Do we have the authority to place holds on checking or savings accounts held by borrowers who are delinquent on loans held by our bank? Or do we have to remove funds from these accounts to exercise our setoff rights?

Your bank likely has a valid right of setoff with respect to the deposit account, in which case the bank could place a hold on the account’s funds in the amount of the setoff. In our view, a valid right to setoff account funds encompasses the right to impose a temporary hold on the setoff amount.

Under Illinois law, a valid right of setoff can arise contractually (when the deposit account agreement provides for a right of setoff) or under the common law when there is “mutuality” of parties (the deposit account is owned by the same party that owes the debt to the bank). We recommend reviewing your checking account agreement to see if you are authorized to set off the deposit accounts against monies owed to the bank. Having said that, even if your account agreements are silent on this issue, we believe you can exercise your common law right of setoff provided that the customer is the sole owner on the checking account and was the sole borrower on the delinquent loan held by your bank. However, note that Regulation Z prohibits banks from exercising setoff rights with respect to consumer credit card debts.

Also, further action would be required to actually exercise the bank’s right of setoff. The U.S. Supreme Court has confirmed that “a setoff has not occurred until three steps have been taken: (i) a decision to effectuate a setoff, (ii) some action accomplishing the setoff, and (iii) a recording of the setoff.”

For resources related to our guidance, please see:

Selby v. DuQuoin State Bank, 223 Ill.App.3d 105, 107 (5th Dist. 1991) (The common law right of setoff requires a mutuality of parties, meaning that the deposit account is owned by the same party that owes the debt, as well as a matured debt.)
Pope v. First of Am., N.A., 699 N.E.2d 178, 180 (3rd Dist. 1998) (This court held that a bank could exercise its contractual right of setoff for customer’s unauthorized withdrawals from another customer’s bank account.)
Regulation Z, 12 CFR 1026.12(d)(1) (“A card issuer may not take any action, either before or after termination of credit card privileges, to offset a cardholder’s indebtedness arising from a consumer credit transaction under the relevant credit card plan against funds of the cardholder held on deposit with the card issuer.”)
Citizens Bank of Maryland v. Strumpf, 516 U.S. 16, 19 (1995) (“The principal question for decision is whether petitioner’s refusal to pay its debt to respondent upon the latter’s demand constituted an exercise of the setoff right and hence violated the stay. In our view, petitioner’s action was not a setoff within the meaning of § 362(a)(7). Petitioner refused to pay its debt, not permanently and absolutely, but only while it sought relief under § 362(d) from the automatic stay. . . . a setoff has not occurred until three steps have been taken: (i) a decision to effectuate a setoff, (ii) some action accomplishing the setoff, and (iii) a recording of the setoff.”)