“Setoff” is the right of a depository bank to appropriate funds in a deposit account it controls to satisfy debt owed by a customer to that depository bank. The right of setoff is derived from common law principals of law and equity, and has long been recognized in court decisions. The Uniform Commercial Code—which South Dakota has adopted—acknowledges the right of setoff and provides rules governing obtaining a security interest in deposit accounts and the perfection of such security interests. While there are several aspects to setoffs, an oft-overlooked element is how such rights are actually set forth in the bank’s documentation.
Davenport Evans lawyer Anthony Hohn provides 5 documentation provisions to include in the bank’s deposit agreements to help protect your bank’s right of setoff.
1. Grant the right of setoff. The customer must affirmatively grant the bank the right of setoff, and the scope of such right should be defined. For example, the provision should state that the bank may take or setoff funds in any or all of the customer’s accounts for “direct, indirect, and acquired obligations” the customer owes the bank.
2. Grant a broad security interest in the deposit account. The agreement should grant the bank a consensual security interest in addition to the right of setoff. For example, the provision should provide the bank has the right of setoff for any debt owed by the customer, and that the customer grants the bank a security interest in all accounts to secure the debt.
3. Include personally guaranteed debt. The provision should grant the bank the right of setoff for debts personally guaranteed by the customer. The agreement should define “debts” to include “amounts owed to the bank by another person or entity if you have guaranteed you will pay their debt,” and that if the debt is due or overdue, the bank “may use the funds in any of your accounts to pay all or part of the debt.”
4. Grant the right of setoff in joint accounts. If the customer has a joint account, the agreement should grant the bank the right of setoff against joint account funds to cover the debts of any account holder.
5. Include a waiver of liability for dishonor. The agreement should set forth the consequences of dishonor and waive liability for wrongful dishonor. For example, the agreement should provide the bank will not be liable for dishonoring items where the bank’s exercise of the right of setoff and enforcement of its security interest results in insufficient funds in the account.
In addition to these basic provisions, a bank should be sure to refer to and incorporate the right of setoff in other bank documents, as necessary. For example, security agreements and personal guarantees should acknowledge the right of setoff, and the scope of such right, as set forth in the deposit agreement. Following these simple documentation guidelines will provide added protection when setoff becomes necessary.
Questions? Contact attorney Anthony Hohn at [email protected] or 605-357-1258. To discuss additional banking law needs, contact a Davenport Evans lawyer at 605-336-2880, [email protected], or visit www.dehs.com.