Generally speaking, a bank has a right to set off a debt owed by the customer to the bank from its customer’s account. In a typical situation, where borrower A owes bank B a debt for a loan, and borrower A has a bank account with bank B, bank B can use funds from borrower A’s account to satisfy the debt where there has been a default under the loan. This general rule may not be applicable, however, if the funds in borrower A’s bank account are held in trust for another entity. The ability to set off such funds will, absent statutory authority, generally turn on bank B’s knowledge of the trust fund nature of the money in the account.
Bank Accounts and Setoffs
Banking institutions “have a long established right of setoff where a borrower is indebted to the institution and also has money on deposit with the institution.”1 When a customer deposits funds in a general bank account, the customer parts with title to the funds, and essentially loans the funds to the bank. Conversely, when an account is overdrawn, such overdraft is considered a loan by the bank to the customer. The application of the bank’s debt (i.e., the deposit) to reduce the customer’s debt (i.e., the overdraft) is a setoff. Because a setoff is any balancing of mutual debts, courts do not distinguish between an active decision to set off funds already in an account against another debt, on the one hand, and an automatic application of deposits to reduce an overdraft, on the other.
