North American Banking Co. v. Brian Leonard

United States Bankruptcy Appellate Panel
For the Eighth Circuit
___________________________
No. 12-6047
___________________________
In re: WEB2B Payment Solutions, Inc.
lllllllllllllllllllllDebtor
------------------------------
North American Banking Company
lllllllllllllllllllll Plaintiff - Appellant
v.
Brian F. Leonard, Trustee
lllllllllllllllllllll Defendant - Appellee
____________
Appeal from United States Bankruptcy Court
for the District of Minnesota - Minneapolis
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Submitted: February 21, 2013
Filed: March 25, 2013
____________
Before FEDERMAN, Chief Judge, SCHERMER, and NAIL, Bankruptcy Judges.
____________
FEDERMAN, Chief Judge
North American Banking Company (NABC) appeals from the Order of the
Bankruptcy Court1 granting summary judgment in favor of the Chapter 7 Trustee and
ruling that NABC relinquished its possessory lien in account funds when it turned the
funds over to the Trustee without requesting adequate protection of its possessory lien
in such funds. For the reasons that follow, the Order of the Bankruptcy Court is
AFFIRMED.
Factual Background
Debtor WEB2B Payment Solutions, Inc., was in the business of providing
check clearing and payment processing services under contracts with third parties.
The Debtor and NABC were parties to a Remote Deposit Capture Service Agreement
(“Agreement”), under which the Debtor submitted to NABC electronic deposits of
funds captured from checks received by the Debtor and its affiliates. NABC
processed the check transactions on the Debtor’s behalf and immediately credited the
Debtor’s account. Throughout the term of the Agreement, NABC says it routinely
received claims from third parties associated with the Debtor’s check cashing
transactions which were rejected for various reasons. Some of these chargeback
claims were made by the United States Treasury for fraudulent, counterfeit, or forged
Treasury checks. Pursuant to the Agreement, when an item was rejected, NABC was
entitled to recover the funds from the Debtor’s accounts at NABC.
Under the terms of the Agreement, the Debtor assigned “all of its deposit
accounts with [NABC] and any affiliate of [NABC] to [NABC] to secure its
obligations to [NABC] under this Agreement,” and authorized “[NABC] to debit any
account maintained by [the Debtor] with [NABC] or any affiliate of [NABC] and/or
set off any of [the Debtor’s] obligations to [NABC] under this Agreement against any
1
The Honorable Robert J. Kressel, United States Bankruptcy Judge for the
District of Minnesota.
2
amount it owes to [the Debtor], in order to obtain payment of [the Debtor’s]
obligations under this Agreement.” NABC asserts that these contractual provisions
granted it both a security interest in the Debtors’ funds deposited with NABC and
rights of setoff.
The Debtor filed a Chapter 11 voluntary petition on April 4, 2011. As of the
petition date, the Debtor had over $933,000 on deposit in its accounts with NABC.
At the request of the United States Trustee, except for a $27,180.542 postpetition
setoff to cover an overdraft in an another of the Debtor’s accounts, NABC froze the
account shortly after the bankruptcy filing. The case was converted to Chapter 7 on
April 20, 2011, at which point Brian Leonard was appointed as Trustee. He
immediately requested NABC to turn over the funds in the Debtor’s accounts. NABC
responded by proposing that it retain $50,000 of the funds (the “Holdback Funds”)
to cover potential future reclamation requests. NABC arrived at the $50,000 amount
by reviewing the Debtor’s history of reclamation claims and determining that this
amount would be sufficient. On April 21, 2011, prior to NABC’s turnover of any of
the funds from the account, the Trustee agreed to NABC’s proposal regarding the
Holdback Funds. After holding back the $50,000, and retaining the $27,180.54
setoff, NABC turned over $883,120.46 to the Trustee on April 22, 2011. NABC
never asked the Court to order that the Trustee provide adequate protection for any
lien it claimed on such funds by, e.g., providing that the funds turned over remain
impressed with its lien.
Thereafter, NABC continued to set off reclamation claims from the Holdback
Funds until the Holdback Funds were depleted. NABC says that there was an
unanticipated and unprecedented volume and dollar amount of Treasury reclamations
2
Apparently, NABC initially setoff $27,225.54, but it refunded $45.00 in
overdraft fees, for a net setoff of $27,180.54.
3
of tax refund checks which had been processed by the Debtor and deposited into its
accounts with NABC prior to its bankruptcy.
By the summer of 2011, NABC began notifying the Trustee that the
reclamation claims associated with the Debtor’s accounts were significantly larger
than anticipated, and began requesting that a portion of the funds be returned to
NABC to satisfy these claims. The largest single chargeback was for a fraudulent tax
refund check for $363,736.55, which was deposited at NABC on March 17, 2011.
