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

)

No. 94-1340 |

In The

Supreme Court of the United States

October Term, 1994

a

CITIZENS BANK OF MARYLAND,

Petitioner,

V.

DAVID STRUMPF,

Respondent.

S

Petition For Writ Of Certiorari

To The United States Court Of Appeals

For The Fourth Circuit

+

BRIEF AMICI CURIAE IN SUPPORT OF

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

¢

Joun H. Cutver III

Counsel of Record

Amy L. PritcHarp

KENNEDY COVINGTON

Lospett & Hickman, L.L.P.

NationsBank Corporate Center

Suite 4200

100 North Tryon Street

Charlotte, North Carolina 28202-4006

(704) 331-7400

Counsel for NationsBank, N.A.

(Carolinas), NationsBank, N.A., and

The First National Bank of Maryland

COCKLE LAW BRIEF PRINTING CO. 225-6964

OR CALL COLLECT (402) 342-

BEST AVAILABLE COPY

got

i

QUESTION PRESENTED FOR REVIEW

Whether a bank creditor may refuse a bankrupt

depositor’s request to withdraw funds pending deter-

mination by the bankruptcy court of the bank’s setoff

rights, without violating the bankruptcy stay under 11

U.S.C. § 362(a).

Il.

ii

TABLE OF CONTENTS

Page

INTEREST OF THE AMICI CURIAE......... 1

SUMMARY OF ARGUMENT ................ 4

ARISUBEENT «os... cknseccded st0dbeeeheeee 4

A. Special and important reasons support the

issuance of the writ in this case......... 4

1. The decision furthers a conflict among

jurisdictions that impedes the ability

of banks to engage in interstate bank-

AM. oc cc vencidancene seinen aseenunes 5

a. Jurisdictions are currently divided

as to permissibility of the adminis-

trative freeze pending relief from

the automatic stay............... 5

b. The widespread conflict among

jurisdictions increases the costs of

developing and managing inter-

state branch banking ............ 9

2. The decision improperly discriminates

against bank creditors by creating an

artificial distinction between banks

and all other creditors that may owe

MONS 00 GENUS ooo csccapskcnaeens 12

B. The question presented by the petition is

an important question of federal law.... 16

BV. CORDES sn cnnccccnddubuse keaseeneneues 20

TABLE OF AUTHORITIES

Page

Cases

Citizens Bank of Maryland v. Strumpf, 37 F.3d 155

SE RN Chews niGeeges wscscesceceras passim

In re Archer, 34 B.R. 28 (Bankr. N.D. Tex. 1983)...... 13

In re Davis, 889 F.2d 658 (5th Cir. 1989), cert. denied

RE EE Gi cbcwesscccceensscece 5, 7, 16, 18

In re Edgins, 36 B.R. 480 (9th Cir. BAP 1984) ..8, 16, 18

In re Ehrman, 171 B.R. 683 (Bankr. D. Ariz. 1994)..... 8

In re First Conn. Small Business Investment Co., 118

B.R. 179 (Bankr. Conn. 1990)............ a He Un a “4

In re Fulghum Construction Corp., 23 B.R. 147

(Bankr. M.D. Tenn. 1982) ........... , seth nate din’ 2 ¢ 15

In re G.S. Omni Corp., 835 F.2d 1317 (10th Cir.

Ls oun nin dh eWie ge cee pec 14

In re Patterson, 967 F.2d 505 (11th Cir. 1992)...5, 7, 17, 18

In re Suncrete Corporation, 21 C.B.C. 2d 185 (Bankr.

ees tke de ce cceceticeereccccces 14

In re Williams, 61 B.R. 567 (Bankr. N.D. Texas 1986) . .8, 18

In re Windmill Farms, Inc., 70 B.R. 618 (9th Cir. BAP

1987) rev'd on other grounds 841 F.2d 1467 (9th

EEE NL SSE LECCE CTT TEE TT EEO TET TEES 8

Keller v. Fredicktown Savings Institute, 66 A.2d 924 -

RES PES FEST Veer ee Peer CEE ET Ee 6

New York County National Bank v. Massey, 192 U.S.

ASE Waie daub b is seh pbapy esd sererccenccns 6

Posey v. Internal Revenue Service, 156 B.R. 910

tice wavs se’cipcccasicerecddba 14

iv

TABLE OF AUTHORITIES - Continued

Page

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

36S Gos Cle, WO indie os tein vd es teases 5, 6, 7

United States v. Norton, 717 F.2d 767 (3rd. Cir.

