4000 - Advisory Opinions
Whether FDIC as Receiver of a Failed Depository Institution Will Allow a Depositor to Offset Deposits Against Indebtedness Owed to Depository Institution
February 5, 1991
Valerie J. Best, Counsel
This letter confirms our telephone conversation concerning setoff. It has been established by case law that the equitable right to offset survives insolvency of a bank. In Scott v. Armstrong, 146 U.S. 499 (1892), the United States Supreme Court established the right of a depositor in an insolvent bank to offset any deposits against his indebtedness owing to the bank. There is no controversy as to this general principle.
The FDIC as receiver of a failed bank will allow a depositor to offset his deposits held in the bank against obligations owed by the depositor to the bank, provided it is allowed by state law. I have enclosed a copy of the FDIC booklet "When a Bank Fails". The response to question 22 shows that the FDIC will allow offset if it is allowed by state law.
Whether or not a debtor will be permitted or required to offset his loan with his deposits upon the insolvency of a bank in any particular situation is determined by state law. This is true in both national and state receiverships. Thus, a bank's customer should ask his attorney to review applicable state law and the customer's deposits and loans in order to determine whether or not offset is available in any particular instance.
Your attorney may want to start his or her research with Michie on Banks and Banking §§113-41 (1983). This text discusses state laws governing setoff. The following annotations may also prove helpful to your attorney. Annot., 68 A.L.R. 3d 192; Annot., 11 A.L.R. 3d 1465. Some of the more common state provisions as described in the above annotations are as follows. There must be mutuality between the debtor and the creditor and between the debt and the funds deposited (the same person or corporation owes the debt and owns the funds deposited). Where mutuality exists then, single name ownership accounts may be offset against singlename debts to the bank. Joint deposit accounts can be offset against joint obligations. Many states allow a joint obligation to be offset by the individually held deposit of one of the joint debtors.
After the FDIC is appointed receiver of a failed bank, the FDIC obtains a legal opinion detailing those offsets allowed by applicable state law. Offsets are not permitted until this legal opinion is received. A borrower whose note has not matured may request an offset on the unmatured obligation owing to the failed bank. The FDIC will require those who wish to request an offset of an unmatured obligation to fill out a form signed by all parties named on the account. As stated above, such a request will generally be allowed where mutuality exists and where an offset is permissible under state law. The FDIC will require offset where the depositor's debt is delinquent or has matured.
While a bank customer's right to setoff would be determined by state law, the FDIC's right to require offset is strengthened by the Federal Deposit Insurance Act. 12 U.S.C. §1822(d) provides:
The Corporation may withhold payment of such portion of the insured deposit of any depositor in a depository institution in default as may be required to provide for the payment of any liability of such depositor to the depository institution in default or its receiver, which is not offset against a claim due from such depository institution, pending the determination and payment of such liability by such depositor or any other person liable therefor.
The term "insured deposit" is defined in 12 U.S.C. §1813(m). This section provides, in part:
(m)(1) Subject to the provisions of paragraph (2) of this subsection, the term "insured deposit" means the net amount due to any depositor (other than a depositor referred to in the third sentence of this subsection) for deposits in an insured depository institution (after deducting offsets) less any part thereof which is in excess of $100,000. Such net amount shall be determined according to such regulations as the Board of Directors may prescribe, and in determining the amount due to any depositor there shall be added together all deposits in the depository institution maintained in the same capacity and the same right for his benefit either in his own name or in the names of others except trust funds which shall be insured as provided in subsection (i) of section 1817 of this title.
Thus, deposits of individuals may be withheld pending settlement of their liability for having caused the bank's failure, and subsequently setoff.
12 U.S.C. §1823(e) was enacted to effectuate a federal public policy of protecting the funds of deposits in federally insured banks, and to bestow upon the FDIC "the protections afforded a holder in due course and shield the FDIC against any defenses that would otherwise be available". Federal Deposit Insurance Corp. v. Rockleman, 460 F.Supp. 999, 1003 (E.D. Wis. 1978). This provision may also generally enlarge the FDIC's authority to require an offset. For example, a depositor may not offset his loan with IRA funds. However, the FDIC may freeze IRA funds pending settlement of its claims.
Setoff "is not absolute or paramount to superior equities". 5A Michie on Banks and Banking §114, at. 343. Thus, the right of setoff may be defeated.
Since you are employed in the banking industry, you may be interested in cases dealing with loan participations. These cases include the following: FDIC v. Mademoiselle of California, 379 F.2d 660 (9th Cir. 1967); Chase Manhattan Bank, N.A., v. FDIC, 554 F.Supp. 251 (W.D. Ok. 1983); Hibernia National Bank v. FDIC, 733 F.2d 1403 (10th Cir. 1984); InterFirst Bank-Abilene, N.A. v. FDIC (CA 5, No. 84-1840, 12/11/85); Essay, The Aftermath of Penn Square Bank: Protecting Loan Participants from Setoffs, 18 Tulsa L. J. 261. Briefly, these cases provide that a depositor in a failed bank has a right to setoff deposits against his indebtedness owning to the bank even where the loan has been participated. However, the FDIC as receiver cannot distribute cash to the participating bank when the depositor's indebtedness is setoff against the deposit in the failed bank. This is so because the setoff does not augment the assets of the estate of the receiver.
Another issue which must be considered when reviewing the availability of setoff is the effect of pledge agreements. Generally, where mutuality does not exist, a deposit pledged against a loan in the same bank will be insured to a maximum of $100,000 after adding it to any other funds held by the depositor. Then the $100,000 will be held as security until the loan against which it is pledged is paid. For example, if a corporation has a $200,000 CD in a bank, and it pledges that CD against a $200,000 loan made by the bank to an individual, and the bank subsequently failed, the corporate deposit will be insured to $100,000 leaving $100,000 uninsured. The FDIC as receiver will hold the $100,000 insured balance as security until the loan to the individual is paid. The corporation would retain a claim against the estate of the closed bank for the $100,000 that was uninsured. The corporation would be given a Receiver's Certificate as proof of the corporation's claim and would receive pro rata payments as the assets of the failed bank are collected or sold.
Since setoff can be a complex area, I want to emphasize that you should ask your attorney to review applicable state law and your deposits and loans in order to determine whether or not offset is available.
The FDIC is often able to arrange for a purchase and assumption transaction or merger of a failed bank. In a merger, all deposits, both insured and uninsured of a failed bank are assumed by a healthy institution with financial assistance from the FDIC. Depositors of the failed bank automatically become depositors of the assuming bank and have access to their deposits to the same extent as they had in the insolvent bank prior to its financial collapse. In a merger the problem of setoff and pledging are usually eliminated.