Breaking with judges in Texas and New Mexico, the Ninth Circuit Bankruptcy Appellate Panel has found that an administrative freeze policy utilized by Wells Fargo Bank violates the automatic stay under 11 U.S.C. § 362(a). Mwangi v. Wells Fargo Bank, N.A., 432 B.R. 812 (B.A.P. 9th Cir., June 30, 2010). The automatic stay is an injunction which arises upon the filing of a bankruptcy proceeding. Among other things, it prohibits attempts to collect a debt which arose prior to bankruptcy or to exercise control over property of the bankruptcy estate.
Wells Fargo's Policy
Every night, Wells Fargo compares newly-filed bankruptcy cases to its list of account holders. If one of its account holders files Chapter 7 bankruptcy, Wells Fargo places an administrative freeze upon the account and sends a letter to the Chapter 7 trustee requesting instructions on disposition of the funds. Wells Fargo does this regardless of whether any money is owed to Wells Fargo.
In the Mwangi case, the debtors did not owe any money to Wells Fargo. They initially disclosed that they had only $1,300.00 in their Wells Fargo accounts. After Wells Fargo froze the accounts, they amended their schedules to disclose $17,075.06 and claimed 75 percent of this amount as exempt. The Bankruptcy Code allows individual debtors to retain certain property defined by statute as exempt in order to facilitate their fresh start. The debtors then demanded that Wells Fargo release the funds based upon their claim of exemption. When Wells Fargo refused, the debtors filed a motion for sanctions. By the date of the hearing, the exemption had become final. The bankruptcy court ruled that Wells Fargo had not violated the stay. Because Wells Fargo was not a creditor, it could not be attempting to collect a debt through its administrative freeze, the court reasoned. The court also concluded that Wells Fargo was not exercising control over property of the bankruptcy estate.
The BAP Doesn't Like the Bank's Policy
The bankruptcy court's ruling was appealed to the Ninth Circuit Bankruptcy Appellate Panel (BAP). The BAP disagreed with the bankruptcy court's conclusions. It found that the funds were property of the estate, so that 11 U.S.C. § 362(a)(3), which prohibits acts to "exercise control over property of the estate," applied. The court found that continuing to hold the funds constituted exercise of control over property of the estate. The court further found that the debtors had standing to assert the violation of the stay because they had an inchoate interest in the funds as a result of their claim of exemption. The panel wrote:
Wells Fargo asserts that it did not exercise control over property of the estate. We disagree. Wells Fargo could have paid the account funds to the trustee; it did not. Wells Fargo could have released the account funds claimed exempt to the Appellants when demand was made; it did not. Wells Fargo could have sought direction from the bankruptcy court, by way of a motion for relief from stay or otherwise, regarding the account funds; it did not. Instead, it chose to hold the funds until a demand was made for payment that it alone deemed appropriate. If that is not "exercising control over" the funds, we don't know what is. (Emphasis added.)
. . .
The impact of Wells Fargo's national policy is to turn on its head the balance between rights of parties legislatively created. As a result of the policy, every party, except Wells Fargo, whose rights are impacted by the administrative freeze will need to take action.
The BAP remanded for a determination of whether the violation of the stay was willful and whether the debtors were entitled to damages.
The BAP Disagrees With Other Courts
The Ninth Circuit BAP's opinion contrasts with the decisions in Wells Fargo Bank v. Jimenez, 406 B.R. 935 (D. N.M. 2008) and In re Calvin, 329 B.R. 589 (Bankr. S.D. Tex. 2005). In each of those cases, the courts found that until the funds became exempt, they were property of the estate. While the trustee could demand that the funds could be turned over to him, the debtors had no similar right until their exemption became final. As a result, both courts found that the debtors lacked standing to enforce the automatic stay and that no violation of the stay had occurred.
Judge Jeff Bohm was sympathetic to the dilemma faced by the bank, writing:
Under the Bankruptcy Act of 1898, entities owing debts, such as the Bank were shielded from liability even if they paid a debtor post-petition as long as the entities were "acting in good faith." (citation omitted). The Bankruptcy Reform Act of 1978 eliminated this provision with the passage of Sec. 542. Entities owing a debt now have exposure to Chapter 7 trustees if payment on the debt is made to the debtor because that debt is owed to the estate until such time as it is abandoned or any exemption becomes final. Under these circumstances, it makes good business sense for the Bank to have instituted a policy that freezes the accounts of depositors who file a Chapter 7 petition. In this manner, the Bank can shield itself from any liability to a trustee while that trustee determines whether the funds are exempt, or nonexempt (or, even if nonexempt, of inconsequential vale to the estate). It is its potential exposure to trustees, not to debtors upon which the Bank must properly focus.
A Big Mess
These cases point out an enormous practical problem. 11 U.S.C. § 541 provides that money in the debtor's bank account is property of the estate. 11 U.S.C. § 542 provides that an entity holding property of the estate "shall deliver to the trustee" the property. But what if the trustee doesn't want the money?
As a practical matter, most funds held by debtors will be exempt or of inconsequential value to the trustee so that the trustee will not administer the asset. Debtors have the expectation that they will continue to be allowed access to the funds since the odds are that they will ultimately receive them. From the trustee's point of view, it is burdensome to hold funds which will not be administered, but potentially more burdensome to recover those funds from the debtor once they have been spent.
At first blush, the bank appears to be an officious intermeddler. It froze the funds even when it had no claim to them. Instead of turning them over to the trustee, it held them. However, Judge Bohm (who was a banker prior to attending law school), has a legitimate point. The Bankruptcy Code says turn over the funds. Recognizing that the trustee might not want the funds, the bank agreed to hold the funds pending direction from the trustee. That direction never came and eventually the funds became the debtors' exempt property.
The Ninth Circuit BAP faulted the bank for not taking a permissible alternate course:
Wells Fargo could have paid the account funds to the trustee; it did not. Wells Fargo could have released the account funds claimed exempt to the Appellants when demand was made; it did not.Wells Fargo could have sought direction from the bankruptcy court, by way of a motion for relief from stay or otherwise, regarding the account funds; it did not. Instead, it chose to hold the funds until a demand was made for payment that it alone deemed appropriate.
While the BAP outlined multiple options, they were not very practical. Paying the funds to the trustee in every case would be burdensome to both the bank and the trustees. Since most cases turn out to be no-asset cases, trustees would likely return the funds in most cases. Freezing the funds and then turning them over to the debtor places the bank at risk if the exemption is not sustained. Seeking direction from the bankruptcy court is also not feasible in large numbers of cases. The only feasible option under the BAP's opinions is not to freeze the funds in the first place.
Wells Fargo filed an appeal to the Ninth Circuit Court of Appeals. Because the BAP's decision was not yet final, the court of appeals dismissed the appeal for lack of jurisdiction in December 2010. As a result, the case will return to the Bankruptcy Court for determination of damages.