Life can be stressful in our modern world. Add debt problems to the everyday stress and it can become terrifying. While not being able to pay your credit card bills, your medical bills or any of your other debt is bad, imagine waking up one morning and finding out that every last dime you had in your bank account is gone. Your bank can take all of the money you have in your bank account without any warning if you owe the bank money for a credit card, car loan, mortgage or any other debt. This is called the right of setoff.
A bank’s right of setoff is ancient, going back as far as the Roman Empire. The theory behind the right of setoff is that the bank has a lien on all of a customer’s property that is in the bank’s possession for the amount due to the bank from the customer. A debtor/creditor relationship is created when a customer opens a general depository account with a bank. Such a bank account constitutes a debt where the bank is the debtor and the customer is the creditor. When the customer takes out a loan with the bank, such as through a credit card, the bank becomes a creditor of the customer. It is this mutual debtor/creditor relationship that gives rise to the bank’s right of setoff.
Before a bank can exercise its right of setoff, the debt owed to the bank by the customer must have come due. If a bank has a right of setoff against a customer’s deposit, that right survives the customer’s death and continues against the decedent’s personal representative. A bank can also exercise its right even when you have filed for bankruptcy. This right is one of the few exceptions to the protection of your assets provided by bankruptcy. Unlike normal setoffs, the bank cannot simply take your money. First, the bank will freeze your account and then ask the bankruptcy court for permission to take the money.
The lesson here is to close any bank accounts you might have if you owe that bank money and you cannot pay the debt. It can be troublesome to do this given that many of us have automatic deposits and/or automated bill pay. But going through the aggravation of changing accounts is far better than going to buy groceries and finding that all of your money is gone.