Amicus Curiae Brief — Citizens Bank of Md. v. Strumpf

Supreme Court, U, $. |

FILED

No. 94-1340

In the Supreme Court of the E_ CLERK

OCTOBER TERM, 1994

CITIZENS BANK OF MARYLAND, PETITIONER

v.

DAVID STRUMPF

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

BRIEF FOR THE UNITED STATES AS AMICUS CURIAE

SUPPORTING PETITIONER

DREw S. DAys, III

Solicitor General

LORETTA C. ARGRETT

Assistant Attorney General

LAWRENCE G. WALLACE

Deputy Solicitor General

KENT L. JONES

Assistant to the Solicitor General

GARY R. ALLEN

GARY D. GRAY

Attorneys

Department of Justice

Washington, D.C. 20530

(202) 514-2217

-BESTAVAILABLE COPY

QUESTION PRESENTED

Whether the creditor of a debtor in bankruptcy may

withhold payment of a debt it owes to the debtor while

the creditor seeks relief from the automatic stay to

exercise its setoff rights.

(I)

TABLE OF CONTENTS

Interest of the United States ..............ccccccccccececosososesesosesoses

Statutory provisions involved ..............:cccccecceecesseeseeeceeeees

aati icitc a acc itecctntehtcntsenensentensesczereecece

I epsnurence

a cesecvees

EEE

TABLE OF AUTHORITIES

Cases:

B.F. Goodrich Employees Federal Credit Union v.

Patterson, 967 F.2d 505 (11th Cir. 1992) ............... 6, 9, 11, 12

Baker v. National City Bank of Cleveland, 511 F.2.. 1016

EEE ET a

Bank of America v. Edgins, 36 B.R. 480 (Bankr. 9th

a secumannocuceovsvvcveece

Bank of Marin v. England, 385 U.S. 99 (1966) ................

Barnhill v. Johnson, 112 S. Ct. 1386 (1992) ............0..000...

Barrier v. Marine Midland Trust Co., 284 A.2d 418

(Md. a cccucccepes

Campbell v. United ‘States, 889 F.2d 658 (5th Cir. 1989),

cert. denied, 495 U.S 983 (1990) ............cccccccccccecsecereeee

Executive Assoc. v. Southern Nat'l Bank, 24 B.R. 171

a

Flynn, In re, 143 B.R. 798 (Bankr. D.R.I. 1992) ...............

Gazelle, Inc., In re, 17 B.R. 617 (Bankr. W.D. Wis.

EE TES, Se

Gifford, In re, 174 B.R. 231 (Bankr. W.D. Ky. 1994) ........

Horton Dairy, Inc. v. United States, 986 F.2d 286

(8th Cir. 1993) ...... a cevetvcccs

Nee cmueccotececce

IV

Cases—Continued:

Kenny's Franchise Corp. v. Central Fidelity Bank,

= ES. Wl GD Ce MP cn

Gaeke. RE TE We ce ee

Moreira v. Digital Employees Fed. Credit Union,

173 B.R. 965 (Bankr. D. Mass. 1994) ........cccccceccce---......

National Bank vy. Air Atlanta, 74 B.R. 426 (Bankr.

N.D. Ga.), aff’d, 81 B.R. 724 (N.D. Ga. EE

Pittsburgh National Bank v. United States, 657 F.2d 36

CR Gil. TE auchunenastiaeaeiaseaeie oe

Rio v. Army Aviation Ctr. Fed. Credit Union, 83 B.R.

BOD GOLA. FE TD sctisictistiininaetie ee

Sisk v. Saugus Bank & Trust Co. (In re Saugus Gen'l

Hosp., Inc.), 698 F.2d 42 (1st Cir. 1983) ......0.0..0..........

Small Business Administration v. Rinehart, 887 F.2d

aD GERD Gir. TD scisdsistteinarctbenteiteeiie ee

Stephenson v. Salisbury, 967 F.2d 1069 (5th Cir. 1992) ...

Tavormina v. ITT Commercial Fin. Corp. (In re

Aquasport), 115 B.R. 720 (Bankr. S.D. Fla. 1990), aff’d,

155 B.R. 245 (S.D. Fla. 1992), aff’d, 985 F.2d 579 (11th

COD. TETTIED snncsteninesiesiechicsiiisiamiieiaine me

Teamsters Credit Union vy. Lee, 40 B.R. 123 (Bankr.

E.D. Mich. 1984) .............. davessnsoscquntinnlnbeattadaabiidbieeseses

Third Nat'l Bank v. Carpenter, 14 B.R. 405 (Bankr.

