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When Can a Bank Exercise the Right of Setoff?

When Can a Bank Exercise the Right of Setoff?

Implementing Right of Setoff

It is quite common to have a bank require a debtor agree to maintain a deposit account with the bank as part of a loan transaction. One benefit of having a debtor maintain its deposit account with its lender bank is the ability the bank then has to implement the right of setoff against that account, whether it is expressly stated in the loan documents or the bank is relying on the statutory right of setoff found in LA R.S. 6:316.

Key Factors to Consider

Before exercising the right of setoff, consider these factors:

  1. The debtor must be in default under the indebtedness owed to the bank.
  2. The account must be one the debtor holds for the debtor’s own account, meaning the debtor can make withdrawals solely on his request. Certain types of accounts are exempt from setoff, such as an IRA or other tax-deferred account or if an account is one in which the debtor is acting in a trust capacity. If a debtor is listed on an account in a fiduciary capacity, such as trustee for a trust on the account holding the trust funds, as the curator for an interdict’s account, or as executor of an estate for the estate’s account, such an account would not be subject to setoff for the debtor’s own debts as the funds held in them do not belong to the debtor.
  3. The debtor must not be in bankruptcy due to the provisions regarding the stay granted when one files bankruptcy. However, the right of setoff may be a valuable tool in obtaining payment from a troubled debtor prior to the debtor filing bankruptcy and may get the bank paid (in whole or in part) ahead of other creditors.

Compliance

While the right of setoff does not require prior notice (which prior notice would be self-defeating as it would simply prompt the debtor to withdraw those funds), it is important that the bank complies with the requirement in LA R.S. 6:316 that the debtor be given written notice by registered or certified mail addressed to the most current address the bank has on record for the debtor within two (2) business days after it exercises the right of setoff. If those notices are mailed within the two (2) business day time frame, then the bank is not liable to the debtor or anyone else if checks are presented against the debtor’s account and are dishonored.

Allen & Gooch is providing this legal update for informational purposes only. This article should not be construed as legal advice or a legal opinion as to any specific facts or circumstances. You should consult your own attorney concerning your particular situation and any specific legal questions you may have.