WASHINGTON - In a preliminary victory for the banking industry, the Supreme Court agreed Monday to decide how far institutions can go to ensure that bankrupt customers pay off their loans.
The justices will hear Citizens Bank of Maryland's argument that it can freeze the deposits of a borrower who declares bankruptcy, and then stops paying off his loans.
Banking lawyers estimate that the industry loses millions of dollars a year fighting bankrupt borrowers who try to clear out their deposits.
Arguments will be held this fall, although the court has yet to set a firm date.
"We are very pleased the Supreme Court has taken the case," said Jefferson V. Wright, a partner at Miles & Stockbridge who represents Citizens. "What we are asking the court to do doesn't give the bank a superior right to anyone else. What it does is keep the bank in the position it is in."
Michael Crotty, deputy general counsel at the American Bankers Association, said the high court's decision also will decide the fate of the secured credit card industry.
The secured card "is getting to be big business for an increasingly large segment of the lending industry, and it is an increasingly important product for a number of consumers," Mr. Crotty said. "That entire emerging business is endangered."
Banks, fearful of losses, will drop the service if the courts allow bankrupt customers to withdraw their security deposits at will, he said.
The courts currently allow banks to seize deposits from solvent borrowers who don't pay their loans. But that right evaporates once a person declares bankruptcy.
Banks are arguing that though the Bankruptcy Code doesn't allow them to seize the deposits, it does permit them to freeze the funds until a judge decides who controls them.
The lower courts have split on this issue, some siding with the depositors and others with the banks.
John Owen, a Hyattsville, Md.-based lawyer who represents debtor David Strumpf in the case, said he expects the Supreme Court to uphold the decision of the U.S. Court of Appeals for the Fourth Circuit in Richmond, Va.
"I thought it was resolved in the Fourth Circuit, which based its ruling on the clear language of the statute," he said.
The court ruled that the Bankruptcy Code prevents banks from blocking a depositor's access to his money. It upheld a contempt citation against the bank for freezing the account.
The appeals court decision gives banks a Hobson's choice, Mr. Crotty said, because banks either must relinquish the deposit or face a contempt fine.
"You are giving a banker a choice between losing money and losing money and asking him to pick one," Mr. Crotty said. "That's not fair."
Jeffrey R. Springer, president of the $3.7 billion-asset bank, said the bank didn't bring the case to recoup the $3,500 it is owed. Rather, it wants the Supreme Court to settle the legal issue, he said.