MEP PPrrTTiTitet. Ty Te ee 5, 6, 7, 8

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

BGR). occ ccccvccccsespecbeml deeded eubeentesh 5, 6, 7, 8

STATUTES

38 UGA.. B BRR sss ticc dies egal ideieeee passim

BS UDR. § Bic ccc cs di. wei eecthewtleteus passim

BB: DRA BF sou diccacenckaudiscueae 14, 16, 17, 18

SS WR Bs cacnstences cones cis ak ccuemeeeee passim

BS WA, GTO oo os CUS areas bateeeeens passim

SS WE BOs cake ceecddatdenes badhdec bet beneunesn 9

SS WBA. BS TB. 0 <b0cndcose se cen te becabetblansihanmiee 9

ieee Fo ai, Sry See Py ee 13, 18

MISCELLANEOUS

Groschadl, Freezing the Debtor's Bank Account: A

Violation of the Automatic Stay?, 57 Am. Bankr.

Lafe FP CHPMODs os cevocnencaredeetic doves Mhhenndcd 18

H.R. Rep. No. 595, 95th Cong., 1st Sess. 369 (1977) .... 13

H.R. Rep. No. 448, 103 Cong., 2d Sess. 19 (1994)

reprinted in 1994 U.S. Code Cong. & Ad. News

SEED ncneveovcdoncgincdes tadsnkescieeeeeene 10, 11, 12

Vv

TABLE OF AUTHORITIES - Continued

Page

2 James W. Moore & Lawrence P. King, Collier on

Bankruptcy | 363.02 (15th ed. 1994)............... 17

2 James W. Moore & Lawrence P. King, Collier on

Bankruptcy, { 363.04 (15th ed. 1994)............... 18

S. Rep. No. 989, 95th Cong., 2d. Sess., 84 (1978) .... 13

Stephen C. Mount, Note, Standards and Sanctions

for Use of Cash Collateral Under the Bankruptcy

Code, 63 Tex. L. Rev. 341 (1984)...............005. 18

No. 94-1340

e

In The

Supreme Court of the United States

October Term, 1994

+

CITIZENS BANK OF MARYLAND,

Petitioner,

DAVID STRUMPF,

Respondent.

¢

Petition For Writ Of Certiorari

To The United States Court Of Appeals

For The Fourth Circuit

+

BRIEF AMICI CURIAE IN SUPPORT OF

PETITION FOR A WRIT OF CERTIORARI

TO THE UNITED STATES COURT OF APPEALS

FOR THE FOURTH CIRCUIT

°

I. INTEREST OF THE AMICI CURIAE

NationsBank, N.A. (Carolinas), NationsBank, N.A.,

and The First National Bank of Maryland! (collectively

! Pursuant to Supreme Court Rule 29.1, the Banks disclose the

following: The parent company of NationsBank, N.A. and Nation-

sBank, N.A. (Carolinas) is NB Holdings Corporation. NationsBank,

N.A.’s only direct subsidiary (other than wholly owned subsid-

iaries) is Suburban Artery Limited Partnership. NationsBank, N.A.

(Carolinas) has no direct subsidiaries that are not wholly owned.

The parent company of The First National Bank of Maryland is First

the “Banks”) hereby respectfully file their brief amici

curiae in this case. The consent of the attorneys for the

petitioner and the respondent has been obtained.

The United States Court of Appeals for the Fourth

Circuit (the “Fourth Circuit”) in Citizens Bank of Maryland

v. Strumpf, 37 F.3d 155, 157 (4th Cir. 1994) (the “Deci-

sion”), held that a bank violates the automatic stay of 11

U.S.C. § 362(a) by placing an administrative hold on a

debtor’s deposit account while seeking relief from the

automatic stay to exercise the right of setoff. The interest

of the Banks in this case arises from the burden that this

decision places upon their operations. Each of the amici

are regional banks. NationsBank, N.A. and NationsBank,

N.A. (Carolinas) currently operate in more than one state.

NationsBank, N.A. operates in more than one federal

judicial circuit. Because each of the Banks has an interest

in regional banking, they are in a unique position to

delineate the effect the Fourth Circuit's decision will have

on the banking industry.

