Stimulus Funds & Existing Debt
Can Banks Seize or Freeze PPP Loan Funds or Individual Stimulus Checks? And What Does the New Relief Package Say?
As many news sources have reported, some banks have reduced CARES Act funds, before paying them to depositors, by exercising legal rights or by complying with obligations related to customer debt. Some, including Senator Elizabeth Warren, characterize the actions as malign. In a Medium article published yesterday, Senator Warren argued that banks and “predatory debt collectors” are “ripping these funds out of the hands of consumers.”
The issue implicates two kinds of debt. The first is existing, matured debt owed by a depositor to the bank, sometimes called “first-party debt.” The second is debt owed by the depositor to a third party, or “third-party debt.” This short article will address banks’ rights and obligations with respect to the two kinds of debt—followed by a potentially relevant provision in the new relief package passed this week by the Senate.
First-Party Debt: Banks Have Discretion
This kind of debt can arise from a negative account balance caused by the depositor’s account activities. Or it can arise from a consumer or commercial loan that has matured or has been accelerated. When depositors owe a matured debt to the bank, the bank generally has the right to offset the deposit account. Offset is one of the ways that banks balance their risk when extending credit (like overdraft or loan credit) to its customers. The right to offset is governed by state laws, federal laws like Reg Z, and the language of the deposit agreement.
In most cases, banks can exercise discretion when deciding whether to offset an account. By electing not to offset against matured debts, banks accept continued credit risk, but usually do not risk arguments of “waiver” or “election of remedies.” In other words, when circumstances change or when the credit risk becomes too great, banks can exercise their offset remedy in the future—and recover some of the money that they have extended to their customer.
The CARES Act does not expressly make stimulus funds exempt from offset. So for now, banks appear to keep discretion over the offset decision. Some banks initially exercised that discretion to offset first-party debt, but after a wave of criticism, have publicly changed their policies.
Third-Party Debt: Banks Have No Discretion
Banks generally have little to no discretion about how to handle third-party debt collection actions. Third parties routinely send garnishments, attachments, levies, and receivership notices to banks, directing banks to hold, freeze, or pay over funds to the creditor.
The law generally treats banks as “strangers to the dispute.” That is—the dispute exists between the depositor (the alleged debtor) and the third party (the alleged creditor) and banks take no position on the amount or legitimacy of the debt. Banks simply follow the law and the orders of a court or a receiver. Banks face serious penalties for failure to comply with those orders. Deposit agreements generally put depositors on notice of bank obligations to comply with third-party debt collection activities.
What Does The New Relief Package Say?
This week, the Senate approved a new relief package that adds about $310 billion to the Paycheck Protection Program. Like its predecessor, the bill—officially known as the Paycheck Protection Program and Health Care Enhancement Act—does not expressly exempt PPP loan funds from debt collection activities.
But Section 304 of the bill states: “Notwithstanding any other provision of law, funds made available in this Act, or transferred pursuant to authorization granted in this Act, may only be used to prevent, prepare for, and respond to coronavirus.” It is unclear whether this provision is intended to preempt state law or otherwise prohibit first-party or third-party debt collection of PPP loan funds.
Senator Warren and others have asked the legislature to make CARES Act funds exempt from first-party and third-party debt collection. The new relief package does not expressly do so. Unless and until that happens, banks will likely continue to exercise discretion over their offset rights, but will be bound by existing law when responding to garnishments, receiverships, and other third-party actions.