CITIZENS BANK OF MARYLAND v. STRUMPF
Legal provision: Bankruptcy Code, Bankruptcy Act or Rules, or Bankruptcy Reform Act of 1978
Argument of Irving E. Walker
Justice Stevens: We'll hear argument in Case Number 94-1340, Citizens Bank of Maryland v. Strumpf.
Mr. Walker, you can proceed when you're ready.
Mr. Walker: Thank you, Justice Stevens, and may it please the Court:
This case presents a single issue involving the interpretation of the Bankruptcy Code, and that issue is whether a bank creditor may refuse a debtor depositor's request to withdraw funds pending a Bankruptcy Court's determination of the bank's right of setoff without violating the automatic stay.
The Court's answer to this question should govern the conduct of nonbank and bank creditors alike, including the United States Government.
The Fourth Circuit held that the bank's refusal to allow the debtor to withdraw funds to the extent of the bank's setoff right, what is referred to commonly as an administrative hold, is tantamount to a setoff.
Unknown Speaker: Mr. Walker, would you mind telling me what your definition is of a setoff?
Mr. Walker: Yes, Your Honor.
Justice O'Connor, a setoff occurs when there is an intention to effect a settlement of mutual debts.
It has several attributes.
One is that the creditor intends to do it.
Two, there is an affirmative action which results in a bank account balance actually being reduced in a corresponding amount.
The bank's claim is reduced, and there is invariably a record evidencing that the setoff occurred.
Unknown Speaker: Is this a matter of Federal law or State law for purposes of this case?
Mr. Walker: Your Honor, I believe it is a matter of Fed... excuse me.
I believe it is a matter of State law consistent with Justice Breyer's view when he was with the First Circuit in the Saugus General Hospital case, that in determining when a setoff occurs, consistent--
Unknown Speaker: We look to State law.
Mr. Walker: --Yes, Your Honor, and there is--
Unknown Speaker: There's no overall Federal meaning of that term for purposes of the Bankruptcy Code.
Mr. Walker: --I do not believe there is, Your Honor.
The Federal Bankruptcy Code, of course, determines what conduct is permissible under the code, and our view is that administrative hold is expressly permitted under section 542(b).
Unknown Speaker: And as a matter of State law in this instance, you think that it depends on the bank's intention?
Mr. Walker: More than that, Your Honor.
Intention would be one factor.
First, I should point out there is no Maryland reported case expressly telling any of us exactly when a setoff occurs, and therefore we look to the general common law and the Federal cases considering nonbankruptcy and State law have generally agreed, at least at the circuit court level and below, with our view of the case, namely that there needs to be an intent, there needs to be an affirmative act to change the status quo, and that's a key point in our case, Your Honors.
An administrative hold, consistent with the purpose behind the automatic stay, accomplishes a preservation of the status quo, and that's quite--
Unknown Speaker: Well, the status quo was changed here.
The bankrupt was able to withdraw funds before the bank's action in freezing the account.
Thereafter, the account was frozen.
Isn't that a change in the status quo?
Mr. Walker: --Yes, Your Honor.
It's a change from the moment before the hold is placed, but the status quo which is most important, Your Honor, is the status quo immediately prior to bankruptcy and the status quo immediately after bankruptcy, and the answer to that question is determined by looking at the depositor's right to withdraw funds under its contract with the bank.
Unknown Speaker: Well, wait.
I thought you said that whether a setoff has occurred depends upon whether there has been a change in the status quo, that there has to be some change in the status quo.
Mr. Walker: That is certainly a factor, yes.
Unknown Speaker: Okay.
Mr. Walker: Where you would--
Unknown Speaker: All I'm saying is that that factor existed here, didn't it?
Mr. Walker: --No, Your Honor, because the way I would measure the change is looking at the debtor's rights prior to bankruptcy to withdraw funds.
That right was conditioned by contract in Maryland law by the bank's right to set off the account upon default.
Unknown Speaker: Yes, but the bank has still gone one step beyond that, because the bank has exercised the right.
That is a change in the status quo.
The bank has said, you can't take the money out, and it hadn't said that beforehand.
Don't you... I mean, it seems to me, I think you have a perfectly reasonable position.
I don't know whether I'm going to ultimately agree with it or not, but it seems to me that you've got to say that the bank's... or concede that the bank's act in instituting the freeze is, in fact, an act that goes beyond mere status quo.
It's an act which on a literal reading offends some of these statues.
And it seems to me that your best argument is to say, well, it just offends them a little bit, and it offends them only to the extent necessary to make sense of this equally valid statutory recognition of the right to set off, that if you don't allow this, the right to set off recognized in the code is nonsense, and try to reconcile, rather than to say, well, the bank is absolutely Simon-pure at all times, and it never literally violates a thing.
It seems to me that that is a more plausible position than to say that, here, for example, the freeze does not affect the status quo.
Mr. Walker: Justice Souter, I agree with your view of it.
You have well and succinctly stated the strength of our case, and namely that section 3--
Unknown Speaker: Well, I didn't mean to be getting into your shoes, but--
Mr. Walker: --I welcome it.
Unknown Speaker: Mr. Walker, would it be fair to say in comparing what this freeze is to what a setoff is that a freeze, a temporary hold, is to a setoff what a TRO is to a permanent injunction?
Mr. Walker: --No, Your Honor.
I would strongly disagree with that.
There is a temporal aspect to it, because an administrative hold is a temporary preservation of the amount of the bank balance, the amount of the bank claim pending bankruptcy court review.
