Turnover Actions and the "Floating Check" Controversy

David R. Hague, Fabian & Clendenin, P.C.

Abstract

When a debtor files for Chapter 7 bankruptcy, a Chapter 7 trustee is appointed and is charged with collecting and reducing to money the property of the bankruptcy estate. One of the most basic collection methods a trustee possesses is its turnover power under section 542(a) of the Bankruptcy Code. Section 542(a) requires any entity that is in “possession, custody, or control,” during the bankruptcy case, of property that the trustee may use, sell or lease to turn it over to the trustee and account for such property or its value.

An interesting issue has arisen that is placing debtors in very problematic situations. Prior to filing for bankruptcy, debtors are writing checks to creditors, but the checks are not clearing until after the bankruptcy case is filed. Armed with its 542(a) collection power, trustees are demanding that the debtor replenish the bankruptcy estate and turn over the account balance that existed on the date the debtor filed for bankruptcy. But debtors are refusing to comply with this demand because the funds represented by the checks are no longer in the account. So who is responsible for replenishing the estate for the transferred funds? Is the onus on the debtor to turn over the funds, even if those funds have been transferred from the estate to the payees? Or does the trustee bear the burden to seek the post-petition payments from the payees of the checks through avoidance actions?

This article examines the “floating check” controversy and the language of section 542(a) of the Bankruptcy Code. It also examines a Chapter 7 trustee’s duties to maximize the bankruptcy estate for the benefit of creditors. This article then reviews one of the leading cases on the floating check controversy, which holds that a debtor is not liable to the bankruptcy estate for the value of the funds if she lacks current possession or control of the actual funds at the time the trustee makes the demand for turnover. Several courts have followed this decision. These courts rely on pre-Bankruptcy Code practice and hold that turnover is permissible only when the entity has possession or control of the property at the time the turnover action is filed. Some of these courts also justify their decisions with policy-based arguments, analyzing who is in the “best position” to prevent transfers by post-petition check and remedy the damages to the bankruptcy estate.

After examining these arguments, this article employs the relevant provisions of the Uniform Commercial Code governing the status of funds represented by an issued check to argue that a payee of a check only obtains possession and control of those funds represented by the check once the funds are physically present in the payee’s account. This article then argues that the enactment of the Bankruptcy Code altered the pre-Code current possession or control requirement because section 542(a) expressly permits a trustee to recover “the value” of the property, in addition to the property itself, from one who possessed the property at any time “during the case.” As such, this article concludes that if a debtor writes checks against funds pre-petition, but the checks do not clear the debtor’s account until after she files for bankruptcy, the trustee is entitled to a money judgment against the debtor for the value of the funds.

Finally, while this article addresses the policy concerns, it raises a new approach that courts have failed to consider. Instead of analyzing who is in the better position to prevent transfers by post-petition checks or which party is in the best position to remedy the damages to the bankruptcy estate, this article poses a simple question: which approach for recovering the funds is in the best interest of the estate and its creditors? This article concludes that by recovering from the debtor, the trustee can recover the value of all the pre-petition checks from one source, with minimal expense, and in the most expeditious manner. Not only does this approach comport with the trustee’s duties under the Bankruptcy Code to maximize a return to creditors, but it is what section 542(a) allows.