The Ninth Circuit Court of Appeals recently rendered its decision in the Mwangi case, dealing whether a debtor can assert a claim against his bank for placing an administrative freeze on his bank account pending a determination of the debtor’s exemption claim as to the funds in the account.

Eric Mwangi and his wife filed a chapter 7 bankruptcy petition.  They had several bank accounts at Wells Fargo Bank.  Following the bankruptcy filing, Wells Fargo placed an administrative freeze against the accounts and requested the trustee advise the bank on how he wanted the bank to pay the funds.  The bank informed the trustee that it would maintain the hold on the accounts until it received instructions from him, or until 31 days following the section 341 meeting of creditors.  After the bank’s action, the debtors amended their Schedule C to assert an exemption in the accounts.  Promptly after filing their amended Schedule C, the debtors requested that Wells Fargo lift the hold on their accounts so the debtors could access the funds, contending that their claiming of the exemption removed the accounts from the bankruptcy estate.  The bank refused, and the debtors filed a motion for sanctions against the bank.  After an adverse ruling against them on remand, the debtors filed an adversary class action against the bank, alleging violations of the automatic stay.

The bankruptcy court dismissed the adversary complaint, holding that the debtors lacked standing to pursue any alleged violation of the automatic stay. The bankruptcy court held that only the chapter 7 trustee has standing to protect estate property.  In addition, the bankruptcy court held the debtors could not allege any injury to their inchoate interest in the account funds because they had no right to possess estate property.  On appeal, the United States District Court found that, before the period for objections to the debtor’s claim of exemptions ran, the accounts remained property of the bankruptcy estate; therefore, the debtors having no right to possess the account funds, they could not allege any injury.  Further, once the deadline for objecting to the debtors’ exemptions passed without any objection being filed, the account funds passed from the estate to the debtors and were no longer estate property; therefore, the debtors could not assert a violation of the stay by Wells Fargo under sec. 362(a)(3).

On appeal, the Ninth Circuit affirmed.  The court began its analysis by stated the automatic stay “is designed to effect an immediate freeze of the status quo by precluding and nullifying post-petition actions, judicial or nonjudicial, in nonbankruptcy fora against the debtor or affecting the property.”  Here, the debtors asserted that the bank violated sec. 362(a)(3), which prohibits any act to obtain possession of property of the estate or to exercise control over property of the estate.  The debtors’ motion for sanctions was brought under sec. 362(k), which provides that an individual injured by any willful violation of a stay shall recover damages for the violation. 

The court stated that resolution of the dispute required it to determine when the account funds revested in the debtors, and held that the Supreme Court’s decision in Schwab v. Reilly, 560, U.S. 770 (2010) guided its analysis.  In Schwab, the Court considered “whether an interested party must object to a claimed exemption where. . . the [relevant statute] defines the property the debtor is authorized to exempt as an interest, the value of which may not exceed a certain dollar amount, in a particular type of asset” rather than an exemption in the asset itself.  Where the exemption is limited to a dollar value in the asset, the Court in Schwab concluded that the property remains property of the estate, and only the debtor’s interest in the property is exempt.  As a result, the property remains property of the estate until administered or abandoned by the trustee.  However, where the exemption claimed is not to a dollar value in the asset but in the asset itself, the Ninth Circuit concluded that the “general rule is that exempt property immediately revests in the debtor.”  Because under applicable state law, the debtors’ exemption was in the funds themselves, the Ninth Circuit concluded that the exemption of the funds revested the property in the debtors.

However, because a trustee and creditors have a right to object to a debtor’s claim of exemption the court concluded that the general rule did not end its analysis.  It still needed to determine when the funds in the accounts revested in the debtors.  The court held that the mere filing of an amended Schedule C did not cause the funds to leave the estate.  From the time of the filing of the amended Schedule C to the deadline for objections to exemptions, the account funds remained property of the estate.  During the objection period, the funds were merely “claimed as exempt” and not actually exempt.  The court held that the funds did not revest in the debtors until the deadline for filing objections passed without an objection being filed.  It was only on this date that the debtors had a right to possess and control the account funds and standing to pursue any claims regarding them.

The next question before the court was whether debtors could assert any claim for damages against the bank for its hold on the accounts during the interim period between the filing of the amended Schedule C and the passage of the deadline for objections.  The debtors asserted that during this time, they had an inchoate exempt interest in the funds which was superior to the bank’s interest in the funds.  The court rejected the debtors’ argument.  The court held that, from the date of the petition filing to the passage of the deadline to object to the debtors’ claim of exemption, the funds belonged to the bankruptcy estate and the debtors had no right to them.  Because the debtors had no right to possess or control the funds during this period, they did not sustain an injury from the bank’s hold on the accounts.  Further the court held the debtors could not allege a plausible injury under sec. 362(k) following the passage of the deadline for objecting to their exemptions.  On that date, the funds lost their status as property of the estate and were no longer subject to the protections of sec. 362(a)(3).  Because any action by the bank after the passage of the objection deadline would not violate sec. 362(a)(3), no claim for damages under sec. 362(k) could exist.