Does a payable on death (POD) beneficiary designation affect our contractual right of setoff with respect to a loan to the deceased party? In other words, can we still set off a customer’s account if the funds within the account immediately become the property of someone else after the customer’s death? We believe we can because our loan contracts identify “death” as a means of considering the loan in default for purposes of accelerating the balance due, and the relevant checking account is owned solely by the deceased borrower.

We do not believe that your institution can assert a right of setoff against a deposit account with a POD designation after the account owner’s death. You may be able to assert a contractual right to the account funds if your deposit account or loan agreements specifically authorize your right of setoff in these circumstances, but we recommend reviewing the relevant agreements and consulting with bank counsel before proceeding.

In Illinois, the right of setoff can arise either contractually (when an agreement provides for a right of setoff) or under common law (when there is “mutuality” of parties — the funds are owned by the same party that owes the matured debt to the bank). A contractual right of setoff in a deposit account or loan agreement can provide for a broader right of setoff than the common law right of setoff. Additionally, a contractual right of setoff does not require mutuality of the parties.

Under the Illinois Trust and Payable on Death Accounts Act, a POD beneficiary becomes the sole owner of the account upon the death of the last surviving holder of the account, “unless otherwise agreed in writing between the person or persons opening or holding the account and the institution.” Also, the Act requires banks to distribute account proceeds to the designated beneficiary or beneficiaries once they have met three requirements: to provide legal evidence of the account holder’s death, their identification, and written direction to close the account and distribute the proceeds (in a form acceptable to your institution). Together, these provisions suggest that when a POD account owner dies, the account funds immediately become the property of the POD beneficiary or beneficiaries.

However, the Illinois Trust and Payable on Death Accounts Act’s general rule that a POD beneficiary becomes the sole owner of an account on the death of the owner can be modified by a written agreement, and a right of setoff can arise contractually without the limitations of a common law right of setoff. Consequently, we believe that a bank may be able to make a contractual argument that it holds a valid right of setoff in this situation — but only if the relevant deposit account or loan agreement expressly provides that the right of setoff trumps any POD beneficiary’s rights in the accounts.

For example, we have found a handful of financial institutions’ deposit account agreements providing that the right of setoff applies “even if a ‘payable on death’ payee has rights to the account,” such as Classic Bank and Delta Community Credit Union. (This article attributes this account agreement language to a “large, well-known bank,” but we were unable to confirm that this language has been used by any large banks in their publicly-posted account agreements.) We recommend reviewing the deceased customer’s deposit account agreement and loan agreement for similar provisions.

Additionally, if your customer pledged the account as security for the loan, your bank likely will be able to assert its rights as a security holder after the account owner’s death. We are aware of one out-of-state court decision upholding a bank’s right of setoff in a situation where the borrower had pledged a certificate of deposit to the bank as security for a loan, even though the certificate of deposit had a POD beneficiary designation.

For resources related to our guidance, please see:

Illinois Trust and Payable on Death Accounts Act, 205 ILCS 625/4(c) (“ . . . unless otherwise agreed in writing between the person or persons opening or holding the account and the institution: . . . (c) Upon the death of the last surviving holder of the account, the beneficiary designated to be the owner of the account . . . shall be the sole owner of the account. . . .”)

Illinois Trust and Payable on Death Accounts Act, 205 ILCS 625/10 (“Upon the death of the last surviving trustee or holder of the account, the institution that maintains the account shall distribute the proceeds to the beneficiary or beneficiaries designated in the agreement controlling the account without further liability. No institution, however, shall be required to distribute the account proceeds until the institution receives (i) legal evidence of death of all trustees or holders of the account, (ii) identification from each beneficiary then living, or business records evidencing the lawful existence and parties authorized to collect on behalf of each beneficiary not a natural person, and (iii) written direction from each beneficiary to close the account and distribute the proceeds in a form acceptable to the institution. . . .”)

Symanski v. First Nat. Bank of Danville, 242 Ill. App. 3d 391, 396–397 (4th Dist. 1993) (“There are two bases on which defendant could assert a right of setoff . . . . Under common law, a bank has the power to apply the deposit to the payment of such depositor’s indebtedness only when there are mutual demands and debts between the parties, and this right of setoff arises at the time the depositor’s indebtedness to the bank has matured. . . . As evidenced by our previous discussion, parties can contractually agree to a right to set off.”)

Fisher v. State Bank of Annawan, 163 Ill. 2d 177, 181 (1994) (“Plaintiff argues . . . that the bank could not set off Robert’s indebtedness against the CDs because no mutuality existed. However, this inquiry into equitable setoff is irrelevant where a contractual basis for a setoff exists. The contract between plaintiff, his sons, and the defendant bank provides an independent basis for a setoff.”)

Jamison v. Soc’y Nat’l Bank, 66 Ohio St. 3d 201, 202, 205 (1993) (“Decedent designated the C.D. as payable on death (‘P.O.D.’) to his beneficiary, Pricy Ann Jamison, appellant. On February 13, 1985, decedent borrowed $5,000 from the bank, executing a security agreement and promissory note by which he pledged the P.O.D. C.D. as collateral for the loan. . . . The interest Jamison received upon decedent’s death could be no more than that owned by decedent during his lifetime. . . . It is axiomatic that a beneficiary can have no greater estate than that bestowed by his benefactor. . . . Therefore, Jamison could receive only an encumbered interest in the P.O.D. C.D. and, since decedent’s estate had failed to make payments on the loan after decedent’s death, the bank was entitled to exercise its right of setoff, paying only the surplus amount in the account to Jamison.”)