The U.S. District Court for the
Middle District of Florida has concluded that a bank could not exercise its
right to setoff of a debtor’s deposit accounts because the bank’s perfected
security interest in the deposit account was not superior to a judgment creditor’s
writ of garnishment. While the bank in American
Home Assurance Co. v. Weaver Aggregate Transport, Inc. (M.D. Fla.) held a
perfected security interest in the deposit accounts, the bank failed to
establish that default occurred prior to service of the writ of garnishment.
Background. In
February 2014, American Home Assurance Company won an action it filed against Weaver
Aggregate Trucking, Inc., for breach of contract and other state law claims in
the amount of approximately $400,000. At American Home’s request, the court
issued a writ of garnishment to Farmers and Mechanics Bank on Oct. 3, 2014. Farmers
responded that, at the time the writ was served, Weaver owed the bank money
pursuant to six different loans issued on May 23, 2014, and the bank sought to set
off the money in Weaver’s general deposit account against Weaver’s obligations to
the bank. Because the amount owed exceeded the amount in the account, the bank
claimed that none of the money should be subject to garnishment.
The bank also filed a motion,
claiming that it had a perfected security interest in the money in Weaver’s
account, and it was entitled to a setoff on the grounds that: (1) it had a
perfected security interest in the money in Weaver’s general account; and (2)
it believed Weaver’s performance of the loan was impaired, the bank was
insecure with respect to the loan, and that the loan was “in default upon the
writ of garnishment being served” on the bank.
Choice of law. Before
considering the merits of the bank’s motion, the court concluded that the Illinois
UCC applied to the transaction. A choice-of-law clause in the loan documents
required that the court apply federal law and, to the extent not preempted by
federal law, Illinois law. Revised Article 9 of the Illinois UCC provides that
“the local law of a bank’s jurisdiction governs perfection, the effect of
perfection or nonperfection, and the priority of a security interest in a
deposit account maintained with that bank.” In addition, Section 9-304 provides
that “[i]f an agreement between the bank and the debtor governing the deposit
account expressly provides that a particular jurisdiction is the bank’s jurisdiction
for purposes of this Part, this Article, or the Uniform Commercial Code, that jurisdiction
is the bank’s jurisdiction.”
Right to setoff. Section 9-340 states that “the application of this Article [the
U.C.C.] to a security interest in a deposit account does not affect a right of
recoupment or set-off of the secured party as to a deposit account maintained
with the secured party.” As a result, said the court, a bank may request a
right of setoff, provided it can show it has a perfected security interest in the
debtor’s deposit account.
Perfected security interest. Under Section 9-314, a security interest in a deposit
account may be perfected by control of the collateral, and a secured party has
control of a deposit account if it is “the bank with which the deposit account
is maintained.”
In the instant case, the
court concluded that Farmers had a perfected security interest in Weaver’s deposit
accounts. Weaver’s deposit accounts and money served as collateral for the
loan. Farmers maintained Weaver’s deposit account, providing the bank with
control of the collateral consistent with Illinois law.
However, cautioned the court,
a perfected security interest does not necessarily entitle a bank to a setoff
under Illinois law. It must also show that it declared the loan in default and
took affirmative steps to enforce its rights.
Timing of default. A key question, said the court, was whether the Weaver loan was in
default at the time the writ was served. The security agreement between Farmers
and Weaver provided that the bank only takes on the rights of a secured
creditor under the UCC after a default occurs. “Default, therefore, is the
essential prerequisite, and in the absence of such, [Farmers] cannot seize the
collateral and apply it against the loan or otherwise prevent another creditor
of the debtor—such as American Home—from taking possession of the collateral,”
wrote the court.
The bank asserted three
grounds for the default of Weaver’s loan: (1) the prospect of performance of the
loan was impaired; (2) the bank was insecure with respect to the loan; and (3)
the service of the writ of garnishment.
The first and second events
allegedly occurred when the original judgment was entered against Weaver in
February 2014—months before Farmers loaned Weaver the funds. “[U]nder the [b]ank’s
nonsensical analysis, Weaver would have defaulted on the loan the moment it
signed the Agreement,” wrote the court.
The third event—the service
of the writ of garnishment—was also not as straightforward as Farmers contended,
the court stated. Due to a crucial distinction Farmers makes between monetary
and non-monetary default, it was unclear that the loan was ever considered in
default.
According to the bank’s vice
president, a monetary default is a default based on non-payment and requires no
affirmative decision by the bank to declare a loan in default. In contrast,
non-monetary defaults, which include the events in the instant case, require
the bank to take affirmative steps to evaluate and decide whether a loan is in
default.
Weaver was current with its
monthly interest payments and not in monetary default. In addition, there was
no evidence that Farmers took any affirmative steps prior to receiving the writ
of garnishment to determine if the loan was in non-monetary default. No
notation that the loan was in default was made. Although Farmers has a loan committee,
it was not advised that the loan was now in default. Lastly, the loan was never
classified as “nonperforming.”
Thus, the court concluded, the
garnishment was served prior to the default, and the bank’s perfected security
interest was not superior to American Home’s garnishment lien. As a result,
Farmers could not exercise a right to setoff.