NationsBank, N.A. and NationsBank, N.A. (Caro-

linas) are national banking associations with banking

operations in Maryland and the District of Columbia for

NationsBank, N.A. and North Carolina and South Caro-

lina for NationsBank N.A. (Carolinas). Both banks are

direct subsidiaries of NB Holdings Corporation, which

owns other banking associations in Florida, Georgia, Ken-

tucky, Tennessee, Texas, and Virginia. The First National

Bank of Maryland is also a national banking association

Maryland Bancorp. The First National Bank of Maryland has no

direct subsidiaries that are not wholly owned.

with operations in Maryland. Each of the Banks has

numerous customers that live in one state and maintain

bank accounts in another state. The issue of whether a

creditor may refuse to pay debts to a debtor to protect its

right to setoff pending relief from the automatic stay is a

fundamental aspect of post-petition debtor-creditor rela-

tions and is raised in countless bankruptcy cases.

The current conflict among the circuits and among

the various district and bankruptcy courts has serious

consequences for the Banks. For example, NationsBank,

N.A. operates branches in both the Fourth Circuit and the

District of Columbia Circuit. The conflict leaves Nations-

Bank, N.A. with no guidance as to what action to take

when a customer who resides in the District of Columbia

but banks in Maryland files for bankruptcy relief in the

District of Columbia.

Although administrative holds are not prohibited by

the bankruptcy court for the District of Columbia,

NationsBank, N.A. risks a violation of the stay and result-

ing sanctions if it freezes demand deposit accounts in

both jurisdictions. Of course, the debtor/borrower can

effectively circumvent a hold communicated only to

branches located in the District of Columbia by with-

drawing funds from branches located in Maryland. More-

over, as the prohibitions on interstate banking relax, and

banks begin to engage in banking across multiple state

lines, banks will be required to maintain separate systems

for tracking and monitoring demand deposit accounts in

each jurisdiction if the Decision is allowed to stand. The

Banks are in a unique position to address the serious

negative consequences of the Strumpf holding for those

who currently engage in interstate banking and those

who intend to pursue the benefits of recent legislation

permitting banks to operate branches in more than one

state.

Il. SUMMARY OF ARGUMENT

The Decision conflicts with decisions from the Elev-

enth and Fifth Circuits. Moreover, conflicting decisions

regarding the appropriateness of an administrative hold

in a bankruptcy setting are proliferating rapidly in the

lower courts of virtually all circuits, and the need for

guidance from this Court is acute. This conflict directly

burdens banks that currently engage in interstate bank-

ing. The Decision also conflicts with the purposes of the

Interstate Banking Act and will impede the purpose and

intent of that legislation.

The Decision is contrary to both the language and the

policies underlying the United States Bankruptcy Code

(the “Bankruptcy Code”). The opinion, which addresses

those policies in a cursory fashion, fails to address the

tension created by the various sections of the Bankruptcy

Code that create and govern the debtor’s and creditor's

rights in cash collateral. The opinion ignores certain sec-

tions of the Bankruptcy Code that directly create a speci-

fic balance of rights.

lil. ARGUMENT

A. Special and important reasons support the issu-

ance of the writ in this case.

The Decision furthers a division among the courts.

The conflict among jurisdictions will seriously interfere

with the efficient development of interstate banking. Fur-

ther, the decision improperly discriminates against bank

creditors by creating an artificial distinction between

lending institutions and other creditors who possess set-

off rights.

1. The decision furthers a conflict among

jurisdictions that impedes the ability of

banks to engage in interstate banking.

a. Jurisdictions are currently divided as to

permissibility of the administrative

freeze pending relief from the auto-

matic stay.

Although the Fourth Circuit viewed its decision as

one of first impression among circuit courts, it recognized

that several circuit courts have addressed very similar

questions. Citizens Bank of Maryland v. Strumpf, 37 F.3d

155, 157 (4th Cir. 1994). In fact, the circuit courts are

divided as to the issue presented to this Court in the

petition for writ of certiorari (the “Petition”). Cf. Small

Business Administration v. Rinehart, 887 F.2d 165 (8th Cir.

1989), United States v. Reynolds, 764 F.2d 1004 (4th Cir.

1985), United States v. Norton, 717 F.2d 767 (3rd. Cir. 1983)

with In re Patterson, 967 F.2d 505 (11th Cir. 1992) and In re

Davis, 889 F.2d 658 (5th Cir. 1989), cert. denied, 495 U.S.

933 (1990).

