Recent Court Decision Exposes Banks To Preference Liability For Payment Of Overdrafts

Recently, the Eighth Circuit Court of Appeals issued a ruling that overdraft payments advanced by Banks which are later repaid by their customer constitute preferential transfers under the Bankruptcy Code. In re Agriprocessors, Inc., involved a meat packing company which periodically overdrew its bank accounts, and the bank issued provisional credit to cover the overdrafts. The bank initially denominated those overdrafts as “intraday” overdrafts until the midnight settlement deadline, at which point they became “true” overdrafts.

During the 90 days prior to the customer’s bankruptcy filing, the customer transferred funds to the bank to cover both “intraday” and “true" overdrafts. After the customer filed a chapter 7 bankruptcy, the trustee brought a preference action against the bank claiming that the debtor’s repayment of the overdrafts constituted preferential transfers that should be disgorged to the bankruptcy estate.

The Bankruptcy Court rejected the bank’s argument that the overdraft obligations were incurred in the ordinary course of the debtor’s affairs, which is a typical defense asserted by banks in preference actions such as this. The Bankruptcy Court treated the “intraday” and the “true” overdrafts differently. It found that the bank discouraged the true overdrafts, and thus held they were not part of the ordinary course of the bank-customer relationship. It also found that there was an “extreme increase” in the number of overdrafts as the debtor “slid toward bankruptcy’ so that the overdraft debts were “very unusual, not ordinary course debts.”

This decision exposes banks to a new source of preference liability, and is contrary to many prior bankruptcy court decisions which have held that overdraft protection is a routine banking practice, and thus protected by the ordinary course of business defense to preference liability. No other Circuit Court of Appeal has made the distinction between intraday and true overdrafts. The key lesson for banks is to carefully monitor overdrafts and beware of increasing, non-routine overdrafts that may catch the attention of a bankruptcy trustee should a customer end up filing for bankruptcy. In order to avoid preference liability, the more prudent course of action in such situations would be to cease offering overdraft protection for “true overdrafts.”

Ross Adler
Erika Gasaway
Sepi Ghiasvand
Marie Gribble
Mark Heyl
Monique Jewett-Brewster
Steve Kottmeier
Andrew McCarthy
Breck Milde
Liam O'Connor
Chuck Reed
Jay Ross

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