Unknown Speaker: But if there is such a thing as an administrative hold or freeze, as you say that there is under the statute, wouldn't one expect to find some auxiliary rules governing it?
It is... it does have the drastic consequence of preventing the accountholder from cashing checks.
Since it does have that consequence, wouldn't one expect the statute to say, but bank, if you do this, you've got to give the debtor immediate notice that you're doing it so he won't write checks that won't be cashed, you have to tell the court that you're doing it, and get the confirmation of the setoff as soon as possible?
But there's nothing.
There's nothing that tells us what conditions govern this hold.
Mr. Walker: Your Honor, I believe there's very clear language in the Bankruptcy Code itself which tells the Court what governs.
If I may refer the Court to page A7 of our original brief, where the Court will find the statute section 542(b), the language I would specifically refer to is where the creditor is directed to pay such debt to or on the order of the trustee except to the extent that such debt may be offset under section 553.
The phrase "may be offset" clearly indicates it is permissible to withhold payment short of a setoff.
Unknown Speaker: Well, tell me--
--I thought that was part of a turnover proceeding.
That's just when there's a turnover... or am I incorrect about that?
Mr. Walker: I would disagree with that, Your Honor.
It could come up in the context of a turnover proceeding.
We recognize that as a proper way for a debtor who wishes to bring the issue to a head to address the point.
Unknown Speaker: Yes, but Justice Ginsburg's point was you're asking us to establish a mechanism that does not have specific grounding in the statute.
I assume under your freeze theory that you would say the bank has to notify the trustee within a reasonable time, he has to notify the bankrupt, I suppose it can freeze no more than is necessary to cover what it reasonably thinks is the setoff... this is a very sensible theory, but I think Justice Ginsburg's question was directed to, where is its grounding in the code?
And you refer to 542, but I thought that was when there was a turnover proceeding.
Maybe I... correct me if I'm wrong.
Mr. Walker: Justice Kennedy, let me address that, and I'll try to give a more complete answer to Justice Ginsburg.
First, this is really respondent's point, that a court order is required before an administrative hold can be placed.
If there is one point this Court should know the Bankruptcy Code is perfectly clear about, that is when a court order is required.
The Code is replete with instances when an order is required.
In fact, section 542 itself, in subpart (e), refers to a court order.
Payment of professionals, employment of professionals, the code says when a court order is required.
542(b) does not contain any reference to a court order.
Unknown Speaker: Well, can we go back to these... tell me when the bank has a hold, or a freeze, must it immediately notify the debtor and the bankruptcy court?
Mr. Walker: I believe it should Your Honor, and I recognize--
Unknown Speaker: Well, should.
Isn't it must it?
Is there an obligation to... how do we know anything about the notice requirement?
Where do we get it from?
Mr. Walker: --I believe there are requirements, Your Honor.
There could well be requirements under State law.
Unknown Speaker: Suppose there are none because this animal of a freeze or a hold is not part of State law?
Mr. Walker: Then a bank who fails to act reasonably will be vulnerable to the bankruptcy court determining that it violated--
Unknown Speaker: Well, so you can't answer my question, other than to say yes, it should notify the debtor.
In what period of time, immediately, the next day, the day after?
Mr. Walker: --I would say promptly, and I recognize, Your Honor, your point that the code doesn't spell out these details, but this is consistent with many, many aspects of bankruptcy practice in the code and the rules.
Unknown Speaker: How about how much could be frozen?
It was a dispute about whether too much was frozen here.
Mr. Walker: The amount permitted to be held is to the extent of the right of setoff.
If a bank holds too much, then it violates the stay expressly.
Let me also point--
Unknown Speaker: It did in this case, then, it violated the stay in this case?
Mr. Walker: --No, Your Honor.
Unknown Speaker: It held... withheld... it put a hold on more than the amount of the offset, didn't it?
Mr. Walker: Your Honor, at the time of the hold the amount owed was approximately $3,250.
Unknown Speaker: And the hold was $3,500.
Mr. Walker: Yes, Your Honor, but given the history of this case, I would submit that the bank didn't hold enough, given its right to attorney's fees as well, and the bank held not enough to cover the attorney's fees and accruing interest.
Unknown Speaker: Was the attorney's fees part of the setoff?
Is that a liquidated debt?
Mr. Walker: Yes, Your Honor.
It was part of the proof of claim filed by the bank, it was in the computation of the amount of setoff, and the bankruptcy court ironically authorized the setoff in that amount.
Of course, it came too late for the bank because the funds had been removed.
Unknown Speaker: But I take it the ultimate point is, if the bank purports to... if the bank freezes too much, if... in aid of its claimed setoff, it's simply going to be found in violation to that extent of the stay, and it takes its chances.
Mr. Walker: Yes, Justice Souter.
Unknown Speaker: If it asks for too much, it's going to get in trouble.
It may have a lesser setoff than it thought, and it may be in contempt with respect to the difference.
Mr. Walker: Yes, Justice Souter, that's absolutely correct.
Unknown Speaker: --Let me--
--Why are you willing to assume that the bank has to notify?
What would happen if the bank didn't notify?
Mr. Walker: Absent--
Unknown Speaker: What if the burden were all... you know, if you think the debt is owing, you demand it, and at that point you find out whether there's a claimed setoff or not.
Mr. Walker: --Absent notice, Justice Scalia, there could be an issue as to what exactly the bank did, what was it's intention, what was the act.
