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Intraday Overdrafts by Banks Do Not Give Rise to an Antecedent Debt

Sarachek v. Luana Sav. Bank (In re Agriprocessors, Inc.), No. 15-CV-1015-LRR, 2016 U.S. Dist. LEXIS 33012 (N.D. Iowa Mar. 15, 2016)

March 15, 2016, Northern District of Iowa – Debtor Agriprocessors, Inc. owned and operated a kosher meatpacking and food processing facility in Postville, Iowa. The Chapter 7 Trustee Joseph E. Sarachek filed an adversary action against Defendant Luana Savings Bank in the U.S. Bankruptcy Court for Northern District of Iowa to avoid the payments made by the Debtor to the Bank as preferential transfers and improper setoff. The Bank denied that it was the recipient of any preference payments and raised various affirmative defenses. The Bankruptcy Court ruled that the Trustee was entitled to recover $1,556,782.89 of preferential transfers that the Debtor made to the Bank during the ninety-day preference period. The Trustee appealed and the Bank cross-appealed.

On appeal, there were two central issues to determining whether and in what amount the relevant wire transfers constituted transfers on antecedent debt – (i) whether the Bankruptcy Court erred in holding that only true overdrafts, rather than both intraday and true overdrafts, constitute antecedent debt under the Bankruptcy Code (ii) whether the Bankruptcy Court erred in finding that the Bank was not a “mere conduit” for Debtor’s funds.

On the first issue, the District Court stated that routine advances (intraday overdrafts) against uncollected deposits do not create antecedent debt under the Bankruptcy Code. The Court reasoned that the banks routinely make uncollected funds available to the depositor, not as a loan, but in recognition of a bank’s anticipated debt to the depositor. Although, it was true, a debt will arise if deposited checks are dishonored, but until dishonor, a bank that advances funds in the expectation that deposits will routinely be collected acts as a conduit for the depositor’s financial transactions, not as a creditor. Thus, the Court determined that intraday overdrafts do not constitute antecedent debt and hence not recoverable by the Trustee as preferences. The Court further determined that only true overdrafts – those overdrafts that were allowed to stand past the midnight deadline – constituted “debt” under preference law, and thus only true overdrafts were avoidable. The Court stated that unlike transfers for intraday overdrafts, true overdraft transfers were not made specifically to cover provisional debits on Debtor’s account, nor did they arrive with a specific directive as to their use.

In the case at bar, the Bank did not merely pass the funds along to a third party or held them for some special purpose at the behest of Debtor. Instead, it received and applied the funds to pay down the negative balance in the Debtor’s account. Thus, the funds did not flow through the Bank as a financial intermediary; the funds stopped with the Bank as repayment on the overdrawn account. At this point, the funds became the Bank’s and it had legal dominion over them. Thus, the alleged transfers for true overdrafts constituted transfers on antecedent debt and hence avoidable as preferences.

The Bank next argued that it was acting as a mere conduit for Debtor’s funds pursuant to the check clearing process and therefore, received no transfers on account of an antecedent debt. The Court stated that if a party is a mere conduit in an avoidable transfer, it is not considered an initial transferee under the Bankruptcy Code and, therefore, is not liable for the avoidable transfer and to be an initial transferee, a party must have dominion and control over the transferred funds. However, in the instant case, the Court concluded that since the Bank failed to demonstrate that it was a mere conduit under either dominion or control test, the Bank was not acting as a mere conduit when it received transfers on account of true overdrafts in the Debtor’s account.

The Court found that the Bankruptcy Court did not err in denying the Bank’s affirmative defenses; the Bank was not acting as a mere conduit. The District Court affirmed the Bankruptcy Court’s order in whole.