Your Checking and Savings Accounts in Chapter 13 Bankruptcy

Debtors filing for Chapter 13 bankruptcy ordinarily do not have to worry about what will happen to their checking or savings accounts. In fact, during the course of the Chapter 13 plan, debtors are able to open new bank accounts (with court approval) and even have plan payments automatically deducted from their bank accounts each month. Chapter 13 also allows debtors to keep bank account funds in excess of the allowable exemption amount provided the excess amounts are worked into the Chapter 13 plan and paid back over the life of the plan.

Read on to learn more, or if you're thinking about Chapter 7, see What Happens to Your Bank Accounts in Chapter 7 Bankruptcy?

However, Chapter 13 is not free of threats to bank accounts. Debtors may face a problem if, at the time of filing for Chapter 13, they owe money to the bank or credit union in which their funds are deposited. Also, some banks have been known to freeze accounts upon filing for bankruptcy until the judge gives authorization to release the funds. These issues are addressed in greater detail below.

What Happens if Your Account Funds Are Not Protected by an Exemption?

Unlike Chapter 7, the purpose of Chapter 13 is not liquidation but repayment of debts during the course of a Chapter 13 plan, which may be for either three or five years. One of the main benefits of the repayment plan is that it allows debtors to remain in possession of their assets upon filing. This is in contrast to Chapter 7, in which the bankruptcy trustee becomes the owner of the debtor's assets upon filing. This means that Chapter 13 debtors may continue to use their bank accounts without having to surrender any non-exempt portions up front.

However, exemptions still play a role in Chapter 13, particularly as they relate to the "best interests of the creditor" rule. According to this rule, payments during the course of the Chapter 13 plan must total at least as much as the creditors would have received under Chapter 7. While non-exempt bank account funds are not turned over to the trustee under Chapter 13, the debtor must pay a sum equal to the funds over the exemption amount during the life of the plan. These payments will be distributed among the debtor's various creditors.

Allowable exemption amounts vary from state to state. In some states you can use federal exemption figures. In other states you may only use state exemptions. (To learn more about how exemptions work, see the articles in our Bankruptcy Exemptions topic area.)

The Bank's "Set-Off" Privilege

One obstacle debtors may face with their bank accounts in Chapter 13 arises when the debtor owes money to the bank or credit union with which they hold an account. In this scenario, the bank or credit union has the right to "set off" the debts owed to it against the funds in any checking or savings account the debtor may have with them. This is particularly an issue for members of credit unions because they frequently have personal loans, auto loans, mortgages, or credit cards with their credit unions.

However, there are some reassurances and protections for debtors. It is important to recognize that the banks' right to set-off exists at any time and is not unique to bankruptcy. Thus, banks are able to set-off the past-due debts owed to it against the funds in your account before bankruptcy, which they are more likely to do. The reason banks rarely exercise their right to set-off after bankruptcy is dependent on a host of factors.

The most important limitation to set-off is the "automatic stay," which goes into effect immediately after filing for bankruptcy. The automatic stay is a protection for debtors which prevents any and all creditor attempts to collect on debts. In Chapter 13, the automatic stay lasts for the life of the plan and is meant to give debtors an opportunity to reorganize their debts. Thus, before any bank or credit union can exercise set-off, it must seek permission from the bankruptcy court and obtain relief from the automatic stay. Most courts will not allow the set-off.

Another limitation is that, for banks and credit unions to exercise their rights, the debt must still be owed to the bank at the time of set-off. Thus, set-off based on credit card debt is not always possible because banks frequently sell the debt to other institutions, especially when the account is delinquent.

The Bank's Decision to "Freeze" Your Account

Some banks, most prominently Wells Fargo, Union Bank, and their subsidiaries, have implemented policies to freeze the bank accounts of individuals filing for bankruptcy, whether or not such individuals owe money to the banks at the time of filing. The banks claim to be acting as custodians of the debtor's property and are freezing the accounts to protect the assets.

When a bank freezes an account upon filing for bankruptcy, the debtor must petition the bankruptcy trustee or file a motion with the court to have the funds released. Although the funds will eventually be released if set-off does not apply, this process could several weeks. Thus, individuals planning on filing for bankruptcy should be wary of keeping funds in Wells Fargo or Union Bank accounts before filing.

The future of this policy to freeze accounts is unclear because the 9th Circuit has recently decided that it violates the automatic stay in the context of Chapter 7 bankruptcies. This decision's application to Chapter 13 cases and its adoption by other circuits remains to be seen.

See Closing Bank Accounts Before Bankruptcy to find out if it's wise to get your cash out first.