Suppose you are paid on a Friday and write a $800 check to your landlord for rent. The following Tuesday you go to your attorney’s office, pay the remaining fees owed on your bankruptcy, and tell your attorney that you have exactly $450 remaining in your checking account.
But that’s not exactly true, because your landlord’s check has not cleared your bank account.
Uncleared bank checks are a common trap for bankruptcy debtors. Your bankruptcy estate is determined on the day you file bankruptcy. The money in your bank account on the day your file bankruptcy is property of the bankruptcy estate. It does not matter if you have written outstanding checks that have not yet cleared. The reason for this is that bank funds do not transfer until a check is honored, not when the check is written. See Barnhill v. Johnson (In re Barnhill), 503 U.S. 393 (1992) (transfer of funds occurred when the drawee bank honored the check). Consequently, the debtor still has “possession, custody, or control” of the funds, and the check is simply an order for the bank to pay the recipient a stated sum of money on demand. Until the bank issues payment, the debtor has the ability to close the account or stop payment of the check.
The practical consequence for the debtor is that the trustee may demand turnover of bankruptcy estate funds, either from the debtor or from the check payee. Avoiding this trap is not difficult, but it requires good communication with your attorney and diligence. The best practice is to print a bank statement of your account on the day you file your bankruptcy case and take it to your attorney for review. If there are any outstanding checks, notify your attorney. Your attorney can then determine the proper course of action, which may include doing nothing (especially if the checks amounts are small and/or there are sufficient available exemptions), a brief delay in filing, or in some extreme cases the debtor may issue a stop payment on the check to freeze the funds.