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Limitations to the Bank's Right to Set Off Account Balances Against Obligations
BY: John Burrus, Esq.

A bank ordinarily has the right to set off account balances against any obligations owed to the bank by the account holder. However, Federal Reserve Board Regulation Z contains an important limitation to this right.

Section 226.12(d) prohibits exercise of the right of setoff with respect to a "[credit] cardholder's indebtedness arising from a consumer credit transaction under the relevant credit card plan. . . .". It is important to understand the scope and limitations of this provision.

The provision applies only to debts arising under a "credit card plan." Thus it has no application to consumer debt in general and would not apply, for example, to an ordinary consumer installment loan. However, the regulation's definition of "credit card" (Section 226.2(a)(15)) includes devices or arrangements which might not ordinarily be considered a "credit card," but which are covered by the provision. The most common of these is a check guarantee card or debit card tied to an overdraft line-of-credit. Setoff rights cannot be exercised against obligations of this nature. On the other hand, if these devices are not tied to a credit line, then they are specifically excluded from the definition of "credit card" and are not subject to the setoff prohibition. Thus, a bank can set off against ordinary overdrafts created by either checks or debit card charges provided the overdrafts are not preauthorized as a credit access device.

The setoff prohibition contained in this regulation does not impair the bank's right under other state law to secure the credit card plan by a security interest in identified deposit accounts or to attach or otherwise levy upon deposit funds after a judgment has been obtained against the debtor or as may otherwise be permitted by state law. It would be advisable, therefore, for a bank's credit card agreement with its customer to include appropriate provisions granting the bank a security interest in identified accounts of that customer.

The commentary to this regulation indicates that a valid security agreement must meet two conditions. First, the customer must be specifically aware that granting the security interest is a condition for the credit card account or for more favorable account terms and must specifically intend to grant a security interest to the bank. The commentary indicates that this condition would be satisfied if the customer separately signs or initials the portion of the agreement granting the security interest, or if the security agreement portion is clearly separated from other provisions of the agreement, or if specific reference is made to particular accounts.

The second condition is that the security interest granted to the bank must be obtainable and enforceable by creditors generally under applicable state law. Since Colorado law permits such an interest to be granted to a creditor, this condition should create no problem for Colorado banks.

Contact John E. Burrus at jeb@bsblaywers.com

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