By notifying the debtor promptly that a hold is in place pursuant to section 542(b) pending the outcome of a pending motion for leave from stay, there should be no question that the automatic stay has not been violated.
Unknown Speaker: But Mr. Walker, there's nothing in the code that requires notification, and I assume that under the scheme as you envision it, the bankruptcy code creates a sort of temporary stalemate in order to enable a creditor having a right of setoff, a potential right of setoff, to take the action to effectuate it, and maybe the burden is on the debtor to file for a turnover order with the bank to get the bank to turn over any moneys being held, and maybe that's how the issue comes up.
Mr. Walker: That is correct, Justice O'Connor.
The Bankruptcy Code does not place the onus of initiating the proceedings on either the debtor or the--
Unknown Speaker: So in other words the debtor just writes a check, and when it bounces he should come in.
He doesn't find out until the check bounces.
Is that your view?
Mr. Walker: --That were possible, but I--
Unknown Speaker: Wouldn't that be normally what would happen, if you didn't tell him there was a hold on the account?
Mr. Walker: --Yes, and that's why I think--
Unknown Speaker: That's why you think a bank ought to give him notice.
Mr. Walker: --That's why I think the bank--
Unknown Speaker: I understood you in effect to say that although the hold itself is not a contempt of court or a violation, if he just... if the bank puts a hold on and then keeps its mouth closed for 30 days or more, it might well ripen into a contempt.
Mr. Walker: --That's... that's--
Unknown Speaker: That's what I thought was your position.
Mr. Walker: --That's possible, Justice Stevens.
I think I can clarify the issues the Court has identified by, let's take this out of the bank-depositor relationship.
Consider the bank as a purchaser of an automated teller machine, and owes money to the debtor but has a breach of warranty claim.
No one would suggest that the automatic stay mandates that the bank pay the disputed claim even though it has a complete defense, and consistent with that, a setoff right is a complete defense under section 542(b).
If the Court were not to agree with our position, some results would occur which I trust almost all would agree are wrong results.
For example, take a landlord with a security deposit.
When a tenant files bankruptcy and is delinquent, is the landlord holding an interest of the debtor's?
It's funds in which the debtor has an interest, but no one I hope would suggest that the landlord upon bankruptcy has to give up the very right he bargained for, which is the security deposit.
Unknown Speaker: Mr. Walker, there's something in the background of this case I don't understand, and maybe you can explain it to me.
What is the standard operating procedure for banks in these situations?
They get notice of the bankruptcy filing.
The debtor, as I understood it, listed the bank as an unsecured creditor.
The bank apparently did nothing until after there was a confirmed plan.
Is that how it usually occurs, that for, what was it, 8 months here, the bank says absolutely nothing?
Mr. Walker: I think, Your Honor, it would be an exaggeration to say what usually occurs because bankruptcy sees it many ways.
Many times, secured creditors will act with great vigilance and speed, and oppose confirmation.
Many times, creditors with security interests don't care about a Chapter 13 plan, and will rely on their lien rights consistent with a long body of case law which says those liens are unaffected, so I would not--
Unknown Speaker: So it didn't matter that the bank was listed as an unsecured creditor.
Since that was not, in fact, the case, the bank could safely ignore it, that characterization.
Mr. Walker: --That's correct, Your Honor.
The only thing it affected is whether the bank was going to be treated under the plan, and there was no requirement that the bank seek to have itself treated under the plan.
If the Court would--
Unknown Speaker: I have one question that, it's... probably you can answer it easily.
542(b) that you refer us to says that an entity that owes a debt must pay the debt to the trustee.
The bank didn't have the obligation to pay the balance of this account to the trustee right away, did it?
Mr. Walker: --No.
Unknown Speaker: Well then, why does this... I don't see how this section enters in.
Mr. Walker: In Chapter 13, Your Honor, there's a section which provides that the debtor is substituted for the trustee in certain rights, and this would be one of them.
Unknown Speaker: All right.
Mr. Walker: With the Court's position, I'll reserve my remaining time for rebuttal.
Unknown Speaker: Mr. Estrada.
Argument of Miguel A. Estrada
Mr. Estrada: Thank you, Justice Stevens, and may it please the Court:
The Bankruptcy Code expressly preserves a creditor's right of setoff, but section 362 of the code stays its exercise pending an orderly determination of the debtor's and creditor's rights.
In our view, the court of appeals was wrong in this case to conclude that the bank exercised its right of setoff and thereby violated section 362 when it froze respondent's bank account pending a judicial determination of its rights.
That freeze was simply a refusal to pay a contract debt that was consistent with the language and the purpose of the automatic stay, and in our view, any other conclusion in this case would render the right of a setoff meaningless.
Let me start with the language of 362(a)(7) on which the court of appeals relied.
A freeze is not a setoff under that provision, because subsection (a)(7) stays the setoff of a prepetition debt.
By using the word setoff without further definition, Congress must have intended to use the word in its ordinary common law meaning, which is... which is one that requires an overt act in order to cancel the competing balances, and that results in the record of that event.
Unknown Speaker: Mr. Estrada, what would your view be if Maryland passed a statue that said, an administrative hold shall be a "setoff" as a matter of Maryland law?
Mr. Estrada: Our view in this case would be entirely identical, Justice Stevens, because in our view for purposes--
Unknown Speaker: You think setoff is defined as a matter of Federal law.
Mr. Estrada: --Yes.
For purposes of section 362 at least, we think it should and is a matter of Federal law, and let me sort of get into that a little bit.