By letter dated November 16, 2011 to the Trustee, NABC claimed a security interest
in the funds it had allowed to be paid over to the Trustee. In a letter dated December
14, 2011, NABC reiterated that it considered itself to have a first-priority lien on the
funds, as well as setoff rights, and stating that it had paid, to date, $512,457.39 to
satisfy the unanticipated reclamation funds. NABC demanded that the Trustee return
the full $883,120.46 to it immediately. The Trustee declined to return any of the
funds to NABC.
On January 31, 2012, NABC filed an adversary proceeding against the Trustee,
seeking a determination that it held a first-priority lien in the funds it had turned over
to the Trustee. Thus, more than nine months after the filing of the bankruptcy case,
NABC filed its first pleading seeking a determination that its possessory lien
continued in the funds it had turned over to the Trustee. The parties filed cross-
motions of summary judgment.
Following oral argument, the Bankruptcy Court held, first, that NABC lost its
contractual right to setoff when it turned the money over, since there were no longer
any funds in its possession to set off. NABC does not contest this part of the Court’s
ruling. In addition, however, the Bankruptcy Court held that NABC also lost its
possessory lien in the funds that were turned over to the Trustee, since NABC failed
to first obtain a Court order granting adequate protection of its possessory lien. It is
this holding from which NABC appeals.
4
Standard of Review
We review the Bankruptcy Court’s grant of summary judgment de novo.3 Rule
56(a) provides that “[t]he court shall grant summary judgment if the movant shows
that there is no genuine dispute as to any material fact and the movant is entitled to
judgment as a matter of law.”4 Here, there is no dispute as to the material facts;
rather, the parties each sought summary judgment based on the application of the law
to those facts. NABC asserts that the Bankruptcy Court erred in its application of the
law. Our review is, therefore, de novo.
Discussion
NABC is correct that a creditor’s secured status is determined as of the date of
the filing of the petition5 and that, absent voluntary release or avoidance by the court,
a secured creditor’s lien generally survives a bankruptcy filing.6 Indeed, in In re
Chaseley’s Foods, upon which NABC relies, the Seventh Circuit agreed with the
secured creditor there that “the filing of a bankruptcy petition fixes a secured
creditor’s rights and that further action to preserve a secured lien is unnecessary and
3
Peter v. Wedl, 155 F.3d 992, 996 (8th Cir. 1998).
4
Fed. R. Civ. P. 56(a), made applicable here by Fed. R. Bankr. P. 7056.
5
See, e.g., Isaacs v. Hobbs Tie & Timber Co., 282 U.S. 734, 738, 51 S.Ct.
270, 272, 75 L.Ed.2d 645 (1931) (recognizing that valid liens existing at the time
of commencement of a bankruptcy proceeding are preserved); In re Cumberland
Molded Prods., LLC, 431 B.R. 718, 722 (B.A.P. 6th Cir. 2010) (“The extent to
which a claim is properly secured in a chapter 7 case is determined as of the
petition date.”).
6
In re Hanson, 132 B.R. 406 (Bankr. E.D. Mo. 1991) (“As a general
matter, a valid pre-petition lien survives bankruptcy even if the obligation that was
the basis for the lien is a dischargeable obligation.”).
5
may even constitute a violation of the 362 automatic stay provisions of the
Bankruptcy Code.”7 Here, it is undisputed that NABC had a contractual security
interest in the account funds and that the security interest was perfected by possession
as of the petition date.8 It is also undisputed that NABC’s lien survived the
bankruptcy filing itself. The parties disagree, however, as to the effect of the turnover
on NABC’s possessory lien.
NABC does not assert that its possessory lien survived the turnover under
Minnesota law – clearly, it did not. Rather, NABC asserts that, by virtue of the
Bankruptcy Code’s § 542’s turnover requirement, and § 362’s automatic stay
provisions, it was required to immediately turn over the funds to the Trustee and that,
pursuant to the United States Supreme Court’s decision in U.S. v. Whiting Pools,
Inc.,9 its lien was preserved.
7
In re Chaseley’s Foods, Inc., 726 F.2d 303, 306 (7th Cir. 1983) (adopting,
as modified, the district court’s opinion holding that the effectiveness of a properly
filed financing statement does not lapse on the expiration of the original financing
statement when there is an intervening bankruptcy).
