Reversing a bankruptcy court order in favor of the debtor, the U.S. District Court for the District of Maryland recently held that a bank that had allowed amounts to be withdrawn from a home equity credit line after the HELOC had been frozen could still recover those amounts from the debtor.

A copy of the opinion is available at:  Link to Opinion.

During 2006, the bankruptcy debtor and his former wife underwent divorce proceedings, and the debtor instructed the creditor bank holding his home equity line of credit (HELOC) to freeze the HELOC.  On June 22, 2006, the creditor bank wrote to the debtor’s former wife a letter serving as notification of the HELOC freeze.

Subsequently, the former wife withdrew funds from the HELOC via two checks. On Oct. 2, 2006, the creditor bank sent a letter to the debtor’s former wife stating the withdrawals were unauthorized and that she should return the funds.

During bankruptcy proceedings, the debtor objected to a claim filed by the bank for the withdrawal amount. The bankruptcy court sustained the objection, and the bank appealed.

On appeal from the bankruptcy court, the District Court first addressed the bankruptcy court’s finding that the single signature of the former wife was unauthorized.  On this issue, the District Court held that the bankruptcy court erroneously relied upon a provision of the Virginia Code that had been amended in 2003, prior to the activity at issue.

The District Court also held that the bankruptcy court’s finding that the debtor did not receive any benefit from the $20,000 in HELOC advances was clearly erroneous. The District Court noted that the former wife testified in bankruptcy proceedings that the money in the advances was used to settle debts, payments and bills that the couple accumulated jointly when married.

In addition, the District Court noted that the debtor’s testimony was not specific as all he testified to was that he was not aware the proceeds from the checks had been used to pay joint debts.  Moreover, the Court also noted that the debtor continued to pay interest on all of the withdrawals from the HELOC up until the time he filed the bankruptcy proceedings, and that the debtor also did not allege misuse of the HELOC withdrawal during the divorce proceedings.

The District Court also held that the debtor’s claim that the withdrawals were unauthorized was time barred. The withdrawals occurred in July and September 2006 and the statute of limitations for a breach of contract in Virginia is five years. The defendant had until Sept. 7, 2011 to file suit against the bank for breach of contract.

The District Court held that the statute of limitations bar could not be avoided by an argument that the debtor’s claim against the bank to declare the withdrawal amounts unenforceable was in the nature of recoupment against the claim by the bank to recover those amounts. The District Court held that, in order for recoupment to apply, both the creditor’s claim and the amount owed to the debtor must arise from a single contract or transaction.

The District Court held that it was clear that more than a single contract or transaction was involved here, because the original HELOC agreement provided that credit could be given on the basis of a single signature from either the debtor or his ex-wife, and the “freeze” direction given by the debtor to the bank constituted a second transaction. Therefore, the District Court held, the doctrine of recoupment did not apply.

Accordingly, the order entered by the Bankruptcy Court was reversed.