The Fourth Circuit held that “an administrative hold

is tantamount to the exercise of the right of setoff and

thus violates the automatic stay.” Strumpf, 37 F.3d at 158.

The crux of the opinion in Strumpf is that the Bankruptcy

Code not only permits, but requires, that the debtor have

use of deposited? funds, which are potentially subject to

setoff, pending a judicial determination of the right of

setoff. Strumpf, 37 F.3d at 158-159. In Norton and Reynolds,

the Courts of Appeals for the Third and Fourth Circuits

each held that the IRS violated the automatic stay by

freezing® funds owed to a debtor in order to preserve its

right to setoff. Norton, 717 F.2d at 771-771; Reynolds, 764

F.2d at 1007. In Rinehart, the Court of Appeals for the

Eighth Circuit similarly determined that the creditor

exercised control over funds of the debtor in violation of

section 362(a)(3) by refusing to turnover funds owing to

the debtor. Rinehart, 887 F.2d at 169.

The analysis employed by the courts in each of these

cases is nearly identical. Each court focused almost exclu-

sively on the relationship between sections 362 and 553 of

? Depositors commonly misperceive the nature of a bank

deposit. It is well established that a general bank deposit creates

a debtor-creditor relationship between the bank and the deposi-

tor. The bank simply owes a debt to the depositor which is

payable on demand. New York County Nat'l Bank v. Massey, 192

U.S. 138 (1904); Keller v. Fredicktown Sav. Inst., 66 A.2d 924, 925

(Md. 1949).

> A freeze, an administrative freeze, or a hold is nothing

more than a bank’s way of communicating that it declines to pay

its debts to a depositor. Unlike smaller businesses, financial

institutions face significant communicative and technological

difficulties in manifesting an intent not to pay. When a bank

determines that it does not wish to pay all or a portion of a debt

that it owes to a depositor, then the bank must notify every teller

at every branch in every state where it has operations as well as

all Automatic Teller Machines (“ATMS”). The only way that a

bank can accomplish this is by electronically coding its com-

puters. This electronic coding is commonly referred to as an

“administrative freeze” or an “administrative hold.”

—

7

the Bankruptcy Code and failed to consider section 542(b)

in determining the respective rights of debtor and credi-

tor. See Strumpf, 37 F.3d at 157, n.* (mentioning section

542 in footnote only); Rinehart, 887 F.2d at 168-169;

Reynolds, 764 F.2d at 1006 (creditor’s contention “involves

two sections of the Bankruptcy Code:” sections 362 and

553); Norton, 717 F.2d at 771 (“The interaction of sections

553 and 362 and the precise meaning of the term setoff

form the core issue of this case.”). The Fourth Circuit

relied heavily on Reynolds in its analysis, and also noted

that Norton and Rinehart “are on slightly different facts

but are fully in accord with our decision.” 37 F.3d at 158.

In contrast, the Fifth Circuit has held that a creditor

should not be penalized for refusing to turn funds over to

the debtor pending the final disposition of claims

between the creditor and debtor. Davis, 889 F.2d at

662-663. In Davis, the court noted that creditors should

not be punished for delaying payment until the amount

of claims is finally determined because “otherwise the

right to setoff is worth little more than the book in which

it is found.” Id. at 662. Although the court in Davis did

not specifically rely on section 542, the decision recog-

nizes a creditor’s right to refuse to pay a debt to the

debtor if necessary to protect setoff rights. Id. at 661-662.

Alternatively, the Eleventh Circuit Court of Appeals,

while finding that an administrative hold is not permiss-

ible, encouraged banks to pay funds subject to setoff into

the registry of the court and seek ex parte relief from the

bankruptcy court. Patterson, 967 F.2d at 511. The court in

Patterson noted that this approach would protect banks

from the risk that funds subject to a valid right of setoff

would be dissipated before the entitlement to set off the

funds could be established. Id. This holding is directly

contrary to the conclusion of the Fourth Circuit that a

hold on an account is impermissible because it

“deprive[s] the debtor of the use of the funds pending the

outcome of the motion for relief from stay.” Strumpf, 37

F.3d at 158. Further demonstrating the differences in the

views of the Eleventh Circuit and Fourth Circuit, the

Fourth Circuit also stated that section 362 allows a debtor

to defeat a creditor’s right of setoff. 37 F.3d at 159.

The Bankruptcy Appellate Panel of the Ninth Circuit

has held that a bank may place an administrative hold on

funds subject to setoff prior to receiving relief from stay.

