The Ninth Circuit Court of Appeals recently ruled that a bank may have to return a borrower’s funds held in an ordinary bank deposit account less than 90 days before the borrower’s bankruptcy.  Because the bank could be considered a recipient of the borrower’s interest in the funds, the deposit may be treated as a “preferential” transfer under the Bankruptcy Code.  

In In re Tenderloin Health, the bank made loans to the debtor. Around one year later, the debtor sold its real property in connection with winding down its operations. After receiving the sales proceeds, the debtor first paid the bank’s loans in full. The debtor then deposited the remaining net sales proceeds into its deposit account at the bank. The debtor filed for bankruptcy fewer than ninety days after paying off the loans and making the deposit. The chapter 7 trustee sued the bank, alleging that the loan payments were “preferential” because they allowed the bank to receive a greater amount than it would have received in a hypothetical chapter 7 case where the payment was not made. The bankruptcy court entered judgment in favor of the bank because the bank had a right of setoff against the deposit. The district court affirmed.

Reversing the lower courts’ rulings, the Ninth Circuit reasoned that the trustee could recover the deposit in the bank’s possession because it constituted a transfer of the debtor’s property, making the bank a transferee against which the estate could recover. By contrast, the Sixth Circuit Court of Appeals reached the opposite conclusion in a recent fraudulent transfer case. In In re Teleservices Group, Inc., the Sixth Circuit ruled that the trustee could not recover deposits held by a bank in a Ponzi scheme precisely because the bank was not a transferee of those deposits.  The Sixth Circuit reasoned that a bank did not become a transferee because the account-holder’s right to withdraw the deposits kept the bank from obtaining dominion and control over them, even where the bank could setoff the deposits.

While these contrasting opinions highlight the unsettled nature of whether a bank may be forced to return ordinary bank account deposits, lenders should keep in mind that the Tenderloin Health decision will govern in those cases filed in California.  Please contact us if you have questions or need assistance in the defense of avoidance actions concerning ordinary bank deposits in possession of the bank.