Protecting co-owners of bank accounts when filing for bankruptcy

I was recently reminded why careful planning is needed to protect the rights of spouses and co-owners of bank  accounts when a bankruptcy is in the works, or even when creditors are suing. A client of mine had an account at Wells Fargo Bank. We were able to claim a substantial balance in the account as exempt. This should have meant that he would be able to keep that money as his own. However, as soon as the bankruptcy was filed, Wells Fargo took it upon themselves to freeze the accounts until the Trustee gave them instructions to release the money.

I think this tactic is of dubious legality but I understand that the few courts that have addressed this practice have not disapproved it. From now on,  all my clients will close their Wells Fargo accounts before filing bankruptcy!

But the more important point is that there are many ways a bankruptcy or a judgment can put money in the bank at risk.

Most bank loan documents have a clause that allows the lender to “offset” or seize any money the borrower has on deposit with the same lending institution if there is a default. Thus, if a client of mine has a bank account at Bank A, but also owes that bank money, I tell them to close the account to avoid precisely this happening. Some years ago, the U.S. Supreme Court approved a bank practice of making such an “administrative freeze” providing the bank promptly sought bankruptcy court approval.

Another problem area is joint accounts. Commonly, we see judgment creditors levying on such accounts in an effort to collect a judgment owed by one of the account holders. This is allowed. In New Jersey this happens when the Sheriff serves a Writ of Execution on the bank, without any prior notice.  The bank must then freeze the account. This then forces the co-owner to go to court to free up their money. In New Jersey, ownership of money in a joint account presumably belongs to the person who put the money there. However, going to court is expensive and time consuming. If a bankruptcy is filed, there is always a question whose money is in the account. I can usually document this and we have few problems but the potential for trouble still exists. So my advice is commonly for people in this situation to create separate bank accounts.

Like so much else, careful planning and the assistance of a knowledgeable adviser are critical to avoiding unexpected problems when dealing with debt issues.

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