In re Edgins, 36 B.R. 480 (9th Cir. BAP 1984).4 In contrast

to the opinions in Strumpf, Reynolds and Norton, the panel

in Edgins recognized that “[t]his case, despite its simple

facts, involves interaction of the automatic stay of 11

U.S.C. section 362, setoffs under 11 U.S.C. section 553,

turnover of property under 11 U.S.C. section 542(b),

determination of secured status under 11 U.S.C. section

506(a), and use of cash collateral under 11 U.S.C. section

363.” 36 B.R. at 482.

Finally, as noted in the petitioner's brief, widespread

confusion exists at both the district court and bankruptcy

court level on this issue. Bankruptcy courts without guid-

ance from their own circuit or district court cite conflict-

ing authority and devise their own solutions. See e.g. In re

* Decisions by the Bankruptcy Appellate Panel constitute

binding precedent on all bankruptcy courts within the Ninth

Circuit. In re Windmill Farms, Inc., 70 B.R. 618 (9th Cir. BAP 1987)

rev'd on other grounds 841 F.2d 1467 (9th Cir. 1988); In re Ehrman,

171 B.R. 683 (Bankr. D. Ariz. 1994).

—_— =>

==

Williams, 61 B.R. 567, 572 (Bankr. N.D. Texas 1986) (noting

that issue has “sparked intense debate in the courts and

among commentators” and finding hold permissible) and

In re First Conn. Small Business Inv. Co., 118 B.R. 179, 181

(Bankr. Conn. 1990) (noting that issue “has been the

subject of conflicting decisions and commentary” and

finding that hold violates stay). This conflict currently

creates uncertainty for banks operating in districts lack-

ing authority on the issue and increases the legal and

administrative costs incurred when a customer files for

bankruptcy.

b. The widespread conflict among juris-

dictions increases the costs of develop-

ing and managing interstate branch

banking.

The lack of uniform treatment creates practical prob-

lems for banks operating in more than one state. If

freezes are permitted in some jurisdictions but not in

others, then banks must devise methods for allowing

some branches to implement an administrative freeze but

not others. Already this conflict poses difficulties for

regional lenders such as the Banks.5 As interstate branch

banking develops, the lack of uniformity and certainty

> Pursuant to 12 U.S.C. §§ 30 and 36, NationsBank, N.A.

already operates multistate branches in both the District of

Columbia and Maryland, and NationsBank, N.A. (Carolinas)

operates branches in North and South Carolina. These two sec-

tions permit the creation of unified multistate banks so long as

their headquarters are within thirty miles of each state’s bound-

ary. NB Holdings Corporation created NationsBank, N.A. as its

first unified multistate bank in 1994.

10

will become an even more costly problem. As such, the

conflict between jurisdictions runs directly contrary to an

important goal of Congress in passing landmark inter-

state banking and branching laws in 1994.

The Riegle-Neal Interstate Banking and Branching

Efficiency Act of 1994 (the “Interstate Banking Act”) was

passed by Congress in 1994 and will become effective in

September, 1995.° The Interstate Banking Act reversed the

established policy of restricting a bank’s ability to operate

branches in more than one state. H.R. Rep. No. 448, 103

Cong., 2d Sess. 19 (1994) reprinted in 1994 U.S. Code

Cong. & Ad. News 2039, 2042 (hereinafter H.R.Rep. No.

448).

A primary goal of the Congress in passing the Iater-

state Banking Act was to promote greater flexibility and

efficiency in the national banking system. As stated in the

legislative history, “enacting this bill will yield important

benefits to the banking system and to the nation’s econ-

omy. First, it will give banks an opportunity to structure

themselves more efficiently, eliminate duplicative func-

tions, and reduce expenses . . . .” H.R. Rep. No. 448 at 19,

1994 U.S. Code Cong. & Ad. News at 2042, quoting Letter

of Under Secretary of the Treasury Frank N. Newman.

Remarks by Representative Neal and Representative

McCollum further evidence congressional intent to

® The Interstate Banking Act will generally permit bank

holding companies to acquire banks in any state beginning on

September 29, 1995. Beginning in 1997, banks will be permitted

to engage in interstate branch banking through merger or by

establishing new branches in foreign states.

