New York Judge Refuses to Waive Collateralization for Debtors’ Bank Accounts

A large company in chapter 11 must ensure that its depository banks comply with Section 345(b), even if it means the bank charges the debtor $80,000 a month for providing a bond to collateralize the deposits, according to Bankruptcy Judge James L. Garrity, Jr. of New York.

The debtors constituted a major mortgage originator and servicer that filed a prepackaged chapter 11 petition in February intended for confirmation in August. The debtors’ operations utilized more than 1,000 bank accounts, including over 500 accounts at Citibank N.A. with aggregate daily balances of some $95 million.

Section 345(b) requires debtors to maintain their accounts at authorized depositories that are required to maintain collateral at the U.S. Treasury amounting to 115% of aggregate bankruptcy funds on deposit in excess of FDIC insurance limits. Or, the bank can obtain a surety bond.

Although Citibank is an authorized depository, the debtors discovered that the bank had not collateralized its accounts as required by Section 345(b). After negotiations, Citibank agreed to obtain a bond, at a monthly cost to the debtors of $80,000.

The debtors nonetheless filed a motion asking Judge Garrity to waive the requirement that the bank post security. In an opinion on June 24, Judge Garrity declined to grant the waiver and stuck the debtors with the $80,000 monthly cost.

Judge Garrity explained that Congress amended Section 345(b) in 1994 by allowing the court to waive the security requirement “for cause.” He analyzed In re Service Merchandise Co., Inc., 240 B.R. 894 (Bankr. M.D. Tenn. 1999), where the court found cause for waiving the collateral requirement based on 10 factors.

Without adopting Service Merchandise, Judge Garrity evaluated the facts before him that weighed in favor of a waiver. Among other factors, moving the accounts to another bank would take nine months and cost $500,000. The U.S. Trustee conceded that the risk of loss was “minimal” because Citibank enjoyed a long-term deposit rating by Standard & Poor of A+.

On the other hand, Citibank was giving the debtors a “favorable” interest rate of 2.6% on its deposits. Judge Garrity estimated that the $80,000 monthly fee would be a “small fraction” of earnings on interest.

Evaluating the factors for and against granting a waiver, Judge Garrity concluded “on balance” that the debtors “failed to establish ‘cause’ to excuse them from collateralizing the Citibank Accounts, as required by Section 345(b) of the Bankruptcy Code.” Providing a bond, he said, “clearly ensures the safety of the funds on deposit . . . and, under the facts of this case, the payment of a monthly fee to do so, does not ‘handcuff’ the Debtors.”