T-aPy. SU» SONU : sisnscsedienctansimiininiensata ees

United States v. Bell Credit Union, 860 F.2d 365 (10th

CER, _ TERED chanecistprnidtininiaisiadeiiaahetites din aie eee ces,

United States v. Citizens & Southern Nat'l Bank,

538 F.2d 1101 (5th Cir. 1976), cert. denied, 430 U.S.

FUND CPT OT: sectarie-citnaiiiniiad indiiiiniaiea leiden a

United States v. Inslaw, Inc., 932 F.2d 1467 (D.C. Cir.

1991), cert. denied, 502 U.S. 1048 (1992) .......................

United States v. Nordic Village, Inc., 112 S. Ct. 1011

CEUEEND sdecesiscssvsntncnipineniniingmsiiadiiei asin tsi he La te.

Cases—Continued: Page

United States v. Norton, 717 F.2d 767 (3d Cir. 1983) ...... 2, 7,8

United States v. Reynolds, 764 F.2d 1004 (4th Cir.

SD eitinadnteiibcapetitanliptininitnens dela thteniais dati ete 2, 7, 8, 10

United States v. Whiting Pools, Inc., 462 U.S. 198

CUE ecceabeupbilnuisstiaisbinigalncabite tia SE OS 5

Weems v. United States (In re Custom Ctr., Inc.),

163 B.R. 309 (Bankr. E.D. Tenn. 1994) ......................... 13

Williams v. American Bank of the Mid-Cities, 61 B.R.

Pe CEI. DET, Team, BOG mocroceecccectetereeceeeoeeeeees..... 13

Woloschak Farms, In re, 74 B.R. 261 (Bankr. N.D.

Ohio 1987), vacated, 109 B.R. 736 (N.D. Ohio 1989) ....... 13

Statutes:

Bankruptcy Code, 11 U.S.C. 101 et seq.:

Bk ARSE ee a trae ae 7

ig SISA Era Ne Sa a 5, la

I a as 11

dk. eR ERE ea ae a 11

a) 5 — ee SOR eae Seno 2, 4, 5, 6, 8, 11

ee 7

Oi a 7

2 ae EE area 5, 10, 11, 2a

|. PO Re eae 5

FET TCI 6, 10

Cae 5, 6

Pe 12

TT OEE Bee Rea a 5, 6, 3a

etn a, ROT ee ER a So 6, 11

‘- ¢ FSR ee. saree 4, 6, 7, 8, 10, 11, 3a

OD I Miia a 4, 5,6

| ESET a Saw eee SAO aA 5, 4a

Bankruptcy Reform Act of 1994, Pub. L. No. 103-394,

I a 7

a. 8} eR ee 9

od}. ge SORES a aS 10

Wl WIN SUID dclibnctediidiiisipitiicisbigibiat tan eee at): 10

Vi

Miscellaneous: — Page In the Supreme Court of the Gnited States

4 Collier on Bankruptcy (15th ed. 1994) ........cccccccccccc0---.. 13 OcTo

2 Lawrence P. King et al., Collier on Bankruptcy (2d ed. eo

SEED sercersenwittonbvationeiatiidesntledusiibianiaiiadinediin eat a iMate 5

Paul S. Groschadl, “Freezing” the Debtor’s Bank Account:

A Violation of the Automatic Stay?, 57 Am. Bankr. No. 94-1340

Rede TP TUMIEEL wetithdtoneisteeemeains ceiek eens Entopengndeecseda 9

CITIZENS BANK OF MARYLAND, PETITIONER

v.

DAVID STRUMPF

ON PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

BRIEF FOR THE UNITED STATES AS AMICUS CURIAE

SUPPORTING PETITIONER

INTEREST OF THE UNITED STATES

This case concerns whether, during the period that

the creditor in a bankruptcy case is seeking relief from

the automatic stay to exercise its setoff rights, the cred-

itor may withhold payment of a debt owed to the debtor.

This issue is of subtantial importance to the United

States, whose agencies and instrumentalities are often

creditors under federal programs involving loans, loan

guarantees, contracts, assistance and benefit payments

and tax collection activities. Indeed, two of the decisions

upon which the court of appeals relied in the present case

involved holdings that the United States violated the

automatic stay by withholding a refund of overpaid taxes

(1)

eS ET eT TCR Ne Me SE a PAM Tn Te ee NN DT eT

2

for one year even though the debtor had a larger out-

standing tax liability for a different year. Pet. App. 9, 10,

citing United States v. Reynolds, 764 F.2d 1004 (4th Cir.

1985); United States v. Norton, 717 F.2d 767 (3d Cir.