11

improve banking efficiency and expand the geographic

scope of banking operations,

Liberalized interstate banking and branching

laws will also give banks greater organizational

and operational freedom. Currently, the banking

industry is the only industry in the nation in

which corporations are permitted to operate

across state’s lines only if they establish a sepa-

rate company in each state. Many bankers view

this requirement as wasteful, because its man-

dates multiple boards of directors and regula-

tory reports, and forces transactions between

different banks within the same holding com-

pany to be carried out in an arm-lengths man-

esr

H.R. Rep. No. 448 at 19, 1994 U.S. Code Cong. & Ad.

News at 2062. The Congressmen’s remarks also emphas-.

ize the importance of allowing banks to engage in busi-

ness across the country and thus expand the geographic

scope of banking activities. H.R. Rep. No. 448 at 19, 1994

U.S. Code Cong. & Ad. News at 2064.

Absent a resolution of the conflict between jurisdic-

tions on this issue, banks operating branches in more

than one state will face different rules governing the

permissibility of protecting their rights through an

administrative freeze prior to receiving relief from the

automatic stay. Banks will be compelled to identify cus-

tomers who reside in districts permitting administrative

freezes and treat those customers differently than those

who file for bankruptcy in districts where the freeze is

12

not permitted.” The cost of devising a solution to this

problem and the continuing administrative costs of man-

aging duplicate systems are exactly the kinds of costs

Congress sought to reduce or eliminate in introducing

interstate banking.

2. The decision improperly discriminates

against bank creditors by creating an artifi-

cial distinction between banks and all other

creditors that may owe money to debtors.

The Court should grant the Petition because the Deci-

sion treats banks differently from all other creditors in the

absence of a statutory basis for doing so. In failing to

recognize that an administrative hold or an administra-

tive freeze is nothing more than a mere declination of

payment of a debt, the Decision denies statutory rights to

banks that are afforded to other creditors. Specifically, the

Decision treats a bank’s election to exercise its rights

under section 542(b) as a violation of the automatic stay,

while other creditors routinely exercise these rights with-

out penalty.

Under section 542(b), Congress expressly protected

the setoff rights of creditors by providing that although

all creditors are required to pay a debtor immediately

upon demand all sums that they owe, creditors are also

” This task is made more complicated by the number of

potential individual debtors who live in one federal district but

work in another. The legislative history to the Interstate Bank-

ing Act points out that four million Americans commute daily to

and from work across state lines. H.R. Rep. No. 448 at 57, U.S.

Code Cong. & Ad. News at 2057.

13

entitled to refrain from paying any sums owed to the

extent they have setoff rights. Individual and small busi-

ness creditors exercise their rights under section 542(b)

by simply not paying. As a practical matter there is

nothing more they need to do to manifest and effectuate

their intent not to pay on demand; they simply decline to

make a payment.

As discussed above, however, banks encounter sig-

nificantly greater difficulties in manifesting an intent not

to pay because a bank must communicate its election to

decline payment to numerous tellers and ATMS. Absent

the ability to communicate such an instruction to its

branches and ATMS, banks are unable to protect their

rights under sections 542(b) and 553. Once a debtor has

withdrawn funds from a deposit account or permitted

others to withdraw such funds (by continuing to write

checks on such account) then the bank’s right of setoff is

extinguished. U.C.C. § 9-306(2) (1978). See e.g. In re

Archer, 34 B.R. 28 (Bankr. N.D. Tex. 1983) (turnover of

funds extinguished setoff rights although monies consti-

tute cash collateral).

A fundamental policy recognized by the Bankruptcy

Code is parity of treatment among similarly situated

creditors. Section 542 draws no distinction between lend-

ing institutions and other creditors. To the contrary, the

legislative history of section 542 explicitly anticipates that

it will apply to banks. H.R. Rep. No. 595, 95th Cong., 1st

Sess. 369 (1977); S. Rep. No. 989, 95th Cong., 2d. Sess. 84

(1978). The Decision, therefore, violates the express con-

gressional intent behind section 542.

14

Two other sections of the Bankruptcy Code provide

supplemental protection to bank creditors with a right of

setoff. The Bankruptcy Code treats creditors with a right

of setoff as secured to the extent of the amount of their

claim subject to setoff. 11 U.S.C. § 506(a). The Bankruptcy

Code also treats deposit accounts as cash collateral pur-

suant to section 363(a). Debtors are specifically prohibited

from using cash collateral absent consent from the

secured creditor or court authorization after notice and a

hearing. Thus, to the extent that a bank holds a pre-

petition claim against the debtor, section 363 prohibits the

debtor from using the deposits on account. Given the

status of a bank with setoff rights as a secured creditor

under section 506(a) and the additional protection given

to cash collateral by section 363, there is no basis for

concluding that Congress meant to treat banks less favor-

ably than other creditors with setoff rights.

