Setoff and Security Interests in Deposit Accounts
| Jurisdiction | Colorado,United States |
| Citation | Vol. 17 No. 11 Pg. 2107 |
| Pages | 2107 |
| Publication year | 1988 |
1988, November, Pg. 2107. Setoff and Security Interests In Deposit Accounts
In Colorado a bank may set off and apply the general deposits of a depositor against the depositor's matured loan obligations. Although setoff is a swift and simple remedy to reduce a past due debt, a bank which wrongfully sets off may be subject to liability which far exceeds the amount of the setoff. After setoff, disputes frequently arise between a bank and other creditors concerning priority of competing interests in a deposit account. The right of setoff has priority over many competing interests, but even a perfected secured interest in a deposit account may not succeed against all third-party claims.
This article explores the limits of a bank's right of setoff, how a creditor can obtain a security interest in a deposit account and priority among competing interests in deposit accounts.
Generally, a deposit account may be set off if: (1) a debt is owed by the depositor to the bank; (2) the debt has matured; (3) the depositor's obligation on the debt and the bank's obligation on the account are mutual; (4) the deposited funds are not a special deposit; and (5) the bank takes some affirmative step to evidence its intent to set off. Although the term "bank" is used in this article, the rules are equally applicable to any savings and loan, industrial bank, credit union or other depository institution.
In order to set off, a debtor/creditor relationship must exist between the depositor and the bank. The extension of a loan creates the requisite debtor/creditor relationship. Without a debt, a bank could not set off because there is no obligation to be paid. Most types of debt are sufficient for a setoff; e.g., a construction loan, unsecured loan, auto loan or a student loan. In addition it is not always necessary that the debt be funded. In a recent case, the Colorado Court of Appeals held that the issuance of a letter of credit, even before a draft had been presented, was a sufficient extension of credit to create the required debtor/creditor relationship for a freeze and setoff where the depositor had been adjudicated insolvent.(fn1)
Even if a depositor does owe a debt to the bank, the bank may be statutorily prohibited from exercising setoff to pay certain types of loans. The Fair Credit Billing Act of 1974 ("FCBA") prohibits setoff of a deposit account to reduce consumer credit debts arising out of a revolving credit card plan, such as MasterCard or Visa.(fn2) However, the FCBA does not prohibit a bank from obtaining and enforcing a security interest in the deposit accounts of a credit card customer.(fn3) The security interest must be agreed to affirmatively by the consumer, must be disclosed in the bank's initial truth-in-lending disclosures and must be obtained and enforced only through procedures equally available to other creditors.(fn4) The methods for obtaining security interests in deposit accounts are discussed below.
A minority of states (usually those which have adopted a one form of action rule) prohibit setoff against a debt which is fully secured by collateral.(fn5) The majority rule permits a creditor to exercise any available remedies including setoff, in any order, until the debt is satisfied. The latter cases reason that a bank should not be deprived of the right to setoff simply because it had the foresight to obtain collateral.(fn6) In cases not involving setoff, Colorado courts have ruled that a secured creditor may proceed against any collateral, reduce its claim to a judgment, or exercise any other remedy in whatever order the creditor so chooses.(fn7)
The second prerequisite to set off is that, with certain limited exceptions, the depositor's loan has matured. If the loan has passed its stated maturity date or if it is a demand loan, maturity is not an issue. However, if the loan is an installment loan, the bank cannot set off unless the loan has been properly accelerated. Nearly all promissory notes contain
Whether an installment loan is being accelerated based on an acceleration or an insecurity clause, it must be properly accelerated prior to setoff. If the loan documents require notice of default and/or acceleration, the notice must be sent. If the loan documents do not require notice of default and provide for automatic acceleration upon default, no notice need be given prior to setoff in a commercial transaction.(fn11) Notwithstanding the loan documents, a bank cannot accelerate a consumer loan which is subject to the Colorado Uniform Consumer Credit Code unless the requisite twenty-day notice of default and right to cure, where applicable, has been sent to the consumer.(fn12)
Even if the loan has not matured, a bank may set off a deposit against an unmatured loan under several circumstances. First, a bank may set off a debt against an unmatured loan if the debtor is insolvent.(fn13) Insolvency has been defined in Glen Justice v. First Nat'l Bank of Fort Collins.(fn14) In this case, the bank lent money to a partnership prior to the general partner's experiencing serious legal and financial difficulties. At the request of the Colorado Securities Commissioner, a receiver was appointed to manage the affairs of the partnership. The bank, no doubt believing that its customer was headed for its scheduled assets list, set off an account against a loan which had not yet matured.
The district court conceded that the partnership's liabilities exceeded its assets (the balance sheet test), but found that the debtor was still able to meet its obligations as they became due (the cash flow test). The trial court held in favor of the partnership. On review, the Tenth Circuit upheld the trial court's application of a cash flow test, defined as the "inability to fulfill one's obligations according to his undertaking,"(fn15) as a proper test of insolvency.
A bank may set off a deposit against an unmatured loan when it is served with a garnishment. Colorado Rule of Civil Procedure ("C.R.C.P.") Rule 103, § 10 provides that a garnishee can set off all demands or claims which the garnishee might have claimed if not summoned as a garnishee, "whether such are payable or not at the time of service."(fn16) Two Colorado cases have applied this rule holding that, when served with a garnishment, the banks did not have to declare a default and accelerate installment loans prior to setoff.(fn17) A bank may set off at any time within that period allowed under Rule 103 for the bank to file its answer to the garnishment interrogatory.
A bank may set off upon the death of an individual depositor regardless of maturity of the loan.(fn18) Some out-of-state cases have either permitted or denied setoff depending on the solvency of the debtor's estate at the time of death. If the estate is solvent, the courts have generally permitted setoff, reasoning that a bank would ultimately succeed on a claim against the estate, even if the bank was temporarily stayed from exercising the setoff. When the estate is insolvent, a few courts have disallowed the claim on the basis that the bank should not be preferred over other creditors.
In Colorado, the insolvency of a decedent's estate has been held to justify a setoff of a deposit account against an unmatured debt of the decedent's estate.(fn19) If a bank may set off against an insolvent estate, logically a Colorado bank also should be permitted to set off the deposits of a solvent estate.
Even if a matured debt exists, setoff is not permitted unless the obligations between the bank and a depositor are mutual. Mutuality means that, in addition to the debt owed by a depositor to the bank, the bank must simultaneously owe a debt to the depositor. In Colorado, when funds are deposited at a bank, the bank takes title to the deposit.(fn20) As such, the bank is a debtor and the depositor is a creditor.(fn21) If both a depository relationship and matured loan relationship exist between the bank and the depositor, the obligations of payment of the deposit account and payment of the loan are mutual.
A bank may only set off the general deposits of a depositor. Most accounts which contain general funds owned by the depositor can create mutuality, such as checking, savings, money market or NOW accounts. An account which is in the name of someone other than the debtor may not be set off because the debtor does not legally own the funds. Legal ownership of the funds can usually be determined by examining the signature card of the account. When the account is opened, a depositor executes a signature card indicating the legal ownership of the account, such as in the name of a corporation, partnership or individual. The signature card for an account may...
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