AREN'T CREDITORS USUALLY PREVENTED FROM TOUCHING YOUR BANK ACCOUNT ONCE YOU FILE BANKRUPTY?
Yes. The powerful federal law called the "automatic stay" strictly forbids your creditors from garnishing your checking or savings account from the moment you file a bankruptcy case. In fact, "any act to collect, assess, or recover" a debt by a creditor is forbidden under the Bankruptcy Code. This applies to both Chapter 7 "straight bankruptcy" and Chapter 13 "adjustment of debts."
BUT WHAT IF A CREDITOR HAS A JUDGMENT AND IS GARNISHING MY BANK ACCOUNT?
It doesn't matter. Even if a creditor sued you and got a judgment against you before you filed bankruptcy, it can't grab money in your bank account.
It's true that a judgment by a creditor is a court determination that you owe the debt. And a garnishment delivered to your bank is a court order that the money in your bank account be turned over to the creditor to pay towards the judgment. Nevertheless, federal bankruptcy law's "automatic stay" defeats that court-ordered garnishment. The law explicitly states that the creditor must stop "the enforcement . . . of a judgment obtained before the commencement of the [bankruptcy] case."
IS IT ANY DIFFERENT IF I OWE MONEY TO THE BANK WHERE I HAVE MY CHECKING/SAVINGS ACCOUNT?
Yes, that CAN make a difference.
Money in your account is essentially a debt owed by your bank to you. You are letting the bank hold and use that money while it is sitting in your account, which the bank must pay to you through all the ways that you are allowed to get access your account—by writing a check, using your debit card, withdrawing money through an ATM machine, etc. But if you owe money TO THE BANK—on a credit card, a personal loan, or a vehicle loan, for example—at the same time that the bank owes money TO YOU (the money in your account), the bank may be able to exercise its "setoff" rights. That is, it could setoff, or cancel, its debt to you against your debt to it. In other words, the bank could take money out of your checking and/or savings account to pay itself on your debt to it.
Of course if you are counting on having access to that money in your account, losing it by setoff against what you owe the bank would not be a good thing.
BUT DOESN'T FILING BANKRUPTCY STOP BANK SETOFFS?
It's true that the "automatic stay" does at least temporarily stop "the setoff of any debt owing to the debtor . . . against any [debt of] the debtor." But under certain circumstances the bank may still be able to get permission from the bankruptcy court to exercise its setoff rights. (See my recent blog post called "Can the Bank Take Money from My Account to Pay What I Owe Them?") The easiest and safest way to avoid a setoff when filing bankruptcy is to not have your checking and/or savings accounts at a bank or financial institution where you owe a debt.
HOW ARE BANK'S "ADMINISTRATIVE FREEZES" DIFFERENT?
But what if a person files bankruptcy and DOES have an account at a bank where he or she owes a debt, and the bank does not attempt to do a setoff to pay itself on that debt but instead merely puts a freeze on the account until the bankruptcy trustee, the debtor, and the bank can sort out who should get the money, with the help of the bankruptcy court, if necessary?
I say "merely puts a freeze on the account" but there would be nothing "merely" about it if you needed the money in your account to pay your immediate expenses, and you had no access to it for weeks or even months.
But as you can see from the title of this blog post, a bank's administrative freeze was recently considered acceptable, in a case called Mwangi v. Wells Fargo Bank decided by the Ninth Circuit Court of Appeals, whose rulings apply to all of California and the far western United States.
WHAT WAS THE COURT'S RULING IN MWANGI?
The Court of Appeals determined that the bank did not violate the "automatic stay" when it put a hold on debtors' account funds and "then requested instructions from the Chapter 7 trustee regarding the distribution of account funds," including the 75% of the funds which the debtors had claimed as "exempt," or protected, from the trustee and creditors (under Nevada state law, where the bankruptcy at issue was filed). Even though the exempt part of those funds belong to the debtors as a practical matter, under bankruptcy law the debtors actually only have a legal right to the account funds after the trustee and creditors have had an opportunity to object to the claimed exemption. The deadline for them to object expires on the 30th day after the "meeting of creditors," which itself happens about a month after a Chapter 7 filing. So the debtors in this case could not complain that the bank violated the "automatic stay" and thereby harmed them by holding onto the account funds during that approximately two months.