In cases addressing demands for turnover under sec-

tion 542 made on creditors other than banks, courts rou-

tinely recognize the right of a creditor with setoff rights

to refuse a demand for payment by the debtor pursuant

to sections 542(b) and 553. See e.g. In re G.S. Omni Corp.,

835 F.2d 1317, 1318 (10th Cir. 1987) (existence of valid

setoff rights a proper defense to turnover action); In re

Suncrete Corporation, 21 C.B.C.2d 185, 188 (Bankr. M.D.

Fla. 1989) (creditor not required to file proof of claim in

order to assert affirmative defense of setoff in turnover

action); Posey v. Internal Revenue Service, 156 B.R. 910, 916

(W.D.N.Y. 1993) (sections 542(b) and 553 permit creditor

with valid setoff rights to refuse to pay pre-petition debt

to debtor even where proceeds of debt would constitute

exempt property of debtor). There is no suggestion in

15

these cases that the creditors effectuated setoff or other-

wise violated the automatic stay by refusing to pay a debt

to the debtor. See also In re Fulghum Construction Corp., 23

B.R. 147 (Bankr. M.D. Tenn. 1982) (Although creditor

should have filed a motion for relief from stay to present

issue to court early in case, it was nonetheless proper to

assert a right of setoff in answer to turnover complaint.

Trustee not entitled to recover amount owed to debtor

under pre-petition contract where amount owed by

debtor to creditor exceeds amount outstanding on con-

tract).

The administrative hold is the only mechanism avail-

able to a bank to evidence and effectuate its declination to

pay. A bank’s rights are no different than those afforded

to a sole proprietor, or a small business, except that the

refusal to pay is communicated to employees and

machines electronically due to the technological and geo-

graphic demands of a large financial institution. The deci-

sion in Strumpf inappropriately treats banks differently

from other creditors by removing the only way they may

protect their statutory rights. Such disparate treatment is

not contemplated by the statutory language articulated

by Congress, nor is there any secondary evidence of a

Congressional intent to impose such disparate treatment.

Accordingly, the Banks request that this Court grant the

Petition in order to ensure that all creditors possessing

setoff rights receive the same treatment under the Bank-

ruptcy Code.

16

B. The question presented by the petition is an

important question of federal law.

The Banks also request that the Court grant the Peti-

tion because the Fourth Circuit erred in ruling that Citi-

zens violated the automatic stay. The Decision is in error

because it failed to recognize Citizens’ rights under sec-

tion 542, the nature of the frozen funds as cash collateral

and the prohibition impused by the Bankruptcy Code on

the use of such cash collateral.

Section 542(b) requires creditors that owe a debt to

the debtor to pay such debt, except to the extent that the

debt may be offset under section 553 against a claim

against the debtor. 11 U.S.C. § 542(b).8

Thus, section 542(b) permits creditors with a right of

setoff under state law to refuse a demand by the debtor

that the debt be paid. See Davis, 889 F.2d at 661. Although

a creditor must receive relief from stay as a precondition

to setting off amounts owed to the debtor from amounts

owed by the debtor, the creditor is permitted to protect

his right to do so pending a hearing on the matter. Id;

Edgins, 36 B.R. at 483.

If a creditor has a valid setoff right, the Bankruptcy

Code provides that the creditor’s claim is secured to the

“extent of the amount subject to setoff.” 11 U.S.C.

§ 506(a). Financial institutions, whose collateral includes

® Section 553 preserves a creditor's otherwise existing right

of setoff, but prevents a creditor from actually exercising that

right until the creditor has obtained relief from the automatic

stay. 11 U.S.C. § 553(a).

17

“cash collateral,” such as demand deposits, receive spe-

cial protection because of the unique nature of their col-

lateral. 11 U.S.C. § 363. Specifically, debtors are

prohibited from using cash collateral absent consent from

the creditor or court authorization after notice and hear-

ing. 11 U.S.C. § 363(c). Creditors secured by reason of a

right of setoff against a deposit account are included

within the protection of section 363. 2 James W. Moore &

Lawrence P. King, Collier on Bankruptcy | 363.02 (15th ed.

1994).

