Greenberg Traurig Alert
Two Recent U.S. Supreme Court Decisions Benficial to Banks and Other Lenders
March 5, 1996
I. "Bankers' Dilemma" Resolved . . . in Favor of the Bankers!
Resolving a long-standing dilemma for banks and their counsel, the Supreme Court has
held that a bank owed a debt by a depositor who files bankruptcy may protect its right to
set off that deposit against the debt by temporarily withholding payment of the deposit,
without violating the automatic stay. Citizens Bank of Maryland v. Strumpf, 116 S.Ct. 286
The "bankers' dilemma" arises each time that a depositor who is also a
creditor of the bank holding the deposit files bankruptcy. The bank then faces the thorny
issue of whether to freeze the account and risk sanctions for violating the Bankruptcy
Code's automatic stay, or to risk the loss of its setoff right by withdrawing funds from
In Strumpf, the Chapter 13 debtor was in default on the remaining balance of a $5,000
loan. Upon the filing of the bankruptcy petition, the bank placed an "administrative
hold" on the debtor's checking account, so as to block withdrawals which would reduce
the balance below the amount due on the loan. Five days later, the bank filed a motion for
relief from the automatic stay and for setoff of the account. The debtor responded with a
motion to hold the bank in contempt, claiming that the administrative hold on his account
violated the automatic stay.
The bankruptcy court first ruled on the debtor's motion, holding that the
administrative hold constituted a setoff in violation of the stay, and assessed sanctions
against the bank. Several weeks later, the bankruptcy court granted the bank's motion for
relief from the stay, and authorized it to set off the remaining account balance against
the unpaid loan. Not surprisingly, the debtor had already emptied the account, leaving the
bank with a hollow victory and nothing to set off.
On appeal, the district court reversed, holding that the bank had not violated the
automatic stay. The court of appeals reversed again, ruling that the administrative hold
was a violation of the automatic stay.
In reversing the court of appeals, the Supreme Court first noted "the absurdity of
making A pay B when B owes A." The Court then went on to rule that the administrative
hold was not a setoff within the meaning of the automatic stay: the bank "refused to
pay its debt, not permanently and absolutely, but only while it sought relief under ¤
362(d) [of the Bankruptcy Code] from the automatic stay." Although the Court did hold
that the bank's administrative hold was not an improper setoff, it declined to rule on
whether the administrative hold was otherwise proper (e.g., whether the bank had frozen
too much money).
It is now the law of the land that a bank may preserve its right to setoff by putting a
temporary hold on a debtor's account. Nevertheless, banks should develop a standard policy
and a set of appropriate forms with outside counsel in order to comply strictly with the
ruling in Strumpf, and preserve the right of setoff while avoiding any risk of sanctions.
II. Supreme Court Rules on Extent to Which Lenders May Rely on Borrowers'
Every day, lenders require that borrowers provide them with certain information and
representations in order to obtain credit. But lenders often fail to consider the extent
to which they must verify the information in order to prevent a discharge of the debt in
the event the information turns out to be false and the borrower files for relief under
the Bankruptcy Code.
The Bankruptcy Code provides that the discharge available under Chapters 7, 11, and 13
of the Bankruptcy Code does not discharge an individual debtor from, among other things,
any debt for money, property, services, or an extension, renewal, or refinancing of
credit, to the extent obtained by:
- false pretenses, a false representation, or actual fraud, other than a statement
respecting the debtor's or an insider's financial condition; or
- use of a statement in writing;
- that is materially false;
- respecting the debtor's or an insider's financial condition;
- on which the creditor to whom the debtor is liable for such money, property, services,
or credit reasonably relied; and
- that the debtor caused to be made or published with intent to deceive.
11 U.S.C. ¤ 523(a)(2).
With respect to a written financial statement, the Bankruptcy Code makes clear that the
lender must have "reasonably relied" on such statement in order to have the debt
excepted from discharge. Therefore, if the bankruptcy court determines that a reasonable
person in the position of the lender would have taken greater steps to verify the
financial information, the debt may be discharged notwithstanding the fact that the debtor
intentionally misrepresented his financial condition to obtain the credit.
The Bankruptcy Code is silent on the standard for determining a lender's right to rely
on representations other than those respecting the debtor's financial condition. Until
now, courts generally applied the same "reasonable reliance" standard, based on
the assumption that the legislature intended the same standard to apply. In Fields v.
Mans, 116 S.Ct. 437 (1995), however, the Supreme Court ruled that the lower standard
of "justifiable reliance," is required for written financial information.
What is the difference between reasonable reliance and justifiable reliance? According
to the Supreme Court, reasonable reliance requires that the court make a determination as
to whether a "reasonable person" would have relied on the information provided;
while the justifiable reliance standard requires that the court consider the
"qualities and characteristics of the particular plaintiff" and "the
circumstances of the particular case."
The lenders in Fields v. Mans were two individuals who took back a purchase
money mortgage as part of the payment for real estate sold to a corporation. The note was
guaranteed by Mans, a principal of the corporation. Several months after the sale, the
borrower conveyed the property to a third party without the lenders' consent, in violation
of the mortgage deed. The day after the transfer, Mans wrote the lenders a letter
requesting a waiver of the due-on-sale clause in the mortgage deed without advising
lenders of the conveyance, ostensibly for the purpose of avoiding complications with
adding a new principal to the corporation. The lenders agreed to the waiver based on the
false representations in the letter.
Three years later when Mans filed for bankruptcy, the lenders argued that the debt due
under the guaranty had been accelerated at the time of the transfer and was
nondischargeable because of the false representations made by Mans. The bankruptcy court
found that Mans did make false representations and that the lenders relied on the
representations in extending credit. However, the bankruptcy court held that a reasonable
person would have checked for conveyances at the time the credit was extended, and
therefore granted the debtor's discharge. On appeal, both the district court and First
Circuit Court of Appeals affirmed.
The Supreme Court reversed the decision, holding that the proper standard was
"justifiable reliance," and remanded the case for further proceedings under the
The decision in Fields v. Mans may prove of little benefit to banks and other
institutional lenders. In considering the "qualities and characteristics of the
particular plaintiff," courts are likely to apply a higher standard to lending
institutions engaged in the business of evaluating and extending credit, than to
individual lenders like the plaintiffs in Fields who may be unfamiliar with the credit
This GT ALERT is issued for informational purposes only and is not intended
to be construed or used as general legal advice. Greenberg Traurig attorneys provide
practical, result-oriented strategies and solutions tailored to meet our clients’
individual legal needs.