SO THE RULING WAS NOT ABOUT THE BANK'S SETOFF RIGHT?
No, in this case Wells Fargo Bank explicitly "took no action to collect" its debt by setoff. The debtors owed the bank two debts totaling $52,000. They had four accounts at the bank totaling more than $17,000. The bank was not asking to take the $17,000 in partial payment of the $52,000 owed. Instead it put a hold on the four accounts "until it received direction from the [bankruptcy] trustee."
WHY IS THIS A CRUCIAL DISTINCTION?
The "automatic stay" statute forbids creditors from taking any of a list of kinds of actions—see Section 362(a) of the Bankruptcy Code for that list. Some of those actions are "against the debtor" and some are "against the property of the estate."
By "estate," the Bankruptcy Code is referring to the legal "person" that is created the moment your bankruptcy case is filed. Technically all of your assets belong to your "Chapter 7 estate" as soon as you file your case, although in most cases you keep possession of it all at that point. In fact, as long as everything you own is covered by your applicable property exemptions (which happens in the majority of cases), you permanently keep all your property and possessions. And if something isn't exempt, only that particular non-exempt asset has to be turned over to the Chapter 7 trustee.
The Mwangi case focused on only one of the "automatic stay" provisions,
Section 362(a)(3), which forbids "any act to obtain possession of property of the estate or of property from the estate or to exercise control over property of the estate." Notice that this does not refer to acts against property of the
debtor. The Court of Appeals reasoned that the money in the debtors' four accounts belonged to their bankruptcy estate the moment their Chapter 7 case was filed. Even though nobody objected to the debtors' claim that 75% of those funds were exempt and so belonged to the debtors, they only had a legal right to that 75% after the objection period expired, 30 days after their "meeting of creditors." Therefore, the Court of Appeals said that Wells Fargo Bank holding onto the whole $17,000 during that period of time did not legally harm the debtors.
WHY DID WELLS FARGO BANK HOLD ONTO ALL THE ACCOUNT FUNDS INSTEAD OF GIVING THE DEBTORS 75%?
The answer the bank would give is that once a Chapter 7 bankruptcy is filed the trustee—as the representative of the creditors over the "estate" assets—is the appropriate person to determine who should get those assets. But notice in this case that the bank was owed $52,000. It stood to get paid at least a portion of that through any non-exempt funds that the trustee would get out of the debtors' bank accounts (which the trustee then distributes to creditors).
SO WHAT ARE THE PRACTICAL LESSONS IN THIS?
First, avoid having any checking or savings accounts at any financial institutions where you owe a debt. Although this Mwangi case is not about setoff, it's not likely Wells Fargo Bank would have gone through all the trouble it did here if the debtors did not owe it a relatively large amount of money. For that matter, regardless of the amount of debt there's a good chance that the bank would not have fought so hard here (this was the fourth court to hear the matter) if the debtors didn't have so much in their accounts. It's just too risky to file a bankruptcy case when your money is in such easy reach of a creditor.
Second, avoid having any accounts at Wells Fargo Bank when filing bankruptcy, EVEN IF you don't owe a dime to this bank. There is no principled reason that Wells Fargo won't do an administrative freeze on your accounts even if you don't owe it any money. For years Wells Fargo has been unusually aggressive in this arena. See this article about a lower appeals court's decision in this same case (where the bank lost, and subsequently appealed to the Ninth Circuit) in which Wells Fargeo is called a "big bully."
Third, talk with your attorney about risks—after this Mwangi decision—that the bank where you have your accounts will "do a Wells Fargo" and put an administrative freeze on money in your checking or savings account (even if you don't owe it a debt). Most people won't have $17,000 in their accounts like the debtors did here. And for most people filing Chapter 7 in California all or most of the money in their accounts will be completely exempt (not just 75% exempt as in this Nevada case). So likely most banks just wouldn't bother going through such a hassle if it does not stand to gain in any monetary way. But your attorney is the best person to know what your particular bank's tendencies are, in your unique circumstances.