1983). A third decision relied on by the court of appeals

involved efforts of the Small Business Administration to

offset its loan claim against crop payments due the

debtor from the Department of Agriculture. Pet. App. 7,

citing Small Business Administration v. Rinehart, 887

F.2d 165 (8th Cir. 1989).

As petitioner notes (Pet. 8-23), the lower courts have

reached a variety of conflicting results in addressing

this recurring issue. As a result, federal agencies face

disparate treatment of identical claims arising under

national programs. The United States therefore has a

substantial interest in the resolution of this recurring

conflict.

STATUTORY PROVISIONS INVOLVED

The relevant provisions of the Bankruptcy Code are

reprinted in the appendix to this brief.

STATEMENT

1. Petitioner is a bank conducting business in the

State of Maryland. In 1989, petitioner loaned respondent

approximately $5000. That loan was in default before

respondent filed a petition for relief in bankruptcy under

Chapter 13 in January 1991 (Pet. App. 3). Under Section

362 of the Bankruptcy Code, the filing of the petition in

bankruptcy gave rise to an “automatic stay” of various

types of activity by respondent’s creditors. In parti-

cular, the filing stayed “the setoff of any debt owing to

the debtor that arose before the commencement of the

(bankruptcy] case.” 11 U.S.C. 362(a)(7).

In October 1991, the bank moved for relief from the

automatic stay in order to set off approximately $3200

then in respondent’s checking account against the

remaining balance that respondent owed on the loan.

While the motion for relief from the stay was pending,

the bank placed an “administrative hold” on the balance

of approximately $3500 in respondent’s checking account.

The hold temporarily barred respondent from making

withdrawals from the account. Respondent reacted to

the bank’s “administrative hold” by filing a motion in

bankruptcy court seeking to have the bank held in

contempt of the automatic stay (Pet. App. 4).

The bankruptcy court ruled on debtor’s contempt

motion before addressing the bank’s prior motion for

relief from the automatic stay. The court concluded that

the bank’s “administrative hold” on respondent’s account

represented a “setoff” in violation of the automatic stay

and, as a sanction for violation of the stay, ordered the

bank to pay actual and punitive damages and attorneys’

fees to respondent (Pet App. 34-36). At that time, the

court reserved its ruling on the bank’s motion for relief

from the stay. .

Nineteen days later, the bankruptcy court granted the

bank’s motion for relief from the stay and authorized the

bank to set off respondent’s remaining account balance

against the unpaid loan. By that time, however, there

was nothing left to set off because respondent had

withdrawn all of his funds from the bank (Pet. App. 4-5).

2. The district court reversed the judgment holding

the bank in violation of the automatic stay. The court

concluded that the bank’s temporary freeze of re-

spondent’s account during the period that the bank

sought relief from the automatic stay was not a violation

of the statute (Pet. App. 18-33).

4

3. The court of appeals reversed and reinstated the

bankruptcy court judgment (Pet. App. 1-17). The court

held that a creditor’s administrative freeze of amounts

subject to setoff is “tantamount” (id. at 9) to the exercise

of the right of setoff and therefore violates 11 U.S.C.

362(a)(7). The court reasoned that its holding was

compelled by “the clear and unambiguous language” of

the statute, which prohibits any “setoff” during the

automatic stay (Pet. App. 13-14). The court further

stated that the bank’s actions in freezing a debtor’s

accounts could substantially diminish the debtor’s

chances for successful rehabilitation (id. at 14-15).

Concluding that the automatic stay had been violated by

the bank, the court ordered reinstatement of the award of

actual and punitive damages and attorneys’ fees to

respondent (id. at 15-16).

ARGUMENT

Section 362(a)(7) of the Bankruptcy Code provides an

automatic stay of “the setoff” of any prepetition debt of

the debtor by any creditor. 11 U.S.C. 362(a)(7). The

court of appeals erred in this case in concluding that a

“setoff” occurs whenever a creditor maintains the

status quo by not turning over funds requested by the

debtor. A “setoff” requires an affirmative act by the

creditor; maintaining the status quo is not a “setoff.”

See pages 7-10, infra. Moreover, Sections 542(b) and 553

of the Bankruptcy Code expressly protect a creditor

from the obligation to turn over funds owed to the debtor

to the extent that the creditor claims a right of setoff. A

creditor such as petitioner is not acting in contempt of

the automatic stay by temporarily declining to pay to the

debtor funds that the Bankruptcy Code expressly pro-

vides need not be paid. See pages 10-11, infra.

