Ninth Circuit BAP Finds Wells Fargo Freeze Policy Violates Automatic Stay

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. No. 09-1408, Mwangi v. Wells Fargo Bank, N.A. (Ninth Cir. BAP 6/30/10). The opinion can be found here.(PACER access required).

Wells Fargo's Policy

Every night, Wells Fargo compares cases filed in CM/ECF against its 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. In the Mwangi case, the debtors 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% of this amount as exempt. 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 the funds were property of the estate and that Wells Fargo had not attempted to collect a debt.

The BAP Doesn't Like the Bank's Policy

The Bankruptcy Appellate Panel disagreed. It held that once the Debtors claimed the funds as exempt, they had an inchoate interest in the funds. This gave them standing to assert a violation of Sec. 362(a)(3), which prohibits acts to "exercise control over property of the estate." The Court found that continuing to hold the funds constituted exercise of control over property of the estate. 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.

Slip Op. at 19, 20.

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. As a result, the debtors lacked standing to complain that the bank was withholding funds from the trustee. 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.

In re Calvin at 604.

A Big Mess

These cases point out an enormous practical problem. Sec. 541 provides that money in the debtor's bank account is property of the estate. Sec. 542 provides that an entity holding property of the estate "shall deliver to the trustee" the property. However, 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 freezes the funds even when it has no claim to them. Instead of turning them over to the trustee, it holds them. However, Judge Bohm (who was a banker prior to attending law school), has a legitimate point. The Code says turn over the funds. Recognizing that the trustee might not want the funds, the Bank agrees to hold the funds pending direction from the trustee. Of course, trustees rarely provide that direction because it would be burdensome in administering large numbers of cases.

The Ninth Circuit BAP outlined what it believed to be the Bank's options in this situation:

1. It could have turned the funds over to the trustee. This would be appropriate under the Code, but would overwhelm trustees.

2. It could have turned the funds over to the debtor. This would violate the Code and expose the bank to liability.

3. It could have sought direction from the court. While this would be appropriate, it would be very burdensome to the bank when it had to be done in tens of thousands of cases.

Under the Ninth Circuit BAP's opinion, the only viable option for the bank is to transfer the funds to the trustee whether the trustee wants them or not. Of course, there is another option. Trustees could agree to hold banks harmless for allowing debtors access to funds unless directed otherwise. There is no chance that banks will be able to negotiate agreements with hundreds of panel trustees or the the U.S Trustee's office would allow them to agree to it.

Since all of the options under existing law are bad, it might make sense to go back to the "acting in good faith" standard under the Bankruptcy Act of 1898 and leave the bank out of the picture.