Business Solutions Client Alert: Banks Can Freeze Funds During Exemption Objection Period Without Violating Automatic Stay

In In re Mwangi, No. 12-16087 (9th. Cir. August 26, 2014), the United States Court of Appeals for the Ninth Circuit addressed the issue of whether a bank violates the automatic stay set forth in Bankruptcy Code section 362 when it freezes a Chapter 7 debtor’s account pending resolution of the debtor’s claim that funds in the account are exempt from bankruptcy proceedings. The Ninth Circuit held that the bank did not violate the automatic stay, and that the debtor could not assert a plausible injury resulting from the alleged stay violation.

The Mwangi debtors, Eric Mwangi and Pauline Mwicharo, filed a voluntary Chapter 7 bankruptcy petition. The debtors held accounts at Wells Fargo Bank. Shortly after the petition was filed, Wells Fargo placed a “temporary administrative pledge” on the funds in debtors’ accounts. The pledge acted as a freeze on the debtors’ accounts. After freezing the accounts, Wells Fargo contacted the trustee concerning the distribution of account funds, and informed the trustee that the funds would be frozen until it either received orders from the trustee, or until 31 days after the Bankruptcy Code section 341 meeting of creditors. The debtors claimed that the funds in the frozen accounts were exempt from the bankruptcy proceedings. Wells Fargo refused the debtors’ requests to lift the freeze. The debtors filed a motion in bankruptcy court for Wells Fargo’s alleged intentional violation of the automatic stay set forth in Bankruptcy Code sections 362(a)(3) and (a)(6).

The filing of a bankruptcy petition automatically creates an estate that includes all of the debtor’s legal and equitable interests as of the case’s commencement. The debtor is required to surrender all estate property to the trustee. However, the debtor may claim certain exemptions by listing all property he claims as exempt. The Bankruptcy Code provides that any claimed exemption is deemed exempt if no party objects within 30 days after the Section 341 meeting of creditors is held, or within 30 days after an amendment to the list of exempted claims. The Mwangi debtors claimed the Wells Fargo funds were exempt from the proceedings under a Nevada statute exempting 75% of their disposable earnings. None of the debtors’ creditors objected to the claimed exemption within the 30 day objection period.

In rejecting the debtors’ arguments that Wells Fargo’s freeze violated the automatic stay, the Ninth Circuit noted that the frozen account funds remained estate property until the end of the 30 day period for creditors to object to the debtors’ claimed exemption. When funds are property of the estate, debtors have no right to possess or control such funds. Thus, the debtors could not assert any injury as a result of the freeze. Further, once the 30 day period for objection to the claimed exemption expired, the funds in the frozen account were deemed exempt, and were no longer part of the estate. Funds that are not part of a bankruptcy estate are not afforded protection of the automatic stay provisions of Bankruptcy Code section 362. The Ninth Circuit therefore held that the debtors could not assert a claim against Wells Fargo for violation of the automatic stay.

Because of In re Mwangi, banks are permitted to place a freeze on a debtor’s bank accounts pending resolution of exemption claims. When banks choose to freeze a debtor’s accounts in this way, creditors can be assured that a debtor will not be permitted to access and dispose of funds to the detriment of creditors who have claims against the debtor’s estate.

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September 3, 2014