5

The decision in this case misapplies the interlocking

set of Bankruptcy Code provisions that protect the setoff

rights of bankruptcy creditors. In doing so, the court

has enlarged the continuing disagreement that exists on

the common, recurring question presented in this case.

Review by this Court is needed to resolve this important

conflict among the courts of appeals.

1. a. Several Sections of the Bankruptcy Code are

implicated in this case. In order properly to understand

the automatic stay of “the setoff” of prepetition debts

under Section 362(a)(7) of the Bankruptcy Code, it is

necessary also to consider other applicable provisions of

that Code. In particular, Section 553 of the Code

specifies that, with only two exceptions, the Bankruptcy

Code “does not affect any right of a creditor to offset”

prepetition debts. 11 U.S.C. 553(a). The two exceptions

specified in Section 553 are the automatic stay of “the

setoff” (under Section 362) and the limited right of the

bankruptcy trustee to require payment of a debt secured

by setoff by providing alternative, adequate protection

for the setoff claim (under Section 363). 11 U.S.C.

553(a).' Subject only to those two exceptions, the

1 Section 363 of the Bankruptcy Code permits a debtor in

possession or trustee authorized to operate the debtor’s business to

“use, sell, or lease” property of the estate. Under that provision a

debtor in possession or trustee may demand payment of a matured

debt that is subject to a creditor’s right of setoff in order to “use”

the proceeds of the debt to operate the business. Bank of America

v. Edgins, 36 B.R. 480, 483 (Bankr. 9th Cir. 1984). Since the

proceeds (which secure the creditor’s claim, 11 U.S.C. 506(a)) are

considered “cash collateral” (11 U.S.C. 363(a)), the creditor may

demand “adequate protection” of its interest as a condition of

payment, 11 U.S.C. 363(e). See 2 Lawrence P. King et al., Collier

on Bankruptcy § 363.02, at 363-16 (2d ed. 1994). See also United

States v. Whiting Pools, Inc., 462 U.S. 198, 203-204 (1983). A

debtor or trustee may force payment of a debt that is subject to

6

creditor’s right of setoff is fully preserved in

bankruptcy. Stephenson v. Salisbury, 967 F.2d 1069,

1076 (5th Cir. 1992); B.F. Goodrich Employees Federal

Credit Union v. Patterson, 967 F.2d 505, 508 (11th Cir.

1992). In particular, Section 542(b) of the Bankruptcy

Code specifies that a creditor who owes a debt to the

debtor is not required to “pay” that debt to the extent

that the creditor’s claim represents a setoff against it.

11 U.S.C. 542(b).? A creditor such as petitioner cannot

logically be said to have violated the automatic stay by

temporarily declining to “pay” a debt that Section 542(b)

specifies does not have to be paid at all.

The decision of the court of appeals in the present case

failed to consider this carefully drafted scheme of

interlocking provisions. By forcing the creditor to pay

over the debt first and seek relief from the stay later, the

decision wholly vitiates the right of setoff that Sections

553 and 542 purport to protect; a creditor obviously

cannot set off a claim with a debt that it has already

satisfied.

b. The automatic stay of any “setoff” under Section

362(a)(7) is not designed to defeat the ultimate right of

setoff. Instead, it stays implementation of a setoff

pending an “orderly examination of the debtor’s and

creditor’s rights.” Stephenson v. Salisbury, 967 F.2d at

1076. A creditor may initiate such an “orderly exam-

setoff, but only after notice and hearing at which the creditor

whose claim is secured by the right of setoff may seek adequate

protection. 11 U.S.C. 363(c)(2)(B). If the estate cannot provide

adequate protection, the court cannot force payment to the estate.

11 U.S.C. 363(e).

2 Section 506(a) of the Code provides further protection for the

right of setoff by specifying that a creditor’s claim against the

debtor “is a secured claim” to the extent that it constitutes a setoff.

11 U.S.C. 506(a).

7

ination” by asking the court for relief from the stay.’ 11

U.S.C. 362(d). A creditor who violates the stay by

setting off the mutual debts without first obtaining the

court’s permission, however, may be liable for damages

and attorneys’ fees to any individual injured by the

violation.’ 11 U.S.C. 362(h). In concluding in this case

that a creditor who seeks such an orderly determination

of the right to exercise its setoff has violated the auto-

matic stay, the court misapprehended what a “setoff”

represents.

