Contributed by Cristine Pirro
What would a rule be without an exception? In the seminal decision of Citizens Bank of Maryland v. Strumpf, the United States Supreme Court held that a bank’s imposition of a temporary administrative hold on a debtor’s deposit account did not constitute a setoff and did not violate the automatic stay.
The debtor in Strumpf maintained a checking account with a bank and was also in default on the remaining balance of a loan from the same bank. To protect its setoff rights, the bank placed an “administrative hold” on a portion of the debtor’s checking account, refusing to pay withdrawals from the account that would reduce the balance of the account below the sum it claimed was due on the debtor’s outstanding loan. Five days later, the bank filed a motion for relief from the stay and to setoff the unpaid balance of the loan against the contents of the checking account.
The right of setoff allows entities that owe each other money to apply their mutual debts against each other. Although there is no federal right of setoff created by the Bankruptcy Code, section 553(a) provides that (subject to certain exceptions) any right of setoff that otherwise exists pursuant to contract or nonbankruptcy law is preserved in bankruptcy. Under section 362(a)(7) of the Bankruptcy Code, however, the debtor’s filing gives rise to an automatic stay of “the setoff of any debt owing to the debtor that arose before the commencement of the case . . . against any claim against the debtor.” Thus, although a creditor’s prebankruptcy setoff rights are preserved by section 553(a), section 362(a)(7) prevents a creditor from actually effecting a setoff while the automatic stay is in effect.
The principal issue in Strumpf was whether the bank’s refusal to pay its debt to the debtor upon demand constituted an exercise of the bank’s setoff rights in violation of the automatic stay. The Court found that, under the Bankruptcy Code, a setoff can only occur in the presence of the party’s intent to settle accounts permanently. The bank’s imposition of the temporary hold did not constitute a setoff because it did not reflect the bank’s intent to withhold the deposited funds permanently from the debtor. Rather, it was undertaken while the bank sought relief from the automatic stay under section 362(d) to actually (and permanently) setoff the mutual obligations.
The Court further reasoned that a creditor with a right of setoff should not be forced to pay amounts to the estate that are explicitly exempted from payment under section 542(b) of the Bankruptcy Code, which requires all entities owing debts to the estate to pay those debts to the estate except to the extent the debt is subject to setoff. The Court explained that it would be odd to find that the automatic stay requires payment of amounts that section 542 explicitly exempts from payment.
In the wake of the Strumpf decision, it is clear that a bank may place a temporary hold on a debtor’s deposit account pending a motion to lift the automatic stay to exercise valid setoff rights against the debtor, which it should file as quickly as possible. Subsequent decisions have further found that, in line with Strumpf, (i) an indefinite administrative hold constitutes a violation of the automatic stay, and (ii) an administrative freeze on funds deposited in excess of amounts subject to proper setoff constitutes a violation of the stay. If a bank violates the automatic stay by imposing an administrative freeze without first (or promptly thereafter) seeking stay relief from the bankruptcy court, or by freezing more cash than is necessary to protect its right of setoff, the debtor should request enforcement of the stay (or, at the very least, authorization to use such cash collateral under section 363 of the Bankruptcy Code).