Presented by: Terri D. Thomas, JD February 10, 2016 Setoff is the act of deducting an amount owed by one party to another from an amount that is due to be paid from the other party to the first party; Example: John has a savings account at First City Bank with a balance of $1000 (John is creditor and Bank is debtor); John has a loan from First City Bank with a balance of $1000 (John is debtor, Bank is creditor). The bank can set off the $1000 that it owes John on the deposit account against the $1000 John owes the bank for the loan, which in this case leaves a net amount of $0 due and owing by either party. 2 1
Contractual Right of Setoff (Page 2)- found in bank s loan documents and in bank s deposit agreement; Statutory Right of Setoff (Page 4) found in state laws. May have also been developed thru case law. An example of statutory language from Kansas at KSA 9-1206: Any bank shall have the right to set off any obligation or claim which it has, when the same is matured against any depositor. 3 Mutuality of debt (Page 4)- parties involved in the setoff action are the same. Example: Loan: First City Bank (Creditor) Deposit: John Doe (Creditor) John Doe (Debtor) First City Bank (Debtor) 4 2
Loan: First City Bank (Creditor) Deposit: John Doe (Creditor) John s Auto Shop, Inc. John Doe, Authorized Signer (Debtor) First City Bank (Debtor) 5 If no consent by co-owner, bank may only be able to exercise setoff against the pro-rata share of the debtor; If consent has been given (typically in deposit agreement), bank should be able to exercise setoff against the entire deposit account. It is highly recommended to incorporate joint owner consent to the right of setoff in all deposit account agreements. 6 3
Reduced to cash. Determined through mathematical calculation. 7 One which is due and owing; Is debt actually due to be paid under terms of default, or has it matured? Can the bank collect just a past due payment or the entire amount? 8 4
Acceleration clause causes all future payments to become immediately due and owing; If no acceleration has occurred, then bank only has a right to collect what is due (past due payments only). 9 John is to make 60 payments of $400.00 each on the 15 th day of each month, beginning March 15, 2010. John misses the June 15, 2010 and July 15, 2010 payments. If bank does not accelerate, bank can only collect the missed payments ($800.00). If bank accelerates, bank can collect all future payments, even though the individual payments are not yet due. 10 5
Consumer laws generally limit default to: Failure to make payment; Significant impairment in prospect for payment, performance or realization of collateral. Lender is required to prove significant impairment. If impairment is not significant, no basis for default. Acceleration clause mandatory in these cases. 11 Not required; Generic notice of default/acceleration can contain right of bank to use any and all powers provided under state law (which would include right of setoff). 12 6
Authorized signers (Page 7)- not subject to setoff action due to mutuality of debt; Examples: No set off for: John Doe and John s Auto Sales, Inc. John Doe and John s Auto Sales, LLC John Doe and John Doe Living Trust John Doe and John Doe, attorney in fact for Sara Doe 13 Credit card debt (Page 8)- Regulation Z (Truth in Lending- 1026.12(d)) generally prohibits bank from exercising right of setoff on credit card debt, unless: Authorized in writing and periodic payments come from the deposit account; AND, Amount in question is not disputed. What about debit cards? If directly accessing a consumer line of credit, may convert the line of credit to a credit card debt for setoff purposes. 14 7
Individual Retirement Accounts (Page 9) Prohibited because IRAs are exempt from attachment under state law; Health Savings Accounts (Page 9) Are not specifically exempt from attachment under state law; May be a violation of custodial/trust agreement and of setoff provision; May not meet mutuality of debt requirement; Consult local counsel. 15 Federal benefit payments (Page 9)- federal law prohibits attaching federal benefit payments such as social security or VA benefits. 10 th Circuit Court of Appeals extended the prohibition to setoff (Tom v. American Credit Union); Some states also have prohibitions against using setoff against federal benefit payments; Must check with legal counsel. 16 8
Statute of limitations (Page 9)- Can not exercise setoff if statute of limitation has expired. Typically, statute of limitations are controlled by state statutes, and will typically be: Promissory notes- six years (under the UCC); Other contract debts- dependent upon state law, usually around five years; Time will be tolled if customer leaves the state or is disabled. 17 Questions? 18 9
Garnishment (Page 10)- Is debt in default/matured? Garnishment may be a basis for declaring default; If no other default exists and loan has not matured, UCCC and consumer statutes will require bank to prove that garnishment is a significant impairment; Many state statutes will require the bank to actually take the money from the deposit account and apply it to the indebtedness when claiming a right of setoff. 19 Tax levies (Page 11)- IRS- Revenue Ruling 2006-42 requires bank to notify IRS of setoff claim before exercising setoff. 20 10
Security interest (Page 11)- Uniform Commercial Code states that setoff is ineffective against a secured party that holds a properly perfected lien in a deposit account (with a control agreement). 21 Bankruptcy (Page 11) Citizens Bank of Maryland v. Strumpf- US Supreme Court established the procedure for exercising setoff against a debtor in bankruptcy- Must have a valid pre-petition debt owed by debtor; Place temporary administrative freeze on the portion of the account needed for the setoff action; Take immediate action to have the automatic stay lifted by the bankruptcy court before actually taking the money from the account; If relief from automatic stay is not obtained, then freeze will be deemed to be a violation of the automatic stay (possibly resulting in sanctions). 22 11