The crux of the court’s ruling is that the temporary

withholding of a payment on a debt constitutes a “setoff”

to which the automatic stay applies. In reaching that

conclusion, the court relied (Pet. App. 9-10) on its earlier

decision in United States v. Reynolds, 764 F.2d 1004 (4th

Cir. 1985), which in turn had relied on the reasoning of

the Third Circuit in United States v. Norton, 717 F.2d

767 (1983). In Norton, which involved the setoff of a

federal tax overpayment, the Third Circuit noted that

the Bankruptcy Code neither defines the term “setoff”

nor explains when a “setoff” occurs for purposes of the

automatic stay. 717 F.2d at 772. The court chose to look

to Pennsylvania law—rather than to federal internal

revenue law—to determine when a “setoff” of federal tax

liabilities occurs. Jbid. Applying Pennsylvania law, the

court stated in Norton that “retention of a debtor’s funds

3 A trustee or debtor in possession also may initiate an

examination of the creditor’s setoff rights by seeking payment of

the debt under Section 542(b) of the Bankruptcy Code, 11 U.S.C.

542(b).

4 Under recent amendments to the Bankruptcy Code, the

United States is now also liable for damages for a violation of the

automatic stay. See 11 U.S.C. 106(a), as amended by the Bank-

ruptcy Reform Act of 1994, Pub. L. No. 103-394, § 113, 108 Stat.

4106.

8

by a creditor provides sufficient evidence of an intent to

setoff.” Jbid., citing Pittsburgh National Bank v.

United States, 657 F.2d 36 (3d Cir. 1981). Invoking the

analysis of Norton in Reynolds, the Fourth Circuit

stated that it could not find any state or federal law as to

when a “setoff” occurs with respect to tax overpay-

ments. The court nonetheless elected to apply what it

regarded as the “broader rationale” of Norton (764 F.2d

at 1007):

5 Pennsylvania applies a rule of “automatic setoff,” under

which a setoff is said to occur as a matter of law at the moment

that the creditor’s claim matures. See Pittsburgh National Bank

v. United States, 657 F.2d at 38. Even if Pennsylvania law, rather

than the Internal Revenue Code, were the appropriate nonbank-

ruptcy law governing the setoff of federal tax overpayments

(which we dispute, see note 6, infra), the Third Circuit’s rationale

in Norton would be incorrect. Under the “automatic setoff”

doctrine of Pennsylvania, it is the maturation of a debt that, by

operation of law, causes the debt “automatically” to be set off. See

657 F.2d at 38. If that reasoning were applied to a case involving

taxes, a setoff could be said to occur “automatically” the instant

that a tax overpayment was received. If the overpayment was

received before bankruptcy, the setoff would be a fait accompli

before the automatic stay ever arose and there would have been no

stay violation. If, on the other hand, the overpayment was

received after the bankruptcy petition was filed, the automatic

stay would intervene to prevent the setoff from occuring

“automatically” under state law. The state automatic setoff would

be stayed by the federal automatic stay. No violation of the stay

against setoffs could occur, at least not by operation of

Pennsylvania’s automatic setoff doctrine, upon which the Third

purported to rely in Norton. Moreover, refusing to “pay” a debt

for which a setoff exists is specifically authorized by Section 542(b)

of the Bankruptcy Code, 11 U.S.C. 542(b), and thus cannot

represent a violation of the stay against a “setoff” under Section

362(a)(7).

9

If a bank could freeze the debtor’s accounts upon the

filing of a petition in bankruptcy, the debtor’s

chances for successful rehabilitation would be

substantially diminished.

There are two significant defects in the reasoning

applied by the Fourth Circuit in Reynolds and in the

present case.

(i) If, as the court assumes, the term “setoff” in the

Bankruptcy Code is to be defined by resort to non-Code

state or federal law, the general rule is that a setoff

requires (i) a decision to effectuate a setoff, (ii) an overt

act accomplishing the setoff and (iii) a record of the

setoff. See, e.g., Horton Dairy, Inc. v. United States, 986

F.2d 286, 291 (8th Cir. 1993); B.F. Goodrich Employees

Federal Credit Union v. Patterson, 967 F.2d at 513;

United States v. Bell Credit Union, 860 F.2d 365, 369

(10th Cir. 1988); Sisk v. Saugus Bank & Trust Co. (In re

Saugus Gen'l Hosp., Inc.), 698 F.2d 42, 47 (1st Cir. 1983);

United States v. Citizens & Southern Nat’l Bank, 538

F.2d 1101, 1107 (5th Cir. 1976), cert. denied, 430 U.S. 945

(1977); Baker v. National City Bank of Cleveland, 511

F.2d 1016, 1018 (6th Cir. 1975). See Paul S. Groschadl,

“Freezing” the Debtor’s Bank Account: A Violation of

the Automatic Stay?, 57 Am. Bankr. L.J. 75, 76 (1983).°

6 With respect to federal taxes, the Internal Revenue Code

provides a federal “setoff” rule (26 U.S.C. 6402(a)):

In the case of any overpayment, the Secretary * * * may

credit the amount of such overpayment * ** against any

liability in respect of an internal revenue tax on the part of the

person who made the overpayment and shall * * * refund

any balance to such person.

