North American Banking Co. v. Leonard (In re WEB2B Payment Solutions, Inc.)

No. 12-6047 (B.A.P. 8th Cir. Mar. 25, 2013)
Affirming the bankruptcy court (the “BC”), the Bankruptcy Appellate Panel (the “BAP”) for the Eighth Circuit held that a creditor loses its possessory lien in deposit accounts when it turns over the account funds to the trustee without requesting a court to adequately protect its lien in the funds. Specifically, a creditor is to seek an order providing that its possessory lien continues in the account funds that are being turned over so that all parties are on notice of the potential encumbrance. The BAP noted that North American Banking Company (“NABC”) had incorrectly read the Supreme Court’s decision in Whiting Pools for the proposition that a creditor may only seek adequate protection in the form of a continuing lien after turning over deposit account funds. However, the creditor in Whiting Pools had a statutory tax lien that remained with the property after it was turned over as opposed to a lien perfected by possession. Therefore, the creditor must remain secured after turnover to be entitled to adequate protection. Additionally, the BAP held that a creditor with a possessory lien is akin to a creditor with contractual setoff rights. In Citizens Bank of Maryland v. Strumpf, "the Supreme Court, recognizing that a bank’s right to setoff is lost when possession of an account is relinquished, held that a creditor asserting a right of setoff does not violate the automatic stay by temporarily freezing the account and seeking a determination from the court, via a motion for relief from stay or for adequate protection, of the parties’ relative rights to the funds." Based on Strumpf, NABC should have sought a court order determining its rights in the account funds before turning them over to the trustee.
Procedural context:
The BC held that NABC lost its contractual right to set off when it turned the account funds over to the trustee because there were no longer any funds in its possession to set off. Additionally, the BC held that NABC also lost its possessory lien in the funds that were turned over to the Trustee, since NABC failed to first obtain a Court order granting adequate protection of tis possessory lien. NABC appealed the BC’s second holding.
The debtor provided check clearing and payment services to third parties. Pursuant to a contract with NABC, the debtor submitted NABC electronic deposits of funds captured from checks received by the debtor. NABC processed the check transactions on the debtor’s behalf and would credit the debtor’s account. If a check was rejected, the contract allegedly gave NABC the right to set off any of the debtor’s obligations to NABC. The contract also purportedly gave NABC a possessory security interest in the debtors’ funds deposited with NABC. The debtor filed a Chapter 11 bankruptcy petition. At the time, the debtor had over $933,000 on deposit in its accounts with NABC. After the debtor’s case was converted, the appointed trustee requested that NABC turn over the funds in the debtor’s accounts. The trustee permitted NABC to retain $50,000 to cover future reclamation requests. These funds proved insufficient and NABC demanded that the trustee return the forwarded funds immediately. NABC contended that it held a first-priority security interest in the forwarded funds, but the trustee refused to return them. NABC filed an adversary proceeding seeking a determination on whether it had a lien on the funds.
Federman, Chief Judge, Schermer, and Nail, bankruptcy judges.

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