Certified checks (Page 11)- bank required to honor certified checks over right of setoff. Medicare receivables (Page 12)- Medicare may require bank to waive its setoff rights on physician accounts receiving Medicare payments. 23 Exercising setoff against checks presented for payment -checks presented for cashing payable to debtor, but drawn on a third party (Page 12)- Is this really setoff? Did bank obtain check through misrepresentation? Seek advice of legal counsel- Note, FDIC fined a Kentucky bank $100,000 for doing this. 24 12
Death is a default, lender may use right of setoff against deposit accounts (Page 13) Accounts in decedent s name solely or Joint accounts (pro-rata or by contract) Could use setoff on deposit accounts with decedent s name for debts of decedent, even accounts with POD or Totten trust clauses (confirm with legal counsel)- (Page 13) Ohio case upheld lender s right to exercise setoff on POD account Theory: Beneficiary is subject to same setoff as owner can t take more of an interest than the owner 25 Liability to third parties (Page 13)- Improperly answering garnishment (may be liable for amount in account, if not the whole garnishment); Violation of automatic stay in bankruptcy (sanctions); Conversion of joint account owner s money (punitive damages). 26 13
Liability to customer (Page 14)- Wrongful dishonor- Uniform Commercial Code states that bank will be liable for damages proximately caused by the wrongful dishonor of an item. Liability is limited to actual damages, but can include damages for arrest or prosecution of customer or consequential damages. May also result in UDAAP liability. 27 Dee Fault has a checking account at your bank that is in joint tenancy with her husband, Joe. The balance in the account is $2,000.00. Dee also has a car loan at your bank that is 25 days past due. The past due payment is $250. The balance remaining due on the entire loan is $9,450. What issues should your bank consider before it chooses to exercise its right of setoff? 28 14
Is Dee s loan a consumer loan subject to the a Consumer Credit law or Uniform Consumer Credit Code, or is there a contractual right to cure required? If so, has a right to cure notice been sent on the loan and has the notice period expired? Has the loan balance been accelerated? If not, the bank will only be able to set off the amount that is actually past due ($250.00). If the bank has accelerated the loan balance, does the bank s deposit agreement contain a provision that makes it clear the bank can take the entire balance in the deposit account, regardless of Joe s co-tenancy interest? If not, the bank may only have a right to Dee s pro rata interest in the account. 29 Dee Fault is also a signer on the following savings account: Dee Fault, Custodian for Billy Fault under the Uniform Transfer to Minors Act. Can the bank exercise its right of setoff against that account? 30 15
Answer: No. The mutuality of debt requirement has not been met. Dee borrowed the money in her individual name, however, the savings account is not owned by her, but rather it is Billy s property. 31 There is a sole proprietorship business checking account at your bank titled: Dee Fault, doing business as Dee s Landscaping Service. Can you exercise setoff against this account? 32 16
Yes. A sole proprietorship account is legally owned by the individual (Dee Fault) and therefore, the mutuality of debt requirement has been met. 33 Dee has a money market account titled: Dee Fault, IRA. Can you exercise setoff against this account? 34 17
No. IRA s are typically exempt from setoff under state attachment laws. These accounts are also exempt from setoff under the provisions of many deposit and loan agreements. 35 Dee is also past due on the credit card your bank issued to her. Can you exercise your right of setoff against Dee s deposit accounts? 36 18
Presuming this credit card was issued under the Truth in Lending Act (Regulation Z), the bank is prohibited from exercising its right of setoff on this debt. 37 Dee and Joe have their home loan through your bank. As part of the loan, you provide escrow services. The escrow account shows a balance of $1,500. Can you exercise setoff against this account and apply the funds to Dee s past due car loan? 38 19
No. When a bank is serving as the escrow agent for a customer, the bank is the customer s agent, which is a fiduciary obligation, meaning that the bank must act in the customer s best interest, not in its own. Furthermore, the funds in the account have been designated to benefit specific parties (property tax collector and insurance company). These are not funds that are generally available for Dee s use. 39 The End! Any Questions? tthomas@ksbankers.com Wesley Kavelaris Total Training Solutions info@ttstrain.com www.ttstrain.com 800-831-0678 Thank You! Upcoming Webinars February 17 th Legal Liabilities When Check Fraud Occurs February 18 th Onboarding Your New Hire February 18 th TRID Compliance Hot Spots! February 22 nd Bank Call Report Preparation for Beginners Five Part Webinar February 22 nd Names and TINs: 15 Reasons They May Not Match February 23 rd The Banker of the Future Becoming a Universal Banker February 23 rd Flood Insurance: Compliance Issues and Enforcement Topics that Continue to Plague Lenders February 24 th Beware! Signature Card Danger Zones February 25 th Opening Accounts for Nonresident Aliens: W-8BEN, W-8BENE, CIP and CDD February 29 th For Sales Managers: How to Hire Better Bankers Who Can Sell 40 20