There is no question that the right that is reserved by the code as a substantive matter under section 553 is one that is not conferred by bankruptcy law but it is dependent in some underlying sorts of law that may be Federal or State.
In the cases in which we deal, it will usually be a Federal right, either because of a statute or because of Federal common law.
But for purposes of the stay, the language that Congress chose indicates that Congress was intending to cover certain classes of conduct that were pretty much to be covered uniformly, and it cannot be, for example, that a State that has a quirky law like the... like Pennsylvania had in one of the reported cases, for example, saying that there was an automatic setoff, that that would result in the violation of a stay without any action on the part of the creditor as a matter of law.
As used in section 362, it seems to me more sensible to read the language in its ordinary legal sense, and therefore, until and unless a creditor takes some affirmative act to credit and debit the offsetting balances and to make a record of that event, a setoff has not occurred.
By contrast, a freeze, like the stay itself, merely maintains the status quo by conserving the offsetting balances in the same State until there is a judicial determination of the party's rights.
So it may well be that in some sense the freeze itself is an affirmative act, but it's not one that is an affirmative act in the sense that is relevant here.
Unknown Speaker: But from the point of view of the debtor, the effect is the same.
You're describing differences in accounting, in bookkeeping, for how you mark the setoff as a permanent one, but from the debtor's point of view it means, I have no access to this account.
Mr. Estrada: That may well be, but we don't think that that controls the interpretation of section 362, Justice Ginsburg, because--
Unknown Speaker: With reference to 362, what does 362 conceivably achieve, then?
Mr. Estrada: --Oh, what it does is to try to keep creditors from taking affirmative acts to improve their status vis-a-vis the other creditors, and--
Unknown Speaker: --It seems to me the only affirmative act that they care about is not paying the money.
Isn't that... and that's achieved this way as effectively as by doing what you call a full dress setoff.
Mr. Estrada: --Well, no, because what 362 does not do, Justice Scalia, is that it is not a section for the turnover or payover of... for the turnover of property or the payover of debts.
If that were the case, then a different section of the statute would have no point, because section 542 deals specifically with the circumstances under which a creditor must turn over property to the debtor, or to pay over debts.
Unknown Speaker: Under your theory, before you get to that section, why wouldn't the bank be violating the automatic stay provisions of (4), which is any act to create or perfect or enforce a lien, or (6), any act to collect, assess, or recover a claim?
These are also just incipient, inchoate, incomplete acts, and so they don't... they're not prohibited by those particular sections.
Mr. Estrada: Well, as to (4), it is not really an act in the chain of enforcement of a lien as such.
It is not like the bank purporting to have a judicial sale of any sort of property claimed by the debtor.
Unknown Speaker: It's not creating... it's not creating the lien by the freeze?
Mr. Estrada: No, because the lien was created as a matter of law by section 506(a) of the Bankruptcy Code, which gives--
Unknown Speaker: And now that's (6), any act to collect or assess--
Mr. Estrada: --Under section (a)(6), our answer would be that as a matter of the structure of the code, Justice Kennedy, it cannot be that where the act simply is one of refusal to capitulate to a debtor's assertion of rights and property that that's covered by the State, because it would be entirely alien to our system for Congress to have intended that anyone who's faced with a demand by a debtor to property that is disputed most fold his tents and go home, and that--
Unknown Speaker: --No, but in a literal sense, it is any act, isn't it?
Mr. Estrada: --It is any act.
Unknown Speaker: Sure.
In a literal... and you're saying, you've got to recognize a literal infraction to the extent necessary to preserve what is obviously intended elsewhere to be a recognition of the setoff right.
Mr. Estrada: I agree with the first part of your statement, Justice Souter, but not the second.
It is true that it is any act.
However, the relevant question is whether it is an act that violates the automatic stay, and that--
Unknown Speaker: Oh, I grant you.
In other words, it can literally fall within the term, and still not be a violation.
Mr. Estrada: --It can literally fall within a clause of the automatic stay, but that does not resolve the question whether the rest of that section, read in light of the other applicable sections of the code, indicate that that isolated act was meant to be covered by the language.
Unknown Speaker: Mr. Estrada, I think it's even... your argument is even stronger with respect to subparagraph (3), to exercise control over property of the estate, because the debt is property of the estate, isn't it?
Mr. Estrada: As the case comes to the Court, it is conceded by the parties that the debt is property of the estate.
Unknown Speaker: And would you not agree that the freeze is an exercise of control over that property?
Mr. Estrada: Not within the intended meaning of that section, Justice Stevens.
Unknown Speaker: Saying--
Mr. Estrada: And the answer--
Unknown Speaker: --We have to depart somewhat from the plain language, I guess.
Mr. Estrada: --No, you do not, because as the Court pointed out in Timbers of Inward Forest, the question is not whether one of the lines or subsections in the Bankruptcy Code, read in isolation, might lend credence to a claim under the code, but whether that is a reading that makes sense in light of the code as a whole.
And the plain meaning rule is not a rule of reading isolated sentences in a statute, it is a rule of reading the code in its entirety, and our submission here is that on the facts of this case, where all a creditor has done is to refuse to capitulate to a debtor's assertion of rights and property so that he may present a defense to a proper legal forum, the other provisions of the code, the entire structure of the law makes the reading that respondent suggests implausible.
Unknown Speaker: Can I ask you a side issue, the side issue being the State or Federal law.
I'd worry about having Federal law here simply because you start defining the word setoff in this provision under Federal law, it will have a spillover to other provisions, where surely it should be State.