Under the Internal Revenue Code, like the rule generally

applicable under state law, an affirmative act—an exercise of

discretion to credit and refund the balance or to refund in full—

10

That general rule—rather than the exceptional

Pennsylvania rule relied on in Norton—appears

applicable in Maryland, where the dispute in the present

case arose. See Barrier v. Marine Midland Trust Co.,

284 A.2d 418, 424 (Md. 1971). See also note 5, supra.

(ii) More fundamentally, the court’s suggestion that

prompt payment of a setoff is desirable to enhance “the

debtor’s chances for successful rehabilitation” (United

States v. Reynolds, 764 F.2d at 1007) simply ignores

Sections 542(b) and 363 of the Bankruptcy Code. Under

Section 542(b), a creditor in bankruptcy is expressly not

required to “pay” a debt owed to the debtor if that debt

may be “offset” by a claim of the creditor. 11 U.S.C.

542(b). The trustee or debtor in possession may require

a claim that is subject to setoff to be paid to the estate

only by providing the creditor, after notice and hearing,

with alternative, adequate protection for the setoff right.

11 U.S.C. 363(c)(2)(B). See note 1, supra.

A creditor who is not required to “pay” a claim subject

to setoff under Section 542(b) cannot be said to have acted

in contempt of the automatic stay by temporarily

declining to “pay” that claim while seeking judicial

authorization formally to set off the debt. Merely

holding the account in suspense to preserve the setoff

must occur before a setoff has been made. Other statutes

governing governmental “setoffs” similarly contemplate the

taking of affirmative action to accomplish the setoff. See 31 U.S.C.

3716 (“The head of an executive or legislative agency may collect

by administrative offset.”); 31 U.S.C. 3728 (“The Comptroller

General shall withhold paying that part of a judgment against the

United States Government presented to the Comptroller General

that is equal to a debt the plaintiff owes the Government [and]

* * * shall discharge the debt if the plaintiff agrees to setoff

** * or * * * have a civil action brought [to establish the

Government’s claim].”).

11

rights that Sections 363 and 542 of the Bankruptcy Code

expressly protect does not constitute a contempt of the

stay.

2. The courts of appeals have splintered in their

efforts to resolve the common question that this case

presents. The Third and Fourth circuits (in Norton,

Reynolds and in the present case) and the Eighth

Circuit (in Small Business Administration v. Rine-

7 Freezing the debtor’s account while seeking relief from the

stay would not violate aspects of the automatic stay other than

Section 362(a)(7). Some courts have concluded that a freeze would

violate Section 362(a)(3), which stays “any act * * * to exercise

control over property of the estate.” 11 U.S.C. 362(a)(3). Those

courts reason that the bank holds the debtor’s “funds” and that the

freeze deprives the debtor of his right to order disbursal of the

funds. See, e.g., Patterson, 967 F.2d at 511. That view is wrong in

both of its premises. The bank does not hold funds belonging to the

depositor; it owes the depositor a debt. Barnhill v. Johnson, 112

S. Ct. 1386, 1389 (1992); cf. United States v. Nordic Village, Inc.,

112 S.Ct. 1011, 1017 (1992). When the depositor files for

bankruptcy relief, his claim against the bank, not the money in his

account, becomes property of the estate. See Bank of Marin v.

England, 385 U.S. 99, 101 (1966). To the extent an account freeze

is an exercise of control over funds in the account, it is not an

exercise of control over property of the estate. Nor is it an

exercise of control over any right of withdrawal, because the

debtor has no such right. To the extent the account is subject to

setoff, it constitutes cash collateral. The debtor must seek court

permission to withdraw the funds. Jn re Lough, 163 B.R. 586, 588

(Bankr. D. Idaho 1994). .

Likewise, a freeze would not violate the stay under Section

362(a)(6) of “any act to collect [a prepetition debt].” 11 U.S.C.

362(a)(6). Because the Bankruptcy Code specifically protects

setoff rights, preserving the status quo pending determination of

the setoff cannot be construed as an act to collect. If it were, the

provisions of Section 542(b) that specify that a debt “subject to

setoff” need not be paid to the estate would be nullified. See 11

U.S.C. 542(b).

