SET-OFFS: LOOK AT THE FINE PRINT

Sometimes what you don’t know will kill you. In this posting we discuss set-offs. Most consumers don’t know that a creditor has the right to net out any debt(s) it owes the debtor against the debt that the debtor owes the creditor. This makes logical sense. Let’s adjust the obligations of the parties so that only the "real," net, number is at issue. Most people understand this concept.

However, most debtors do not know that a checking or savings account is a debt that the bank owes them. An account actually creates a contract between the depositor (debtor) and the bank (creditor). In the account relationship the parties are reversed. The debtor becomes a creditor of the bank for the amount on deposit, and the bank becomes a debtor for that amount. You may ask, “well so, what do I care?” Well, if one has an account at a bank and a loan at the same bank, for a mortgage, credit card, or installment loan, etc., the bank can set-off its banking account obligation to the debtor against the debtor’s obligation to pay back the loan.

Under Section 553 of the Bankruptcy Code, if the set-off is made by the bank within 90 days of the filing of the bankruptcy petition, the set-off may be set aside if it puts the bank in a preferred position over the debtor’s other unsecured creditors. While the bank has the right of set-off after the bankruptcy is filed, it is subject to the provisions of the automatic stay under Section 362, and it cannot exercise its right of set-off except by leave of court.

Basically, the debtor should never maintain his operating funds in an account with a bank, which is also the debtor’s lending institution. No one in the past told the debtor this, but the reason a lender usually gave the debtor around 1/4th of a point off his loan interest for also maintaining an operating account with the lender is so that in a pinch the lender could exercise its right of setoff against the operating account. It’s all in the fine print in the debtor’s banking account agreement.

Martin Conway
This blog is not intended to render legal services to the reader, including advice about bankruptcy or taxes. Consult with a lawyer concerning the specific application of the law to your unique circumstance.