All the other things like liens are State, the Bankruptcy Code's property definitions are primarily State, and so why should we start saying it's Federal when it sort of mucks up the Code, particularly when you don't need to?
Mr. Estrada: As I said, because in the context of 362, that would make sense.
Unknown Speaker: Yes, but you'd be parsing one thing out of 362, where all of the other property definitions are State, suddenly call this one Federal, and the word setoff appears throughout the rest of the code, and you'd say, oh, those are... I mean, those are State, too, and we don't need to do it.
Mr. Estrada: Except that as used in section 362, the word setoff is not used to describe property but to describe conduct, and in that context it makes sense to deal with a uniform Federal definition, Justice Breyer.
Unknown Speaker: Mr. Schlossberg.
Argument of Roger Schlossberg
Mr. Schlossberg: Justice Stevens, may it please the Court:
In hearing the argument of counsel just now, I'm struck that I think what's being argued for is a different construct of a Bankruptcy Code than what Congress intended.
It seems like I'm hearing that we're supposed to have a creditor in possession, not a debtor in possession, not a Chapter 13 debtor in possession, but that Congress intended that the creditor is supposed to make the determination as to when he may have a lien right and as to when that lien right might well be satisfied by some claim of setoff in some amount that they think is satisfactory to satisfy their claim.
Unknown Speaker: This claim is basically that banks and other people like landlords have to be able to keep the property temporarily, not pay the debt temporarily, until they can run in and get the automatic stay lifted, otherwise, as happened here, the person will run to the bank and he'll withdraw all the money, and that's the last they'll ever see of it.
That's basically their argument.
They say if the word setoff means anything, they have to have at least a temporary freeze, otherwise it's meaningless.
Mr. Schlossberg: Your Honor, two answers to that.
The one is with respect to the way that the bank comes into the bankruptcy court.
The bank can come into the bankruptcy court under a provision crafted by Congress.
Section 362(f) of the Bankruptcy Code says they can come in and get ex parte relief from the order--
Unknown Speaker: But that takes more than an hour, doesn't it?
Mr. Schlossberg: --Yes, Your Honor.
Unknown Speaker: I mean, and so during that hour, the guy runs in and takes all the money out.
Mr. Schlossberg: Your Honor, perhaps that's a possibility.
I would suggest, though, that the bank has until its midnight deadline to respond.
The midnight deadline is the day after presentment of the check.
It does put a burden on the bank, there's no question about that.
I don't suggest for a moment that it doesn't put a burden on the bank.
Unknown Speaker: Well, what do you do with section 542(b)?
You talk about the intent of Congress.
Doesn't Congress seem to want to preserve the ability of individuals to use setoff rights?
Mr. Schlossberg: Yes, Your Honor.
Unknown Speaker: That ability is totally eliminated if you don't allow this temporary freeze.
Mr. Schlossberg: By no means, Your Honor.
With all due respect, what Congress has done in section 542(b), it has said, to the extent that this may be set off under section 553.
This is a tip that we're supposed to go to 553, and 553 starts off and says, except as otherwise provided in this section and in sections 362, nothing in this title affects the right of setoff.
Section 362 when we go through it says, you can't take any right to offset.
Unknown Speaker: You give me an explanation that, I mean, it makes sense, what should I say, physically, but you might as well not have 542(b) if you're going to follow that track.
What good does 542(b) do you?
You tell me, essentially, none.
Mr. Schlossberg: With all due respect, Your Honor, I believe, Justice Scalia, that it does still give protection to the bank, because it tells the bank there's a way to protect your right of setoff but you have to be vigilant.
Congress made a decision that there's two parties here, there's the debtor, there's the creditor, and somebody's got to be vigilant in here.
Someone has to come into court and ask their permission.
The creditor cannot arrogate to itself the right to decide to be its own judge and jury as to the validity of its claim or the validity of its setoff.
Unknown Speaker: Well, it's not doing so.
I mean, it is putting itself in a position in which validity will be determined when the time comes to adjudicate a request to lift the stay.
That's when validity is determined.
Mr. Schlossberg: But in the meantime, Your Honor, the bank in this case, the bank has denied to the debtor the right to the use of his deposits, and that--
Unknown Speaker: That's right, yes, but it is not a final determination of validity.
It is not the equivalent of the final effectuation of the setoff by any means.
Mr. Schlossberg: --No, Your Honor, it's not the final effectuation of the right of the setoff, but it's certainly an interference with the debtor's right to use his property--
Unknown Speaker: Absolutely.
Mr. Schlossberg: --during the bankruptcy.
Unknown Speaker: Absolutely.
Mr. Schlossberg: And in fact, that's what section 362 says that the court cannot... excuse me, that the creditor cannot do.
Section 362 gets pretty broad in its phrasing.
It operates as a stay applicable to all entities of, under subsection (3), any act to exercise control over property of the estate, under subsection (6), any act to collect, assess or recover a claim, or (7), or the setoff of any debt.
Unknown Speaker: It's curious, isn't it, that the setoff under (7) doesn't have the any act provision, does it?
Mr. Schlossberg: I was looking at that last night, Your Honor, trying to reconcile it for myself, and I think it's just in the drafting, because it says, the setoff of any debt--
Unknown Speaker: Well, it is in the drafting, but the drafting occurs in a series in which it presents a definite contrast, and it would suggest that perhaps any act to effectuate the setoff is not meant to be prohibited in the same sense that any act in these other contexts are meant to be prohibited.
