Wednesday, September 17, 2014

FYI: 9th Cir Rules Bank Did Not Violate Automatic Stay by Placing Temporary Administrative Pledge on Debtors' Deposit Accounts

The U.S. Court of Appeals for the Ninth Circuit recently held that a bank did not willfully violate the automatic stay by placing a temporary administrative pledge on the debtors’ accounts in favor of the bankruptcy trustee.

The debtors filed a voluntary Chapter 7 bankruptcy in August 2009. The debtors were deposit account holders at a bank (Bank). They held four accounts with an aggregate balance of $17,075.06. They did not list two accounts in their original schedule of assets, and did not claim any exemption for account funds. The debtors listed Bank as an unsecured creditor for two debts totaling $52,000.00.

When Bank discovered that the debtors filed for Chapter 7 bankruptcy, it placed a temporary administrative pledge on their account.  Bank  then sought instruction from the Chapter 7 trustee regarding the distribution of funds.  Bank sent a letter to the trustee stating that upon the filing of a bankruptcy petition, the account funds became the property of the bankruptcy estate, payable only to the trustee or upon the trustee’s order.

The debtors claimed a portion of the funds were exempt under Nevada law. They filed an adversary class action against Bank alleging violations of 11 U.S.C. § 362(a)(3)’s automatic stay provision.  Bank filed a motion to dismiss for failure to state a claim.

The Bankruptcy Court granted Bank’s motion to dismiss with prejudice finding (1) that the debtors lacked standing to pursue any violation of the automatic stay because the trustee alone has standing to protect estate property; and (2) that debtors could not allege any injury to their interest because they had no right to possess estate property.

On appeal, the District Court held that if there is no objection to a debtor’s claimed exemption, the property is exempt upon the expiration of the thirty-day objection period. The District Court noted there is an exception to this rule where the particular exemption statute does not allow the debtor to exempt the entire property interest. The District Court found that the statute here, § 362(a)(3) permits a debtor to exempt an entire property interest.

According to the District Court, before the objections period ran, the property remained with the estate and Bank did not violate § 362(a)(3) during this period. After this period, the District Court held, the property passed out of the bankruptcy estate and Bank could not violate § 362(a)(3) because that section only applied to estate property. Accordingly, the District Court affirmed the Bankruptcy Court’s ruling dismissing the account holders’ allegations.

The account holders then appealed to the Ninth Circuit.  The Appellate Court first determined when the account funds revested in the debtors. In reaching its decision, the Ninth Circuit examined United States Supreme Court’s ruling in Schwab v. Reilly, 560 U.S. 770 (2010). In Schwab v. Reilly, the U.S. Supreme Court held that where a debtor claims an exemption in an amount equal to the entire amount of the property, the asset remains in the estate, and only an “interest” in the property is removed from the estate.

The Ninth Circuit relied on the general rule that exempt property immediately revests in the debtor. The Ninth Circuit read Schwab v. Reilly as an exception to the general rule and found that the debtors in question did not fall within the Schwab exception.

The Nevada Statute in question exempted only seventy-five percent of the disposable earnings of a debtor.  Thus, the Ninth Circuit found that the general rule, and not Schwab v. Reilly, applied.

Finding that the general rule applied, the Ninth Circuit ruled that the account funds automatically became part of the bankruptcy estate when the debtors filed the petition. When the debtors filed the account exemption, the funds did not become exempt because of Section 341(a)’s 30-day objection period. The funds revested in the debtors after the expiration of this period, when no objections were made.

The Ninth Circuit rejected the debtors’ argument that they were injured during the thirty day period when the Bank placed the hold on the funds. The Ninth Circuit held that there was no injury because during this time, the funds remained estate property. After the funds revested, Bank could not violate the automatic stay provision because it applied only to estate property, and because the property revested, it was no longer estate property. 

Accordingly, the Ninth Circuit affirmed the District Court’s ruling in favor of the Bank.

Eric Tsai
McGinnis Wutscher Beiramee LLP
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