Ryley Carlock & Applewhite

Creditors Rights & Bankruptcy

Court Limits Bank's Administrative Freeze in Bankruptcy

In Strumpf,(1) the Supreme Court held that a bank may place an administrative freeze on a bankruptcy debtor's bank account while the bank pursues relief from the automatic stay to exercise its right of setoff against the account. In the recent case of In re Mwangi,(2) the Ninth Circuit Bankruptcy Appellate Panel ("BAP") held that a bank cannot place an administrative freeze on the debtor's bank account when the bank does not claim a right of setoff, simply because the bank is unsure what to do with the funds.

In Mwangi, the bank placed a temporary administrative freeze on several bank accounts upon learning of the debtors' Chapter 7 bankruptcy filing. As part of its normal procedures, the bank then sent a letter to the Chapter 7 trustee requesting instructions as to whom the bank should send the funds. The trustee never responded. The debtors demanded that the bank release the funds to them, claiming that the funds were exempt. When the bank refused to release the funds without the consent of the trustee, debtors sought sanctions for a willful violation of the automatic stay. The lower court held that the bank did not violate the automatic stay because 1) the funds were exempt and therefore not property of the estate; and 2) the bank was not trying to collect a pre-petition debt.

On appeal, the BAP reversed, holding that the bank violated the automatic stay because it "exercised control" over the account funds when it imposed an administrative freeze. The BAP observed that the turnover provisions of the Bankruptcy Code are automatic and thus, the bank's failure to turn over the funds to the bankruptcy estate improperly shifted the burden to the trustee to demand the return of estate property. According to the BAP, a bank must promptly surrender a debtor's bank account to the bankruptcy estate without awaiting instructions from the trustee to do so. The BAP remanded the case to the lower court to determine whether the bank's retention of the funds in light of the debtors' turnover demand was reasonable and whether the bank should be sanctioned for willfully violating the automatic stay.

The bank faced a dilemma when it received the debtors' turnover demand claiming that the funds were exempt. If the bank had honored the debtors' demand, the bank may have faced liability to the trustee for turning over the funds. The BAP response appears to be that a bank cannot simply hold place an administrative freeze and do nothing; it must promptly release the funds to the trustee or seek direction from the bankruptcy court. The bank's failure to turnover funds in a bank account will constitute an exercise of control of estate property in violation of the automatic stay that may subject the bank to potential sanctions.

For questions regarding the impact and application of the Mwangi holding, please contact a member of our Creditors' Rights and Bankruptcy Practice Group.

1. Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 116 S.Ct. 286 (1995).

2. In re Mwangi, Nos. NV-09-1408-DHPa, 09-24057-BAM 2010 WL 2723204 (9th Cir. BAP. June 30, 2010).

SARE in Bankruptcy Cases

What is the significance of a "single asset real estate" bankruptcy case?

SARE stands for "Single Asset Real Estate" and is used to describe a bankruptcy case involving a debtor that owns a single real estate parcel or project. Specifically, Section 101(51B) of the Bankruptcy Code provides that SARE means real property constituting a single property or project, which generates substantially all of the debtor's gross income and on which no substantial business is being conducted other than the business of operating the real property.

Read our client alert.

Arizona Anti-Deficiency Changes Repealed

On September 4, 2009, Governor Jan Brewer signed a repeal of the new amendment to the anti-deficiency law. This move comes weeks before the new amendment was to take effect.

The amendment had changed Arizona's anti-deficiency law to restrict residential real estate investors and developers from availing themselves of anti-deficiency protection. It would have allowed lenders to pursue deficiency actions against borrowers or guarantors if no certificate of occupancy had been issued for the property, or if the borrower or guarantor had not utilized the property as a one or two family home for at least six consecutive months. Importantly, the new amendment put the burden of proving these conditions on the borrower or guarantor.

The repeal of the amendment has left Arizona's anti-deficiency law unchanged. Now, as before, a lender cannot recover a deficiency following a trustee's sale if the trust property consists of two and one-half acres or less and is limited to and utilized for either a single one-family or single two-family dwelling.

For questions regarding the impact and application of the repeal of the new anti-deficiency legislation, please contact a member of our Bankruptcy, Creditors' Rights, and Real Estate Lending group

New Anti-Deficiency Law in Arizona

Arizona Senate Bill 1271

On July 10, 2009, Governor Jan Brewer signed a new anti-deficiency law that will apply to lenders' deficiency actions brought after completion of a trustee's sale under a deed of trust. The new law will become effective September 30, 2009.

Currently, a lender cannot recover a deficiency following a trustee's sale if the trust property consists of two and one-half acres or less and is limited to and utilized for either a single one-family or single two-family dwelling. This law has been interpreted to extend protection to investors and developers who own such property, even if the property is not used as anyone's permanent residence.

The new anti-deficiency law will limit a borrower/guarantor's ability to seek the protection of the anti-deficiency statute by inserting two additional conditions: 1) a certificate of occupancy must have been issued for the property, and 2) the trustors themselves must have utilized the property as a one or two family home for at least six consecutive months. Importantly for lenders, it is the trustor who must prove that both of these new conditions have been met.

It appears that the new law will allow lenders to pursue a deficiency after completion of trustee's sales of investment properties, rental homes, and spec homes that were never occupied by the trustor. Lenders will also be able to seek a deficiency after trustee's sales of partially completed homes that have not yet been issued a certificate of occupancy.

The new anti-deficiency law does not contain language that limits its application to deficiency actions brought under loans entered into, or trustee's sale started, after September 30, 2009. It is therefore possible that the new requirements will apply to all deficiency actions arising from trustee's sales completed after September 30, 2009, regardless of when the loan transaction or trustee's sale was initiated. There are several additional uncertainties that arise from the enactment of the new law. For questions regarding the impact and application of the new anti-deficiency legislation, please contact a member of our Bankruptcy, Creditors' Rights, and Real Estate Lending group.

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