the proceeds deposited in the COD account. This amount represented the best guess of the company, after examination of the records, of the total claimed by COD shippers. With respect to funds on deposit in this account the Bank mounts a two-pronged argument: that their setoff was proper at all times, and, alternatively, if their setoff was ever improper, it became proper again on February 9 when the Bank gave notice to APSC that it would no longer supervise A-OK's operations.

We agree with the District Court that funds from this account could not be set off. COD collections were collected by A-OK on behalf of its shipper-customers. The custom and practice in the business is that they be segregated from general funds of the collecting carrier. The Bank arranged to set aside COD collections not for its benefit but for the protection of the class of persons whose complaints had jeopardized A-OK's capacity to continue to operate. The Bank operated under that arrangement while it was supervisor and notified the APSC of the viability of the arrangement when it stopped supervising. The Bank could not later appropriate COD funds to its benefit in derogation of the rights of those whom the account was set up to protect.¹¹

The Bank's alternative theory that the status changed on February 9 misconceives the function of the bank as depository. The unusual service performed by the Bank as a temporary supervisor of the business operations of an ailing creditor heavily indebted to it neither annuls nor limits its responsibilities as a banking institution, placed upon it by operation of law. Once the Bank had knowledge of the nature of the account, and of the funds being deposited therein, it could not shuck off its responsibilities (and give itself access to the funds) by, in its phrase, "disavowing ownership and supervision of A-OK."¹²

The status of the escrow account is in somewhat more dispute. But the issue is factual. In May 1970 A-OK closed a $350,000 loan made by the Bank and 90% guaranteed by the Small Business Administration. From the proceeds $150,000 was used to pay off an existing loan from the Bank (also referred to as an SBA loan). From the remaining $200,000 some $95,000 was deposited in the newly created escrow account. These were the only funds ever deposited in it. All agree that $35,000 of the amount deposited was set aside to be paid to the Internal Revenue...