## Facts

- N. Eddie Montgomery owned Southland Escrow Services, Inc., which handled real-estate closing transactions.
- Montgomery used a bank “cash-management system” with a main funding account and a zero-balance checking account at Third National Bank in Nashville.
- The system often posted checks as overdrafts and covered them later by debiting the main account, and the main account frequently lacked sufficient funds.
- By March 1988, the overdraft at Third National exceeded $2 million, and the bank suspected Montgomery was running a multi-bank check-kiting scheme.
- In early April 1988, after the bank confronted him, Montgomery agreed to stop writing checks on the zero-balance account while continuing to make deposits.
- With outgoing checks halted, deposits were applied to reduce the overdraft until the negative balance at Third National reached zero.
- Montgomery’s broader check-kiting activity continued at other banks.
- On June 3, 1988, creditors filed an involuntary bankruptcy petition; the trustee later sued Third National to avoid and recover approximately $2 million as preferential transfers.

## Issues

1. Whether deposits and credits applied to reduce Montgomery’s overdraft constituted transfers of an interest of the debtor in property avoidable as preferences under 11 U.S.C. § 547(b).
2. Whether the bank could defeat avoidance under defenses including earmarking and ordinary-course (or related) theories.

## Decision

- The Sixth Circuit affirmed judgment for the trustee, holding the overdraft-reducing payments were avoidable preferences under § 547(b).
- The court found the transfers involved an interest of the debtor in property because Montgomery exercised sufficient control over the deposits and check-kiting proceeds.
- The court concluded the transfers were on account of antecedent debt (the existing overdraft), made within the 90-day preference period while insolvency was presumed and not rebutted, and enabled the bank to receive more than in a Chapter 7 liquidation.
- The court rejected earmarking because the funds were not supplied and tightly controlled by a third party; Montgomery could direct the use of the funds, and the transfers diminished the estate available to other creditors.
- The court rejected ordinary-course and similar defenses because a large kiting-generated overdraft and a bank-directed “workout” producing concentrated repayment were not routine transactions.

## Legal Principles

- For § 547(b), “property of the debtor” turns on whether the debtor had dominion or control sufficient to direct disposition of the funds; debtor control over kited funds can make resulting credits property of the estate.
- A creditor’s receipt of funds applied to pay down an overdraft can be a transfer “for the benefit of a creditor” and “on account of an antecedent debt” for preference purposes.
- Earmarking is limited to situations where a third party supplies funds that are restricted to paying a specific creditor such that the debtor lacks meaningful control and the estate is not diminished.
- Transactions undertaken to protect a creditor after suspicion of financial trouble (e.g., structured repayment to eliminate exposure) are unlikely to qualify as ordinary-course dealings.

## Conclusion

The court held that deposits used to eliminate a check-kiting overdraft were avoidable preferential transfers because the debtor controlled the funds and the repayment improved the bank’s position relative to other creditors; earmarking and ordinary-course defenses did not apply.


In re Montgomery, 983 F.2d 1389 (6th Cir. 1993)