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Do you have a right of setoff clause?

February 20, 2020

Related PeopleRonald N. Primack

Practice AreasFinancial Services

A setoff acts as a self-help remedy for creditors, which can be accomplished outside of court and often allows creditors to collect a greater amount than obtained under bankruptcy proceedings. A setoff clause in a lender’s agreement is a powerful, yet often an underutilized collection tool of defense available to creditors, ensuring that a greater percentage of what is owed is collected. Click here for an in-depth historical and legal analysis of setoff.

Overview of the setoff

A setoff cancels mutual obligations involving unrelated transactions and often occurs when a bank seizes the funds of one of its depositors in order to satisfy the debt owed by the depositor to the bank. In other words, entities apply their mutual debts against each other. Under federal law, the relationship existing between banks and their depositors is that of debtor and creditor, out of which the right of setoff arises.

Setoffs with general and special deposit accounts

Under Illinois law, specific statute provides a procedural roadmap for a garnishee with a claim against indebtedness. The garnishee is entitled to retain other property for the balance of the debt. A bank also has the right to set off funds on a general deposit against the debt owed by a depositor to the bank. The Uniform Commercial Code (UCC) defines general deposit accounts as the following:

“…a demand, time, savings, passbook, nonnegotiable certificates of deposit, uncertificated certificates of deposit, nontransferable certificates of deposit or similar account maintained with a bank. The term does not include investment property or accounts evidenced by an instrument.”

In addition, the Illinois garnishment statute establishes that the garnishee is only liable for the balance of the debt due to the judgement debtor after the offsetting claims are adjusted.

Special deposit accounts refer to money that is deposited and is held in trust for a specific purpose, rather than owed to the depositor. Special deposits, according to the general rule, may not be set off by the bank for payment of the debt or payment of other claims. A creditor holding debtor funds may be in the enviable position (at least as it relates to other creditors) of holding a right to setoff. To learn more about setoff clauses that allow a bank to seize the assets included in the clause, contact a Chuhak & Tecson Banking law attorney.

This Chuhak & Tecson, P.C. communication is intended only to provide information regarding developments in the law and information of general interest. It is not intended to constitute advice regarding legal problems and should not be relied upon as such.

Client Alert authored by: Ronald N. Primack, Of Counsel