That's a reading of the text, isn't it?
Mr. Schlossberg: --That certainly is a reading of the text, Your Honor, but it can't ignore the reading of section (3), subsection (3), which says that also proscribed is any act to exercise control over property of the estate.
Unknown Speaker: Absolutely.
Absolutely, but if you're going to read the sections together, which is what we have to do in construing statutes, there's a pretty darn good argument to say there that any act necessary but not conclusive of effectuating the setoff is not necessarily prohibited.
Mr. Schlossberg: I understand Your Honor's argument.
I would suggest that the Court in Norton looked to exactly this point, and suggested that there's a... there's a trap in the setoff argument that until the third step is taken, that is, that you actually note the books to mark it off, it's not really a setoff.
Now, Norton was decided under Pennsylvania law, but the court in Norton also said it's ridiculous to say that we should wait around and that a creditor can make you wait until they mark off the books, otherwise they could hold their freeze in place forever, exclusively within their control.
Unknown Speaker: Well, not if you can get into court.
Of course they can't hold the freeze in place forever.
Mr. Schlossberg: Well, until someone comes into court.
Unknown Speaker: Yes.
Mr. Schlossberg: Should the debtor have to come--
Unknown Speaker: Yes.
You can go into court and say, I want the dough.
Mr. Schlossberg: --I want the dough because they have taken the dough from me beforehand and said, I can't use my property.
Unknown Speaker: Absolutely, but I'm simply responding to your statement that in fact the bank's autonomous act could endure, in effect, indefinitely.
It can't endure indefinitely.
There is a way of reconciling these two competing kinds of claims.
Mr. Schlossberg: My apologies.
Of course, the debtor can certainly bring this issue to the fore.
The question is, did Congress intend for the debtor to have to bring this to the fore to use his very own property?
Unknown Speaker: Right, and that is the serious question to me, anyway, in this case, is it's not just banks, or even just landlords.
Anybody, anybody might owe money to a bankrupt company.
You might, I might, we get bills every month, and I refuse to believe, at least so far, that if the company goes bankrupt I have to pay my bill no matter what, even if I think they didn't deliver the merchandise.
I mean, I refuse to believe that the ordinary person who owes somebody some money but has a claim against that same person suddenly has to write out the check and pay it just because the debtor went bankrupt.
That's why they put the word offset in here.
That's why you have an offset.
So we're trying to reconcile these provisions, and it would help me if you'd explain why they just can't be reconciled.
Mr. Schlossberg: Your Honor--
Unknown Speaker: Or... yes.
Mr. Schlossberg: --I would like to explain why these can be reconciled in the following context.
In the case we have presented here today, we have a bank on the one hand, we have the Government on the other.
Let's just take what's special about their particular debtor-creditor relationship, as opposed to the garden variety contractor you were just talking about a moment ago.
In the context of the bank, the bank has a special debtor-creditor relationship.
This Court determined what that debtor-creditor relationship was back in 1904 in the New York County Bank case cited in petitioner's brief, interestingly, New York County Bank v. Massey.
In that case, this Court held that the relationship between the bank and its depositor is as follows.
The deposit of money by a customer with his banker is one of loan, with the superadded obligation that the money is to be paid when demanded by a check.
It's not just your ordinary variety contract.
You pay me when it's done, we do what we have to do.
You have to pay me when I draw a check.
Unknown Speaker: Well, do you think the rule that you're advocating is somehow different if the creditor asserting some potential setoff is not a bank?
Mr. Schlossberg: Your--
Unknown Speaker: Is there a different rule?
Mr. Schlossberg: --If the creditor has a special obliga--
Unknown Speaker: I would think it would have to be the same rule.
Mr. Schlossberg: --What I believe, Your Honor, is that if there is a special obligation, an obligation by contract, an obligation implied by court, or provided by statute, as in the case of the Federal Government, then in that event you can't, you the creditor can't unilaterally deny the performance of that obligation.
Unknown Speaker: But why isn't the goal of the Bankruptcy Code here best achieved by creating a stalemate until this issue of right to setoff is properly before the bankruptcy court?
You have to be able to create a temporary stalemate so that the bankruptcy court gets to decide it, otherwise it's too late.
Mr. Schlossberg: Your Honor, it is a very difficult situation that is presented, and it's presented in all the cases.
I don't suggest for a moment that Congress wasn't presented with a difficult task when they had to decide who's going to make this decision.
Unknown Speaker: Well, they made a decision.
They tried to protect the right of setoff.
I don't think it's that difficult.
Mr. Schlossberg: They in fact did, but they said that you have to get relief from the stay before you can set off, and to the extent that you need it in a particular case, you can get ex parte relief.
Unknown Speaker: Well, there wasn't a setoff, as yet.
Who provides the definition of setoff here, the State or the Federal Government?
Mr. Schlossberg: I believe it's a matter of State law, Your Honor.
I agree with Mr. Walker.
Unknown Speaker: Getting back to Justice Breyer's question, and it's the same thing Justice O'Connor's touching on, suppose you have this wholesaler and retailer, and they present... they have accounts going back and forth all the time for returned goods and so forth, I take it from your earlier answer that if the wholesaler owes, that has an offset and the retailer goes bankrupt, the wholesaler can... need not need to pay the retailer's bill for returned merchandise.
Mr. Schlossberg: I think that's correct, Your Honor.
I think that's consistent with the whole history of setoff and bankruptcy.
Unknown Speaker: All right.