8
See Min. Stat. § 336.9-312(b)(1) (“a security interest in a deposit account
may be perfected only by control under section 336.9-314”); § 336.314(a) (“[a]
security interest in . . . deposit accounts . . . may be perfected by control of the
collateral under . . . section 336.9-104”); § 336.9-104(a)(1) (“[a] secured party has
control of a deposit account if . . . the secured party is the bank with which the
deposit account is maintained”); and § 336.9-203(a) and (b)(3)(D) (“a security
interest attaches to collateral when it becomes enforceable against the debtor with
respect to the collateral,” which with respect to deposit accounts, occurs when “the
secured party has control under section 336.9-104 . . .”).
9
462 U.S. 198, 103 S.Ct. 2309, 76 L.Ed.2d 515 (1983).
6
NABC cites several cases holding that a properly perfected lien survives
turnover.10 And, in Whiting Pools, Inc., the United States Supreme Court held that
a secured creditor may be compelled under § 542 to turn over collateral in its
possession, but that, if the creditor has a properly perfected security interest, such
creditor is entitled to “adequate protection” for its interest in the property when it is
turned over:
In effect, § 542 grants to the estate a possessory interest in certain
property of the debtor that was not held by the debtor at the
commencement of the proceedings. The Bankruptcy Code provides
secured creditors various rights, including the right to adequate
protection, and these rights replace the protection afforded by
possession.11
NABC asserts that Whiting Pools mandates that it could seek adequate protection
only after turning the money over.12 Of course, NABC never sought such adequate
10
See General Elec. Credit Corp. v. Nardulli & Sons, Inc., 836 F.2d 184,
192 (3rd Cir. 1988) (holding that, because the creditors had properly perfected
liens in equipment prepetition, their rights as a lienholders were superior to those
of the trustee as a hypothetical lienholder under § 544); Goggin v. Division of
Labor Law Enforcement of California, 336 U.S. 118, 119 (1949) (concluding that
secured creditor’s relinquishment of possession of collateral to bankruptcy trustee
did not alter the validity of the creditor’s lien); In re Archer, 34 B.R. 28, 31 (N.D.
Tex. 1983) (concluding that turnover of cash collateral to avoid violation of
automatic stay did not extinguish a security interest which was perfected at the
time of filing).
11
Whiting Pools, 462 U.S. at 207, 103 S.Ct. at 2313 (footnote omitted).
12
462 U.S. at 212, 103 S.Ct. at 2317 (“Section 542(a) simply requires the
[creditor] to seek protection of its interest according to the congressionally
established bankruptcy procedures, rather than by withholding the seized property
from the debtor's efforts to reorganize.”).
7
protection here. NABC also asserts that, under Whiting Pools, its right to adequate
protection – i.e., a continuing lien in the money turned over – automatically replaced
its possessory lien. However, Whiting Pools involved a statutory tax lien, not a
possessory lien,13 so the creditor’s lien remained with the property after it was turned
over to the Trustee. The situation here – where the creditor’s rights are dependent
on possession – was later squarely addressed by the Supreme Court in Citizens Bank
of Maryland v. Strumpf.14
Congress preserved a creditor’s right to setoff in §§ 553 and § 542(b) of the
Bankruptcy Code. In Strumpf, the Supreme Court, recognizing that a bank’s right to
setoff is lost when possession of an account is relinquished, held that a creditor
asserting a right of setoff does not violate the automatic stay by temporarily freezing
the account and seeking a determination from the court, via a motion for relief from
stay or for adequate protection, of the parties’ relative rights to the funds.15
NABC asserts that Strumpf does not apply because it is not asserting its right
of setoff, but is relying instead on its rights under its possessory lien, to which, it
asserts, §§ 553 and 542(b) do not apply. To emphasize the distinction between its
setoff rights and its contractual lien rights, NABC points to In re Cumberland,16
13
A federal tax lien attaches to property when the tax is assessed and exists
regardless of whether a notice of lien has been filed; perfection of an IRS lien “is
completed at the time the IRS files its Notice of Tax Lien” and “a federal tax lien
once filed, follows the property of the taxpayer, no matter into whose hands the
property goes.” Western National Bank, Odessa, Tex. v. U.S., 812 F.Supp. 703,
705 (W.D. Tex. 1993) (emphasis added).
14
516 U.S. 16, 116 S.Ct. 286, 133 L.Ed.2d 258 (1995).
15
Id., 516 U.S. at 19-21, 116 S.Ct. at 289-90.
16
In re Cumberland Molded Prods., LLC 431 B.R. 718 (B.A.P. 6th Cir.
2010).
