By: Donald L Swanson
The Uniform Law Commission offers a Uniform Special Deposits Act. Such Act is designed to provide certainty on issues surrounding the ownership and use of money deposited in a bank account for a special purpose.
Here’s an example of the type of disasters that could be averted by enactment and use of the Uniform Special Deposits Act:
- Hopkins Hospitality Investors, LLC v. Guttman (In re Star Development Group, LLC), Case No. 24-1722 (4th Cir.; decided April 17, 2025; Unpublished).
What follows is a summary of details in the Hopkins Hospitality case, which resulted in a $1 million deposit in a bank account being used to pay Debtor’s general unsecured creditors—surprise, surprise!!—when that $1 million was intended to provide security for Bank’s letter of credit.
Facts
Hopkins Entities develop a hotel and retain Debtor as development manager. Debtor retains the construction Contractor.
To fund the project, the Hopkins Entities obtain multi-million-dollar loans from Bank.
As hotel construction nears completion, payment disputes arise. Contractor, (i) files a lawsuit seeking a $1.7 million mechanic’s lien against the Hopkins Entities, and (ii) initiates arbitration proceedings against Debtor.
In 2016, the state court grants a mechanic’s lien by consent order.
But the mechanic’s lien poses a refinancing problem for the Hopkins Entities. So, those Entities seek a $1 million bond to release the mechanic’s lien.
Insurer agrees to provide the bond “on the condition that it receive a $1 million irrevocable letter of credit as collateral for the bond.” And Bank agrees to issue that letter of credit, on the condition that it receives an assignment of $1 million in a bank account as “cash collateral” to secure the bond.
To satisfy Bank’s condition, Debtor’s Owner opens a new account at Bank in Debtor’s name and funds the account with $1 million, funded by:
- $353,315.41 from Debtor’s Owner; and
- $646,684.59 from Hopkins Entities.
Then, the arbitration proceeding results in a $1.7 million award to Contractor. A district court confirms that award, Debtor appeals, and the U.S. Fourth Circuit Court of Appeals affirms.
While the arbitration appeal is pending, Debtor files a voluntary Chapter 7 petition.
Meanwhile, back in state court:
- the court orders that the $1 million bond be paid to Contractor;
- so, Insurer pays Contractor; and
- Bank pays Insurer.
However, due to Debtor’s bankruptcy, the $1 million remains in Debtor’s Account, Bank is not reimbursed, and Bank’s proof of claim points to the assignment as the basis for its claim.
The Chapter 7 Trustee claims the $1 million in the account as property of the bankruptcy estate for distribution to general unsecured creditors.
In response, the Hopkins Entities file an adversary proceeding against the Chapter 7 Trustee for a declaration that the $1 million in the account is not part of Debtor’s bankruptcy estate.
In the adversary, Debtor’s Owner claims that, (i) the $1 million account was “established for the purpose of securing” the letter of credit, (ii) Debtor “had no discretion in how to use” the money in the account, and (iii) Debtor’s Owner and Hopkins Entities expected that, if the $1 million they deposited into the account became unnecessary, those funds would be returned to them.
Debtor’s Owner declares:
- Debtor’s Owner and the Hopkins Entities did not provide the $1 million “for Debtor’s unfettered use”; and
- Debtor could only use these funds to pay obligations related to the Letter of Credit and to ultimately pay the Bank.
The Bankruptcy Court rules in favor of the Trustee. The District Court affirms on appeal. And the Plaintiffs appeal to the Fourth Circuit.
The Fourth Circuit declares:
- “The issue in this case is whether the Account is properly included in Debtor’s bankruptcy estate”;
- “Plaintiffs advance three theories for why the Account should nevertheless not be considered part of the estate”; and
- “We agree with the bankruptcy court and district court that none are persuasive.”
Conclusion
Had the Uniform Special Deposits Act been in existence and enacted, back in 2016, when the bond, deposit and letter of credit arrangements were being made in the Hopkins Hospitality case, the parties could have used the simple arrangements authorized by that Act to assure the intended use of the $1 million deposit.
Too bad the Uniform Special Deposits Act did not exist at that time! But enactment and use of the simple arrangements authorized by that Act could prevent similar problems from arising in the future.
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