12

hart, supra) have held that a creditor violates the

automatic stay by temporarily withholding payment of

debts for which a setoff is available under state or federal

law. By contrast, the Eleventh Circuit has held that a

creditor does not violate the stay if, upon the debtor’s

demand, the creditor proceeds to the bankruptcy court,

deposits the contested amount and seeks relief from the

stay. B.F. Goodrich Employees Federal Credit Union

v. Patterson, 967 F.2d at 511. The Fifth Circuit, more-

over, has concluded that a creditor does not violate the

stay by refusing a demand to pay a debt to the estate

pending resolution of the creditor’s right of setoff.

Stephenson v. Salisbury, 967 F.2d at 1077; see also

Campbell v. United States, 889 F.2d 658 (5th Cir. 1989)

(court cannot sanction IRS under Section 502(d)—which

authorizes disallowance of uncooperative creditor’s

claim—for refusing to pay debt to estate pending

resolution of IRS’s right to set off), cert. denied, 495

U.S. 933 (1990). Cf. United States v. Inslaw, Inc., 932

F.2d 1467, 1472-1473 (D.C. Cir. 1991) (withholding

property subject to disputed legal claims is not a

violation of automatic stay; such a “view would turn

every act of the possessor that implicitly asserts his

title over disputed property into a violation of § 362(a)

* * * creating a kind of universal end-run around the

limits on turnover”), cert. denied, 502 U.S. 1048 (1992)).*

8 The bankruptcy and district courts are also sharply divided in

their disposition of this issue. Many courts have held that it does

not violate the automatic stay for a creditor temporarily to

“freeze” sums subject to offset and thereafter seek authority

formally to set off the claim. See, e.g., In re Edgins, 36 B.R. at 484;

Rio v. Army Aviation Ctr. Fed. Credit Union, 82 B.R. 138, 143-144

(M.D. Ala. 1986); Kenny's Franchise Corp. v. Central Fidelity

Bank, 22 B.R. 747, 748 (W.D. Va. 1982); In re Gifford, 174 B.R. 231,

232 (Bankr. W.D. Ky. 1994); Moreira v. Digital Employees Fed.

13

This recurring conflict leads to uncertainty and

wasteful litigation. The decisions to date have yielded a

patchwork of inconsistent answers. This disparate

treatment is especially confusing for creditors whose

operations occur in more than one circuit. Moreover, in

the circuits where a clear answer has not yet been

provided, creditors can only speculate as to what steps—

if any—they may take to protect setoff rights without

violating the automatic stay.

This continuing uncertainty has particular signifi-

cance for the federal government. Many federal depart-

ments, agencies and instrumentalities have national

programs affected by this dispute. Agencies of the

Credit Union, 173 B.R. 965, 967 (Bankr. D. Mass. 1994); In re

Lough, 163 B.R. at 588; Weems v. United States (In re Custom

Ctr., Inc), 163 B.R. 309, 319 (Bankr. E.D. Tenn. 1994); Jn re

Briggs, 143 B.R. 438, 445-450 (Bankr. E.D. Mich. 1992); In re

Learn, 95 B.R. 495, 496 (Bankr. N.D. Ohio 1989); National Bank v.

Air Atlanta, 74 B.R. 426, 427 (Bankr. N.D. Ga.), aff’d, 81 B.R. 724

(N.D. Ga. 1987); Williams v. American Bank of the Mid-Cities, 61

B.R. 567, 573-574 (Bankr. N.D. Tex. 1986); Teamsters Credit Union

v. Lee, 40 B.R. 123, 126 (Bankr. E.D. Mich. 1984); In re Gazelle,

Inc., 17 B.R. 617, 620 (Bankr. W.D. Wis. 1982); Third Nat’l Bank

v. Carpenter, 14 B.R. 405, 407 (Bankr. M.D. Tenn. 1981). Accord, 4

Collier on Bankruptcy 4 553.15[6), at 553-87 (15th ed. 1994). Other

courts have held that a creditor’s failure to pay a debt to the estate

(including a bank “freeze” on the debtor’s account) violates the

automatic stay. See, e.g., Hudson v. United States, 168 B.R. 449,

453 (Bankr. S.D. Ga. 1994); In re Midway Indus. Contractor, Inc.,

167 B.R. 139, 143-144 (Bankr. N.D. Ill. 1994); In re Flynn, 143 B.R.

798, 801 (Bankr. D.R.I. 1992); Tavormina v. ITT Commercial Fin.

Corp. (In re Aquasport), 115 B.R. 720, 722 (Bankr. S.D. Fla. 1990),

aff’d, 155 B.R. 245 (S.D. Fla. 1992), aff’d, 985 F.2d 579 (11th Cir.

