Funds for Uncleared Pre-Petition Checks Are Property of the Estate

Recently, in In re Brubaker, 426 B.R. 902 (Bankr. M.D. Fla. 2010), a Florida bankruptcy court held that funds related to checks that had not cleared were property of the estate under section 541(a)(1) of the Bankruptcy Code. In Brubaker, the debtors wrote several checks before filing for chapter 7 relief. As of the filing date, these checks had not cleared, and therefore the funds remained in the debtors’ bank account. The bankruptcy court rejected the debtors’ argument that these funds transferred on the dates that the checks were presented to the recipient, and thus were not property of the estate. Instead, the court noted that funds do not transfer until the checks are honored. Thus, the court held that funds remaining in the account were property of the estate since the debtors’ bank had not honored the checks.

Under section 542(a) all property in “possession, custody, or control” of the debtor at the start of the case must be delivered to the trustee. The court looked at the UCC for guidance in determining “control” under section 542(a). Under the UCC, a check is simply an order for the bank to pay the recipient a stated sum of money on demand. U.C.C. § 3-104(a)(2). Until the bank issues payment, the debtor has the ability to close the account or stop payment of the check. Since the checks in Brubaker had not been cashed at the time of filing, the funds were in debtors’ control and remained part of the estate. In Barnhill v. Johnson (In re Barnhill), 503 U.S. 393, 401 (1992), the Supreme Court held that transfer of funds occurred when the drawee bank honored the check. The court followed this decision and also considered the bankruptcy policy that the trustee must distribute funds among creditors fairly and equitably. The court decided that the best way to accomplish this goal was to determine that the transfer of funds did not occur until the bank honored the check. Holding otherwise would make it too easy for debtors and aggressive creditors to outsmart the system by selecting to pay certain creditors instead of others, knowing that those payments would be honored, thus defeating the goal of equitable distribution. As a result, courts have consistently held that outstanding funds remain property of the estate.

How should a debtor deal with these checks becoming property of the estate? Some options exist for the debtor. First, the debtor could notify his bank that he has filed for bankruptcy protection, his account is part of the estate, and any checks presented for payment should no longer be honored. Debtors should be careful writing checks on the eve of filing. It may be fraudulent if the debtor knows he intends to file for bankruptcy at the time the checks are written and therefore payment will be stopped. See Shake v. County of Buffalo, Neb., 154 B.R. 270, 276 (Bankr. D. Neb. 1993) (allowing criminal complaint against drawer of bad check to proceed as exception to automatic stay of section 362); Johnson v. Lindsey, 16 B.R. 211, 213 (Bankr. D. Fla. 1981) (permitting criminal prosecution for issuing worthless check, but not permitting repayment if found guilty). Second, the debtor can wait until all drawn checks have cleared from the account before filing a petition of relief. It should be noted that this option only relates to “when” a debtor should file bankruptcy. Although a debtor may want his checks to clear, there may be more imminent concerns. For example, the value of outstanding checks is probably not the biggest concern if a debtor’s home is being foreclosed.