Now, the bank is different, because it has a superadded obligation--
Mr. Schlossberg: This Court's words.
Unknown Speaker: --to pay, but does... that superadded obligation is also defined by reference to the bank's right to assert its secured claim, is it not?
Mr. Schlossberg: Yes, Your Honor, but for the fact that the bank's right to assert its secured claim by way of setoff is conditioned by section 362(a)(7), and their right to administratively freeze beforehand is similarly conditioned by section 362(a)(3), certainly, and section 362(a)(6).
Unknown Speaker: Well, I guess we're right back where we're started.
I'm not sure what in the code gives the bank... puts the bank in any worse position, and then you cite the Supreme Court case, and then I say, well, of course there's... that's subject to the setoff, and you say, well, the setoff is controlled by 362, but it seems to me that that puts the bank just on a par with any other creditor.
Mr. Schlossberg: Well, no, the bank's not on a par with any other creditor, because the bank, remembering also that any setting off creditor... any setting off creditor has got a stepped up, a jumped up status over any other unsecured creditor.
Remembering that a setoff claim is, at its very basis, nothing more than an unsecured claim, this is the only unsecured claim that gets paid 100 cents on the dollar in a bankruptcy case, because it gets offset against the claim that the debtor has against that creditor.
It gets paid 100 cents, and Congress has decided that there's a little bit of an obligation, a little conditioning, excuse me, that goes with that right to get 100 cents on the dollar instead of dimes on the dollar, and that is, you've got to come into court first and ask the court for permission to take your 100 cents.
Unknown Speaker: But the other side is telling us Congress didn't decide that.
They're saying Congress decided a different thing, which is quite simple, that reconciles it.
They say if the bank or the landlord or you or I are simply not offsetting, which requires an intent to deprive the person permanently of the money, but rather are simply holding it administratively until such a determination can be made, that does not fit within State law setoff, and that's what this code is after, and they say that reconciles it.
You give notice to show that your intent is not to deprive the person permanently of the money, your intent is simply to see that the administrative determination is made, and that's how they've come in and argued this.
Now, that's... I'm trying to get you to focus on that more than on, you know, the general language here, which I think is ambiguous.
I will concede, Your Honor, that the general... the language in all these statutes we're talking about are difficult to reconcile.
If I may just address one part of your question there, you mentioned again the security deposits, and I think I'd be remiss if I didn't point out why this is particularly a red herring.
A security deposit is a deposit in which the debtor does not have immediate rights.
The debtor doesn't have the immediate right to get back his security deposit.
It's held as security.
It's locked up.
It's just like the secured credit card that's argued in the brief of one of the amicus counsel, one of the bank counsel who have argued that they have a secured credit card, and that if you rule in favor of David Strumpf in this case, you will somehow undermine their ability to give secured credit cards.
The difference is, again, that security deposit put up to the landlord, put up to the bank for the secured credit card, does not have in it any right of the debtor to take the money out at any time to draw on it by a check.
That's why that is not the same kind of situation as is presented where, with Citizens Bank, they have a superadded obligation to honor my checks when drawn, or, in the instance of the Federal Government, when it has a statutory obligation to refund overpayments made back to the taxpayer.
Now, your garden variety creditor, the guy on a contract, the two... manufacturer you just talked about and his vendee, do not have that same situation.
There is not a superadded obligation.
There is not a statutory imposition of an obligation to make a payment on a date certain.
Now, that I see as a very important distinction and difference between the two situations.
Your Honor, I submit that what we have in this case is something of an Alice-in-Wonderland scenario.
The suggestion is made here, sentence first, verdict afterwards.
We'll seize the property first, then we'll figure out if we have an entitlement to it.
That's not what Congress intended.
Congress set up a scheme for taking this theory of setoff under consideration.
It's a careful scheme.
It's one which requires a creditor to come into the bankruptcy court and seek relief from the stay, ex parte if necessary, get that relief, and then take the action that they're entitled to take.
Could you tell me what... how the bankruptcy act would have a different effect from the effect that you say it now has if section 542(b), the last portion of it, were eliminated, except to the extent that such debt may be offset under section 553 of this title.
Suppose that were just totally eliminated.
Would not the bankruptcy act do, without that, exactly what you say it does with it?
Mr. Schlossberg: With... without that clause involved, Your Honor--
Unknown Speaker: What is the function, in other words, that you assert that clause has?
Mr. Schlossberg: --That clause has a function when brought before the court in the context of, let's take the ex parte motion as suggested in Patterson.
If the ex parte motion is made, the bank can say, I bring this money in, I'm paying it into court because I want to offset it.
I don't want to have to give it to the debtor under section 542.
Unknown Speaker: 553 would achieve that purpose, wouldn't it?
Mr. Schlossberg: That they have the right of setoff?
Unknown Speaker: Yes.
Mr. Schlossberg: Yes, Your Honor, I think that it would--
Unknown Speaker: I think it would, too.
Mr. Schlossberg: --provide that to them as well.
Unknown Speaker: And therefore, I don't see anything that this except clause does unless it does what the petitioner here says.
Mr. Schlossberg: Well, I think what it does, Your Honor... what section 542 says is, you've got to give a debtor the property he needs to operate his estate from day one.
We're trying to keep businesses going.
We're trying to keep individual consumer debtors, such as David Strumpf, able to make his mortgage payment and buy food, so you've got to give him his property for this purpose.
You've got to turn it over to him, except to the extent that you may have some other rights.
Go over here and look at section 553.
