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Consumer Banking and Payments Law: 10.2.1.1 Types of Setoff

A bank’s right to set off its customer’s funds arises by operation of the common law, by contract, or by a specific state or federal statute.2 The requisites for the bank’s common law right of setoff are: (1) mutuality of obligation between the bank and its customer;3 (2) the funds against which a setoff is exercised belong to the customer; (3) the money to be set off has been deposited into a general—as opposed to a special, reserve, or trust—account; and (4) the debt owed by the customer to the bank i

Consumer Banking and Payments Law: 10.2.2.1 Federal Limitation on Bank’s Offset of Credit Card Debt Against Deposit Account

Particularly with the continued growth in bank mergers and acquisitions, many credit cards are issued by banks or other financial institutions that have a deposit account relationship with the card user. The Truth in Lending Act (TILA) provides that a card issuer “may not take any action to offset a cardholder’s indebtedness arising in connection with a consumer credit transaction” against a deposit account.19

Consumer Banking and Payments Law: 10.2.2.2 Setoff After Consumer Files for Bankruptcy

When a consumer files a petition in bankruptcy, the Bankruptcy Code’s automatic stay prohibits creditors from seizing the debtor’s assets.32 Nevertheless, the Supreme Court has held that the automatic stay does not prevent a bank from temporarily “freezing” a debtor’s bank account where the debtor owes the bank money and the bank wishes to exercise its right of setoff.33 The C

Consumer Banking and Payments Law: 10.2.5 Notice of Setoff

Absent notice of a setoff, a customer likely will not be aware of the setoff until receiving a monthly statement. In the interim, the customer may bounce checks because the account has insufficient funds due to the setoff. Timely notice of setoff also allows a consumer to promptly seek to undo an invalid setoff.

Consumer Banking and Payments Law: 10.2.6.1 Debts Must Be Mutual

Setoff is permitted only when there are mutual debts.63 Setoff rights arise when both the bank and the customer have the dual status of being debtor and creditor. In a typical setoff scenario, the customer has a general deposit account at the bank, making the customer a creditor in regard to that account and the bank a debtor.

Consumer Banking and Payments Law: 10.2.6.2 Debt Must Have Matured

A bank cannot exercise setoff unless both its debt and the consumer’s debt have matured. Maturity is not an issue with respect to the bank’s debt to the consumer, because the customer has a right to funds the bank holds in the consumer’s savings or checking account.

On the other hand, whether a consumer’s debt to the bank has matured will depend on the facts of the case. Ordinarily, the consumer’s debt to the bank matures on any of the following dates:

Consumer Banking and Payments Law: 10.2.7.1 Account Must Be in Debtor’s Name

The setoff must be exercised against the customer-debtor’s account, not against an account that belongs to another person—such as an account that is held in trust by the debtor or that is held by the debtor as agent of another88—unless the account owner is secondarily liable.89 Setoff is tortious if the bank knows or has reason to know that funds in the account belong to another.90 Moreover, setoff cannot be used if the b

Consumer Banking and Payments Law: 10.2.7.2 Special Purpose Accounts

Banks may not set off accounts if they know that the account was set up for a special purpose.93 For example, if the bank knows the funds in the debtor’s account are being held in trust for a third party, the bank is liable for its setoff against those funds.94 Individual retirement accounts (IRAs),95 payroll accounts,96 and escrow accounts97 are other examples of

Consumer Banking and Payments Law: 10.2.7.5 Convenience Accounts

Some banks advise older depositors to put an offspring’s name on a joint account to enable the offspring to write checks “in an emergency” and then provide the customers with a contract allowing the entire account to be set off for the debt of either co-tenant.

Consumer Banking and Payments Law: 10.2.8.1 Generally

Certain sources of funds—primarily federal and state benefits payments—are exempt from garnishment, even when deposited in a bank account. In other words, a judgment creditor cannot reach these funds in the debtor’s bank account even with a garnishment order. The question is whether these same funds are exempt from a bank’s right of setoff—that is, can the bank can seize otherwise exempt funds deposited in that bank account to offset amounts the debtor owes to that bank?

Consumer Banking and Payments Law: 10.2.8.4 Are Deposited Benefits That Are Exempt from Garnishment Also Exempt from Setoff?

Many courts hold that, if funds in a bank account are exempt from garnishment, they are also exempt from setoff.127 The leading case, a California Supreme Court decision, states the reasoning behind this rule: “The assertion of a banker’s setoff has exactly the same effect as a third party’s levy of execution on the account—it deprives the depositor of the income that the state provided him to meet subsistence expenses, compelling the state either to give him additional money or leave him without means of physical survival.”

Consumer Banking and Payments Law: 10.2.9 Remedies for Wrongful Setoff

When a bank wrongfully sets off funds in the consumer’s account, the consumer’s remedy is for breach of contract.157 The measure of damages is at least the amount of the funds the bank has set off.158 If the bank had actual knowledge that the funds belonged to another person, the bank may be liable for conversion.159 In cases of conduct the court finds egregious, the consumer may be awarded punitive damages.160

Consumer Banking and Payments Law: 10.3 Security Interest in Deposit Accounts

A bank that wishes to avoid restrictions on the right of setoff, or a creditor that wishes to avoid restrictions on garnishment, may attempt to perform an end-run by trying to take a security interest in the consumer’s bank account. The consumer’s bank would do this by seeking a security interest at the time an account is opened and then claiming that money in the account is collateral for obligations later incurred by the consumer.