We recently reviewed a situation where a bank set off on a customer’s deposit account, following an event of default. The customer claimed that that bank did so wrongfully.
We all understand that the relationship between the bank and its customer with respect to the common law right of setoff is that of creditor (the “Depositor”) and debtor (the “Bank”). Once deposited, the money is then the property of the Bank subject to the customer’s right to retake such property. The Bank of course has a right of setoff, which allows it to exercise such right and seek redress of a claim in full or partial satisfaction of what it owes to the Depositor.
In exercising the right of setoff, there must be mutuality of obligations, which means that the Bank can only exercise such right against the Depositor in the same capacity that the Depositor owes money to the Bank. Moreover, the Depositor’s obligation to the Bank must be due. Certain deposits, such as a payroll account or other trust account will generally not be subject to set off. Furthermore, Chapter 167D of the Massachusetts General Laws imposes a requirement that state chartered banks notify a Depositor immediately following a set off by written notice, sent first class mail to their last known address. The failure to do so could jeopardize its set off.
Lastly, it is critically important that you review the Bank’s loan documents prior to the exercise of the right of setoff. In this case, the prior loan officer who negotiated the transaction documents, allowed the borrower’s counsel to modify the right of set off to make it subject to the Bank’s liquidation of “all collateral” securing the loan (“Marshalling Clause”). As such, the right of set off should not have been exercised until the collateral was liquidated.
Equally problematic was the way that the Marshalling Clause was written. This will be further explained next month.