Academic journal article Iowa Law Review

An Argument for Creating an Exception to § 547 for Payments on Intraday Overdrafts

Academic journal article Iowa Law Review

An Argument for Creating an Exception to § 547 for Payments on Intraday Overdrafts

Article excerpt

I. INTRODUCTION

Every day, businesses take advantage of delayed check settlement procedures to get short-term credit.1 When a bank customer writes a check that overdrafts the corresponding account, banks may provisionally honor the check on the expectation that the customer will cover the negative balance before the bank's acceptance of the debt becomes final. This short-term credit is called an intraday overdraft. Some intraday overdrafts can run into the millions-in a recent case, a business ran up a single intraday overdraft of over $5 million.2 This Note analyzes whether these intraday overdrafts should be considered "debts" under the Bankruptcy Code. A recent bankruptcy court decision addressing this question noted that "[w]hether an intraday overdraft may constitute a debt for preferential transfer purposes is certainly a complicated and difficult question on which courts have disagreed," but ultimately found that these overdrafts are not extensions of credit.3

This question has serious implications for banks, which would face liability if intraday overdrafts were considered extensions of credit. To minimize their liability, banks would freeze accounts and stop payments because-if intraday overdrafts were extensions of credit-payment on the intraday overdraft could be avoided as a preferential transfer.4 If this were the case, the bank would be unable to recover the overdrafted amount and so be exposed to liability on the overdraft. This exposure, arising every time banks extend intraday overdraft credit, would likely result in banks freezing overdrafted accounts and prompting a fiscally dangerous loss of liquidity in payment systems. Courts have prevented this undesirable consequence by rejecting the Code's expansive definition of "debt" in the context of provisional credit.

This Note argues that, contrary to the case law, intraday overdrafts do fall within the definition of "debt," such that repayment may constitute a preferential transfer. It also argues that this result is untenable because of the implications for the financial system and future bankruptcy litigants. This Note expands on the policy conversation from a proceduralist perspective and demonstrates how the current Code provisions actually undermine the proceduralist conception of bankruptcy law's proper role. It proposes that Congress amend the Code to make an exception for intraday overdrafts under § 547, which provides the statutory framework for whether a repayment is a preferential transfer. Examining the relevant law on preferential transfers in the context of intraday overdrafts, this Note identifies that courts have considered the creditor's ability to dishonor the overdrafted checks as a sufficient basis for treating intraday overdrafts as standard debts. This fact should guide an effort to amend the Code.

Part II explains bankruptcy policies and the two goals-equality of distribution and maximizing the benefit to creditors-that come into conflict when applied to intraday overdrafts. This Part also explains the relevant provisions of the Bankruptcy Code and payment systems law. Part III argues that intraday overdrafts fall under the current Bankruptcy Code definition of "debt." Part III also examines the case law holding that intraday overdrafts do not fall under the definition of "debt," but on the basis of payment systems policy instead of interpretation of the Code. Part IV shows that intraday overdrafts put bankruptcy policies in tension, and argues that maximizing the benefit to creditors over time should be valued over short-term equality of distribution. Part IV further argues that, because courts have an obligation to follow the Code, and important bankruptcy and payment systems policies are threatened by applying the current Code definitions, Congress should amend the Code to provide an exception for provisional credit. This Note concludes by noting the current dilemma in applying the Code to intraday overdrafts and how the proposed amendment would resolve this dilemma. …

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