8
which NABC describes as “nearly identical” to the case at bar. In that case, the
Bankruptcy Appellate Panel for the Sixth Circuit concluded that a bank, holding a
perfected security interest in funds in the debtor’s deposit account when the
bankruptcy case was filed, had priority over the trustee’s hypothetical judicial lien
under § 544, notwithstanding the bank’s postpetition turnover of the deposited
funds.17 Citing Whiting Pools, that court distinguished a bank’s right to setoff from
its rights under a security interest:
While compliance with a turnover request or the release to the trustee by
a creditor holding a secured claim may result in a waiver of the ability
to setoff pursuant to § 553 or § 542(b), it is not a waiver of the
underlying claim nor an avoidance of the underlying security interest.18
However, in every case cited by NABC for the proposition that turnover of
funds does not extinguish the lien, including Cumberland, the creditor’s underlying
security interest in account funds (as opposed to any setoff rights) was perfected by
the filing of a UCC-1, not possession. Indeed, as stated above, Whiting Pools
involved a tax lien, which is not a possessory lien. We view this to be a critical
distinction because, as opposed to a lien perfected by filing or recording – which is
released only upon another affirmative act such as the filing of a release – a
possessory lien is, by definition, released when possession of the collateral is
relinquished. Thus, even in contrast to Chaseley’s Foods, where the creditor simply
failed to file a continuation statement and did not affirmatively give up its lien post-
bankruptcy by, e.g., releasing its lien, NABC did voluntarily and affirmatively release
its lien by operation of law when it relinquished possession.
17
431 B.R. at 724. See also In re Cordle, 187 B.R. 1 (Bankr. N.D. Cal.
1995) (holding that a credit union with a security interest perfected by a UCC-1
would not lose its security interest upon turnover).
18
Id. at 725.
9
In this context, therefore, we view the distinction between a setoff right and a
possessory security interest in account funds to be a distinction without a difference
since in either situation the creditor’s rights in the funds are lost when possession is
given up. Indeed, although it declined to decide the issue, the Supreme Court in
Whiting Pools suggested that the outcome there might be different with a possessory
lien when it noted that “if property is pledged to the secured creditor so that the
creditor has possession prior to any default, [§] 542(a) may not require turnover.”19
Taken together, Whiting Pools and Strumpf provide a roadmap for creditors
whose rights in collateral will be relinquished with possession. Although § 542’s
turnover requirement is self-effectuating and obligates a creditor to turn over
collateral upon demand by a trustee, the Supreme Court has said that a creditor in
NABC’s position – where relinquishment of possession will in and of itself destroy
the creditor’s rights – may withhold turning the collateral over until the bankruptcy
court is able to make a determination as to whether, and to what extent, the creditor
is entitled to adequate protection. This procedure approved by the Supreme Court
enables a secured creditor to both comply with a trustee’s demand for turnover of
assets of the estate, as required by Whiting Pools, but at the same time preserve its
possessory lien in the manner approved in Strumpf. These cases properly place the
burden on the party wishing to preserve its lien, here NABC, to ask the Court to
adequately protect its possessory lien by entering an order providing that such lien
continue in the proceeds being turned over. In that way, the trustee and the unsecured
creditors may be made aware that the funds being held by the trustee are not available
for estate administration and other expenses, without having to go to the expense of
filing an action seeking that determination. In this case, as stated, NABC never did
seek adequate protection, and waited more than nine months before it sought a court
determination that its possessory lien remained in effect after turnover.
19
462 U.S. at 207 n. 14, 103 S.Ct. at 2315 n. 14.
10
Indeed, as the Bankruptcy Court pointed out, NABC did assert its lien and
setoff rights in the funds when the Trustee made demand. Even without obtaining
Court approval, NABC set off over $27,000 to cover an overdraft, and it demanded,
and the Trustee agreed, to allow it to keep the $50,000 Holdback Funds for future
charge-backs. As the Bankruptcy Court held, NABC itself determined the amount it
needed to hold back; there would have been no need to hold back anything if its
possessory security interest automatically remained with the funds after it gave up
possession.
Finally, NABC asserts on appeal that it did not seek relief from the stay or
adequate protection because it was relying on § 552. That statute provides, in
essence, that if a creditor’s prepetition security interest extends to “proceeds,
products, offspring or profits” of its collateral, then the lien extends to such proceeds,
products, offspring, and profits received postpetition. The funds at issue here are not
proceeds, products, offspring, or profits so § 552 does not apply.
Conclusion
For the foregoing reasons, the Bankruptcy Court did not err in holding that
NABC lost its possessory lien when it turned the Debtor’s account funds over to the
Trustee without first seeking adequate protection. The Order of the Bankruptcy Court
granting summary judgment in favor of the Trustee on NABC’s complaint to
determine the validity and priority of NABC’s lien is, therefore, AFFIRMED.
11