Chapter 3 Accounts

• Jurisdiction: United States

Chapter 3 Accounts

A. Deposit Account Basics

Adeposit account is not a pile of currency and bills that a bank holds somewhere deep within its vaults. A deposit account is better described as a relationship in which each party (bank and depositor) has various rights. These rights are governed by the bank's deposit account agreement, federal and state statutes, and federal and state regulations.

Legally, in most contexts, courts have said that once funds are deposited with a bank, the funds become the property of the bank.²¹ The bank can use the funds for its own business or investment purposes (such as making loans to other customers). For this privilege, the bank may agree to pay interest to the depositor. In essence, the depositor makes a loan of the deposited funds to the bank and becomes the bank's creditor. The depositor has a claim against the bank for the amount reflected in the account plus any interest, and the bank has a contractual obligation to pay the depositor back on demand (in the case of a demand account) or within a specified period of time (in the case of a timed account such as a certificate of deposit). For the bank, the deposit account is a liability on its books, and conversely, a loan would be shown as an asset.

B. Deposit Accounts in Bankruptcy

Thinking of the deposit account relationship as a debtor/creditor one is helpful in understanding the bank's and depositor's rights in the event of a depositor bankruptcy. This chapter will discuss (1) the automatic stay's effect on the bank's right of setoff, (2) who is authorized to give the bank instructions with regard to the account after the bankruptcy filing, (3) administrative freezes and holds, and (4) the Office of the U.S. Trustee's requirements affecting the banking relationship.

1. Setoff

a. General Setoff Principles

Often, a bank will have two roles: (1) as the customer's depository bank; and (2) as the customer's lender. In this situation, the bank will owe the customer money (related to the account), and the customer will owe the bank money (on account of the loan). One way that they can treat the mutual debts between them is to set them off. So that both parties do not have to each pay the other (which in some cases is a bit absurd), setoff allows them to apply their respective debts against one another, with one party owing the net remaining debt.²² The right of setoff can be based on contract (for example, most deposit agreements give the bank the right of setoff) or on state common law. In order to have the right of setoff, the debts must be fully liquidated and due, and the two parties must be directly "mutual" (except in the case of certain contractual setoffs, described below). This means that the parties on each side must be the same (i.e., A owes B and B owes A).

To determine mutuality when ownership is unclear, banks generally use the Social Security numbers or Tax Identification numbers of the account owners to match owing obligations and deposit accounts. If legal setoff is not available due to the failure of direct mutuality, it may remain available under the contracts evidencing the loan or deposit relationships, which may, in fact, expand the setoff right to cover non-mutual-but-related debts among affiliates or co-debtors. Contractual setoff may also alter the instant when setoff first becomes available by mirroring the laws in certain states.²³ Many banks use loan or account documentation to expand the setoff rights beyond that state's laws.

Not all monies and deposit accounts are available for setoff. In addition to direct mutuality issues, there are types of accounts where ownership is uncertain, such as escrow accounts, jointly titled accounts, IOLTA accounts and the like. Further, assets in certain accounts may also be exempt from setoff, such as IRA or retirement accounts and Social Security monies in the hands of the recipient. Care must be taken to undertake these analyses before the setoff can occur.

b. Setoff in Bankruptcy

Setoff issues arise in bankruptcy cases when a customer is both a borrower and a depositor. Normally, the bankrupt customer (now debtor) owes the bank money on account of the loan, and the bank could be eyeing a large deposit account for repayment. In a default situation outside of bankruptcy, the bank could have a right to set off the bank account and reduce the loan obligation. The sooner that the bank exercises a setoff, the more likely it is that the bank will successfully capture the funds before the customer moves them out of the bank. However, the rules change after bankruptcy occurs.

Bankruptcy adds a twist to the right of setoff, by requiring that both of the offsetting debts be pre-petition obligations.²⁴ The Bankruptcy Code limits the parties to the rights they had at that magical moment that the bankruptcy petition was filed. Only funds that are on deposit on the petition date may be set off; later deposits may not. Therefore, a debtor may deposit funds in the bank after bankruptcy, but the bank will not have the right to set off those post-petition deposits against the debtor's pre-bank-ruptcy loan.

Bankruptcy creates other risks as well for the nondebtor party who sets off against a prospective debtor. Section 553(b) of the Code creates an entirely different statutory calculation to determine preference exposure for the nondebtor creditor who sets off. Rather than using the more conventional test in § 547, the Code looks at the highest deposit account balance during the 90 days prior to the petition date to determine what setoff payment can be avoided. To counter this mechanism, many banks build security interest grants in deposit accounts into their loans and account documentation so that the bank creditor effecting a setoff can argue that it is instead foreclosing on a security interest, shifting the analysis to § 547 rather than § 553.

Sometimes a setoff will occur before the bank learns about the bankruptcy filing. Unfortunately for the bank, the automatic stay goes into...