As ‘noted by the Bankruptcy Appellate Panel in

Edgins, this statutory framework establishes a “stale-

mate” or balance with regard to the funds subject to

setoff. Edgins, 36 B.R. at 483. Neither the creditor nor the

debtor can place those funds permanently out of the

reach of the other without court authority. Id. See also,

Patterson, 967 F.2d at 511. This situation can be altered by

the court upon request of either the debtor (by filing a

motion for permission to use the cash collatera! pursuant

to section 363 or for turnover pursuant to section 542) or

the creditor (by filing a motion for relief from stay). Id.

The Fourth Circuit analyzed the stay issue without

reference to the important rights extended to creditors by

sections 542(b), 506(a) and 363. Although the Decision

notes sections 542 and 506, it makes no effort to apply

those provisions to the facts of the case. Strumpf, 37 F.3d

at 157, n.*. Rather, the Court reviewed only section

362(a)(7) and section 553. In so doing, the Court ignored

the statutory balance created by the Bankruptcy Code.

The Fourth Circuit did not recognize the nature of

the deposit account as cash collateral. In reaching its

18

decision, the court stated that a freeze was tantamount to

an actual setoff because it deprived the debtor of its use

of the funds. 37 F.3d at 158. The court also stated that

pursuant to 362(a)(7), the debtor was permitted to use the

funds, even if this ultimately defeated the creditor's right

of setoff. 37 F.3d at 159. That incorrect premise is directly

contrary to the provisions of section 506(a) and 363.

Edgins, 36 B.R. at 483; See also, Patterson, 967 F.2d at 511.

Under the Decision, banks are now subject to the risk

that they may not obtain the intervention of the courts

until after the funds are dissipated. Even judicial inter-

vention may have little meaning, however, because when

cash is turned over to the debtor and no longer identified,

it may lose its character as cash collateral. See Davis, 889

F.2d at 662; Patterson, 967 F.2d at 511. Once the cash is

commingled with other cash or spent by the debtor, it is

no longer identifiable and may not be subject to the

bank’s security interest. U.C.C. § 9-306(2). This result is

contrary to the statutory language and policy of the Bank-

ruptcy Code. Edgins, 36 B.R. at 483-84. Further, the rule

set forth in the decision invites abuse for which there is

no effective remedy.

% Although prohibited from using cash collateral under the

Bankruptcy Code, not all debtors carry out that statutory duty.

Williams, 61 B.R. at 576; Groschadl, “Freezing the Debtor's Bank

Account: A Violation of the Automatic Stay?,” 57 Am. Bankr. L.J.

75, 77 (1983). The Courts have consistently recognized that there

is no true remedy for a debtor’s wrongful use of cash collateral,

because the cash is gone. This unique risk is explicitly recog-

nized by Section 363. Stephen C. Mount, Note, Standards and

Sanctions for Use of Cash Collateral Under the Bankruptcy Code, 63

Tex L.Rev. 341 (1984); 2 Collier on Bankruptcy, { 363.04 at 363-23.

19

The facts of this case illustrate well the need to

acknowledge the full scope of the statutory framework

established by the Bankruptcy Code. Citizens placed a

hold on a borrower/debtor’s account to the extent of the

approximate amount of its claim against the borrower/

debtor. After placing the hold, Citizens promptly filed a

motion for relief from stay seeking permission to setoff

those funds. The bankruptcy court ultimately determined

that Citizens had a valid right to setoff Mr. Strumpf’s

checking account against its pre-petition unsecured claim.

However, because the court had previously required Citi-

zens to “unfreeze” the funds on hold, by the time the stay

was lifted Citizens could no longer identify the cash that

had been its collateral. As a result, Citizens was left with

an unsecured claim. If the Decision is allowed to stand,

banks will be left without opportunity to enforce rights

granted to creditors by the Bankruptcy Code.

20

IV. CONCLUSION

For these reasons, NationsBank, N.A. (Carolinas),

NationsBank, N.A., and The First National Bank of Mary-

land respectfully request that this Court grant the Peti-

tion for Writ of Certiorari.

Respectfully submitted this 7th day of March, 1995.

JouHN H. Cutver Il

Counsel for Amici Curiae

Of Counsel:

KENNEDY COVINGTON

LospeLt & Hickman L.L.P.

NationsBank Corporate Center

Suite 4200

100 North Tryon Street

Charlotte, North Carolina 28202-4006

(704) 331-7400