In re Ruiz Decision Affects Colorado Bankruptcy Filers with Uncleared Checks as of Filing Date

October 27, 2011

By: David M. Serafin

Here’s a lesson for unprepared bankruptcy filers (and their lawyers) in Colorado: earlier this month, the 10th Circuit Court of Appeals in In re Ruiz held that the chapter 7 trustee – on behalf of debtors’ bankruptcy estate - was entitled to make claim to over $3,700 in funds attributable to personal checks which had not yet cleared or been honored by the payee bank as of the date of the bankruptcy filing.  This decision reversed a court decision in Utah (in which debtors listed a balance of only $10.02 on Schedule B) which held that the checking account was only a debt owed by debtors to the bank and that only the right to pursue the debt, and not the funds, belonged to the bankruptcy estate.

The 10th Circuit reasoned that debtors still had control or possession of the funds as of the date of filing such that they should be required to turn over the funds.  Debtors had the ability to withdraw the funds from the account, transfer funds from one account to another, cancel any of the pending checks or close the account.  Debtors could also have first allowed all checks to clear before filing bankruptcy.  

However, often an emergency bankruptcy petition needs to be filed because of an impending foreclosure or wage garnishment.  Even in this situation, the court found that debtors could have stopped payment, closed the account or notified the bank in advance of the pending petition, which triggers a duty for the bank not to deposit the check.

The 10th Circuit was not persuaded otherwise by the fact that compelling turnover of the funds to the bankruptcy estate would force debtors to pay to same amount to both the original creditor and the chapter 7 trustee (even though it was undisputed that debtors did nothing unethical).  Despite the fact that this holding runs counter to the objective of providing debtors a fresh start, the court considered the competing goal of providing creditors with a fair distribution of debtors’ assets.

The 10th Circuit also was unconvinced that the bankruptcy trustee could have used his avoidable preference powers to instead directly recover the funds from the creditors.  The trustee argued that, particularly in situations where debtors made out multiple checks for smaller amounts to multiple creditors, and the potential for filing multiple adversary proceedings (with separate filing fees) against each creditor, it was not practical to mandate direct collection by the trustee against the payee creditors.  This approach was deemed consistent with the Bankruptcy Code’s requirement that the trustee administer the estate and collect non-exempt assets as expeditious as possible pursuant to the best interests of the creditors test.

The bottom line is that money held in a bank account on the date of the bankruptcy filing belongs to the bankruptcy estate.

One bit of good news for Colorado debtors: the Colorado wage garnishment exemption allows a bankruptcy debtor to claim an exemption as to 75% of weekly net earnings, which includes unprotected funds in a bank account – assuming the bank account funds can be traced directly to the earned wages.

Nonetheless, before deciding to file for bankruptcy, you should discuss with the Law Office of David M. Serafin to avoid this type of costly mistake.   

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