As Economy Continues To Weaken, Is Your CU Ready For More Bankruptcy Filings?

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As the economy continues to show signs of weakness, credit unions increasingly face the prospect, if not the actual event, of a credit union member filing for protection from creditors under the Bankruptcy Code. When this happens, a credit union may be faced with several interrelated issues and questions:

* Can the credit union expel a member solely because of a bankruptcy filing?

* Could the credit union's expulsion process violate the automatic stay imposed by a bankruptcy filing?

* Should the credit union wait until after a member has obtained a bankruptcy discharge before considering expelling that member?

Credit unions typically have a policy that allows them to deny future credit-or future services altogether-to a member who has caused the credit union a loss, including a loss due to a bankruptcy discharge. The question is whether policies like these violate the anti-discrimination provisions of the Bankruptcy Code.

Upon the filing of a bankruptcy petition, an "automatic stay" is imposed by operation of the Bankruptcy Code. The automatic stay prevents creditors from, among other things, taking "any act" to obtain possession of the property that was held by the debtor prior to the bankruptcy filing, or to exercise control over that property. As one court phrased it, "The automatic stay is one of the fundamental debtor protections provided by the Bankruptcy Code...Acts done in violation of the stay are void."

Violations of the automatic stay, even those done inadvertently, can subject the party who violates the stay to severe penalties, including monetary penalties. The automatic stay remains in place until a debtor obtains a discharge. Once the debtor obtains a discharge, a "discharge injunction" replaces the automatic stay, and generally prevents any creditor from taking or continuing any action against a debtor on any debt that was incurred prior to the bankruptcy petition being filed.

How The Issues Might Play Out

A common scenario faced by a credit union may go something like this: suppose you have a situation where the member has bounced several checks, so this member's checking account now has a negative balance. The member won't, or can't, deposit funds into the account, but comes in to cash checks over the counter. The member has now filed for bankruptcy protection. The credit union wants to deny the member services (check cashing) because of the negative balance, and they'd like to send the member a letter warning that they will close the account if the negative balance isn't corrected. However, they are concerned, among other things, about violating the automatic stay.

Reading broadly the provisions in the Bankruptcy Code regarding the automatic stay, which is always prudent, credit unions should be hesitant to take any action against a debtor/member prior to their discharge.

Such actions could be seen as an act to exercise control over property of the estate-in this case money-even if that control means asking the member to move to another credit union.

This issue comes up frequently when bankruptcy courts are asked to consider whether the credit union's imposition of an "administrative freeze" placed on a debtor's account is effectively an impermissible setoff, and thus a violation of the automatic stay. The Supreme Court has held that an administrative freeze of account funds by a depository bank for the purpose of protecting a right of setoff does not violate the automatic stay of the Bankruptcy Code if it is temporary and the depository bank immediately seeks relief from the stay. The Supreme Court recognized, however, that its ruling should be applied narrowly:

"The principal question for decision is whether the bank's refusal to pay its debt to [debtor] upon the latter's demand constituted an exercise of the setoff right and hence violated the stay...All that concerns us here is whether the refusal was a setoff."

A different question arises when a credit union is asked to extend future credit to a member who has filed for bankruptcy and has already obtained a discharge. There are several reported bankruptcy court cases in which credit unions have instituted policies whereby members who have caused a loss to the credit union can be denied future services.

Where the courts have sided with the credit union in upholding such policies, they have made clear that these policies must be instituted on a nondiscriminatory basis (i.e., applied evenhandedly to bankruptcy debtors and nondebtors alike who cause a financial loss by not paying their debt), and a credit union cannot use such policies to coerce a member into reaffirming their debt.

It goes without saying that credit unions should proceed with caution when dealing with members in bankruptcy, or even with members contemplating bankruptcy. Expulsion policies should be worded carefully and followed precisely. Any communication with a member in bankruptcy should be carefully crafted. A number of bankruptcy court decisions in this area turn not on the policies themselves, but on the content of the letters sent to the members advising them of the policies. With the continued downturn in the economy, credit unions will increasingly be faced with the complicated task of sorting through these bankruptcy issues. Consultation with an attorney who is practiced in this area of the law can often save the credit union time, money and pain.

Daniel J. McGarry is a business and commercial litigation attorney with Milwaukee-based Whyte Hirschboeck Dudek S.C. He can be reached at 608234-6046 or by e-mail at dmcgarry 2008 The Credit Union Journal and SourceMedia, Inc. All Rights Reserved.

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