Do you have some rights under section 553?
Yes, I do have some rights, but I can't get those rights unless I go and get permission to exercise them first.
Unknown Speaker: But this is a turnover provision.
It says, you don't have to turn over except... it has that except clause, and you're saying, even with the except clause, you have to turn over.
Your only protection is, at the end of the day, if you've brought it before the bankruptcy court in the proper fashion, you will be allowed your setoff.
Mr. Schlossberg: Justice--
Unknown Speaker: But to achieve that, all you need is section 553.
You do not need this special protection in the except clause of 542(b).
Mr. Schlossberg: --Well, section 553 does not set out any affirmative obligation on the bank to turn over property.
Section 553 sets out the bank's right to protect its property.
Unknown Speaker: Yes.
Mr. Schlossberg: Section 542 without the clause would say, you must turn over property... all property must be turned over to the debtor.
Now, what Congress is saying, reconcile these two clauses together.
That's why that it's included, 542 and 553 must be reconciled together.
And then again, Congress has said, but you can't read section 553 in a vacuum.
You have to read it and reconcile it with section 362.
By including the last clause in section 542(b), I believe Congress is directing that there is a reconciliation to be made between 542 and 553, even though they seem to be reconcilable if you take the clause out.
Unknown Speaker: There would be no need for reconciliation, because once you've gone in and had the automatic stay to the extent that it operates against the setoff eliminated, there's nothing more to be done.
You don't... it seems to me you don't need 542(b), because then the provision of 543 that has a prologue, except as otherwise provided in 362, it would no longer apply.
362 would be no longer applicable.
You've gotten the stay eliminated insofar as your ability to set off is concerned.
362 has no application, and therefore you're entitled to assert your setoff.
All of that is achieved by section 553 alone.
Mr. Schlossberg: Section 553 alone, with the inclusion of the introductory clause--
Unknown Speaker: Yes.
Mr. Schlossberg: --does, in fact, provide that protection, but the question then becomes, what was the obligation of the bank to turn over property?
That is then set out in section 542.
I believe, Your Honor, that we could resolve this issue without the inclusion of the final clause in section 542(b).
I concede that.
However, the difficulty in reconciling these provisions makes clear that Congress intended that 542... read it with 553, not just, take this one and we'll go see what it conflicts with.
We've thought about this, they're telling to the courts.
Congress is saying, we have thought about this, and you should bring these two together and reconcile them in making a decision as to whether or not to permit a setoff in any particular setting.
If Your Honors have no further questions, I'll complete.
Thank you, Your Honor.
Unknown Speaker: Thank you.
Mr. Walker, you have about 2 or 3 minutes remaining, about 3 minutes.
Rebuttal of Irving E. Walker
Mr. Walker: Thank you, Justice Stevens.
Respondents liken an administrative hold to seizing property.
That is absolutely incorrect.
This Court recognized in Bank of Marin v. England that the funds in the bank account belong to the bank, not the depositor.
When the bank places an administrative hold on the account, all it is doing is simply refusing to pay its debt to the depositor to the extent of the right of setoff.
There is no basis in the code, contrary to respondent's position, to treat financial institutions worse than every other class of creditors.
Maryland law certainly doesn't, and the respondent's answers to this Court's questions today have been inconsistent, depending on the question, and the only reconciliation of those positions is that financial institutions are not entitled to be treated, under the code, like other creditors, but that is not the case.
The legislative history indicates that the Congress thought about financial institutions and the right of setoff, and they wanted to preserve it for a policy reason.
They didn't want banks to act precipitously in anticipation of a possible bankruptcy and by a setoff actually cause more bankruptcies to occur.
If the lower court's decision is upheld, it would have that effect of encouraging precipitous action by banks.
This Court recognized in Studley v. Boylston National Bank, that the doctrine of setoff is based on the absurdity of making A pay B when B owes A.
The Bankruptcy Code does not require this Court to make that absurdity the law of this land.
Unknown Speaker: Mr. Walker, do you distinguish the position of the bank in any way from the position that Mr. Estrada was representing?
That is, the position of the IRS that has... where the taxpayer is due a refund, but on the other hand is alleged to owe the Government money?
Mr. Walker: No, Your Honor.
I believe they are the same.
Where there are mutual debts, assuming there are mutual debts, both the Internal Revenue Service and the bank would have a right under 542(b) to withhold payment.
Unknown Speaker: Under your theory of the case and the interpretation, what happens if the bank is wrong about its setoff?
Mr. Walker: They will be held liable under section 362(h) in an appropriate case.
Unknown Speaker: Would they be in contempt?
Mr. Walker: Yes, Your Honor.
They would be in contempt, subject to damages and attorney's fees.
In fact, the irony in this case is, after the bankruptcy court granted my client, Citizens Bank, the right to exercise its setoff, it was too late, because the bank had already been sanctioned, and that's how we got here.
Unknown Speaker: Would they be in contempt if they acted in good faith, I mean, they just happened to be wrong?
Mr. Walker: That is an interesting question.
In my own view, I would say that if the bank acted in good faith, the bankruptcy court would have the discretion not to hold them in contempt of court, but that would be up to the bankruptcy court on a case-by-case basis.
If I have any time remaining, I would just respectfully point out that section 363(a)(3), which does have, indeed, broad language about exercising property of the estate, does not prohibit a creditor from refusing to pay a debt under section 542(b).
If there are no further questions, thank you very much.
Justice Stevens: Thank you, Mr. Walker.
The case is submitted.