1993) (Table); In re Woloschak Farms, 74 B.R. 261, 264 (Bankr.

N.D. Ohio 1987), vacated on other grounds, 109 B.R. 736 (N.D.

Ohio 1989); Executive Assoc. v. Southern Nat'l Bank, 24 B.R. 171,

172 (Bankr. S.D. Tex. 1982).

14

United States that lend or collect funds, guarantee

loans, enter into contracts, or distribute grants or

benefits are all subject to the varying treatment that the

circuits have afforded to a creditor’s right of setoff.

Review by this Court is warranted to resolve the

continuing conflict on this common, recurring question.

CONCLUSION

The petition for a writ of certiorari should .e granted.

Respectfully submitted.

DREw S. Days, III

Solicitor General

LORETiA C. ARGRETT

Assistant Attorney General

LAWRENCE G. WALLACE

Deputy Solicitor General

KENT L. JONES

Assistant to the Solicitor General

GARY R. ALLEN

GARY D. GRAY

Attorneys

MARCH 1995

APPENDIX

1. 11 U.S.C. 362 (1988) provides in relevant

part:

(a) Except as provided in subsection (b) of this

section, a petition filed under section 301, 302, or 303

of this title, or an application filed under section

5(a)(3) of the Securities Investor Protection Act of

1970 (15 U.S.C. T8eee(a)(3)), operates as a stay,

applicable to all entities, of—

2.2 2 8

(7) the setoff of any debt owing to the debtor

that arose before the commencement of the case

under this title against any claim against the

debtor * * *.

* *+ *&* *&

(d) On request of a party in interest and after

notice and hearing, the court shall grant relief from

the stay provided under subsection (a) of this section,

such as by terminating, annulling, modifying, or

conditioning such stay—

(1) for cause, including the lack of adequate

protection of an interest in property of such party

in interest; or,

(2) with respect to a stay of an act against

property under subsection (a) of this section, if—

(1a)

2a

(A) the debtor does not have an equity in

such property; and

(B) such property is not necessary to an

effective reorganization.

* + * * *

(h) An individual injured by any willful violation of

a stay provided by this section shall recover actual

damages, including costs and attorneys’ fees, and, in

appropriate circumstances, may recover punitive

damages.

2. 11 U.S.C. 363 (1988) provides in relevant

part:

(a) In this section, “cash collateral” means cash,

negotiable instruments, documents of title, securi-

ties, deposit accounts, or other cash equivalents

whenever acquired in which the estate and an entity

other than the estate have an interest and includes

the proceeds, products, offspring, rents, or profits of

property subject to a security interest as provided in

section 552(b) of this title, whether existing before or

after the commencement of a case under this title.

(b)(1) The trustee, after notice and a hearing, may

use, sell, or lease, other than in the ordinary course

of business, property of the estate.

* * *+ * *

(c)(2) The trustee may not use, sell, or lease cash

collateral under paragraph (1) of this subsection

unless—

(A) each entity that has an interest in

such cash collateral consents; or

3a

(B) the court, after notice and a hearing,

authorizes such use, sale, or lease in

accordance with the provisions of this

section.

= on aa *

(e) Notwithstanding any other provision of this

section, at any time, on request of an entity that has

an interest in property used, sold, or leased, or

proposed to be used, sold, or leased, by the trustee, the

court, with or without a hearing, shall prohibit or

condition such use, sale, or lease as is necessary to

provide adequate protection of such interest.

i Se oe

3. 11 U.S.C. 506(a) provides:

An allowed claim of a creditor secured by a lien on

property in which the estate has an interest, or that

is subject to setoff under section 553 of this title, is a

secured claim to the extent of the value of such

creditor’s interest in the estate’s interest in such

property, or to the extent that the value of such

creditor’s interest or the amount so subject to setoff

is less than the amount of such allowed claim. Such

value shall be determined in light of the purpose of

the valuation and of the proposed disposition or use of

such property, and in conjunction with any hearing

on such disposition or use or on a plan affecting such

creditor’s interest.

4. 11 U.S.C. 542(b) provides:

Except as provided in subsection (c) or (d) of this

section, 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

4a

order of, the trustee, except to the extent that such

debt may be offset under section 553 of this title

against a claim against the debtor.

5. 11 U.S.C. 553(a) provides in relevant part:

Except as otherwise provided in this section and in

sections 362 and 363 of this title, this title does not

affect any right of a creditor to offset a mutual debt

owing by such creditor to the debtor that arose before

the commencement of the case under this title

against a claim of such creditor against the debtor

that arose before the commencement of the case,

* * *