Consequences of Wrongful Setoff

We have listed for you many restrictions on the right of setoff, such as the requirement of mutuality, the restrictions on setting off against an unmatured debt, and so forth. You might be wondering at this point just how serious a violation of these restrictions might be or what would happen to you if you set off in spite of one of these restrictions.

So, for example, suppose you set off the entire balance of a joint account against a debt owed by only one of the joint account holders. Because of your setoff, a number of checks written by the nondebtor account holder bounce. This account holder is later arrested for passing bad checks, in particular, the ones you bounced. The account holder sues you and claims that the setoff was improper since it lacked mutuality. If the account holder wins on that point (which he or she may or may not do depending, in part, on what your deposit account agreement says—see below), the account holder could then claim that the improper setoff caused the checks to be wrongfully dishonored. Under the UCC section cited earlier, you would then be liable for any actual damages that the account holder can prove were proximately caused by the wrongful dishonor. Those damages could be substantial in a case where the account holder was arrested (damages for mental distress, loss of reputation, or loss of income).

In addition to the “actual” damages for which you might be liable under the UCC, it is possible to be liable for what are known as “punitive” damages for wrongful setoff. The difference between actual and punitive damages is that actual damages are supposed to compensate the plaintiff (the party bringing a lawsuit) for harm actually suffered by the plaintiff. Punitive damages are sometimes added to an award of actual damages, and the punitive damages are intended to punish the defendant (the party against whom a lawsuit is brought) for particularly outrageous wrongdoing and to discourage others from doing the same. The punitive damages are paid to the plaintiff, even if the plaintiff has already been awarded adequate actual damages. Punitive damages have been awarded in cases of wrongful setoff. [See John TeSelle, “Banker’s Right of Setoff—Bankers Beware,” 34 Oklahoma Law Review 40 at 75 (1981).]

The federal Racketeer Influenced and Corrupt Organizations Act (RICO) allows for triple damages (three times the actual damages) against persons found civilly liable under its provisions. RICO contains rather broadly written provisions under which a person can be civilly liable, and a recent trend in the RICO area is for plaintiffs in ordinary civil suits to try to convince the court that a RICO violation has occurred in order to get triple damages. One bank has been found liable for triple damages under RICO for wrongfully setting off. [See Masi v. Ford City Bank and Trust Co., 779 F.2d 397 (7th Cir. 1985).]

Other consequences of wrongful setoff can arise depending on the reason the setoff is wrongful. For example, we pointed out earlier that setting off against an individual retirement account (IRA) is improper. The consequences of doing so range from liability for breaching your fiduciary duty as trustee or custodian on the account to paying a penalty tax under the tax code for being a “disqualified person” participating in a “prohibited transaction.” Setting off to recover a debt incurred under a consumer credit card account can result in liability under Truth in Lending. And, setting off after your debtor has filed for bankruptcy is a violation of the “automatic stay.” Knowing and willful violations of the automatic stay are subject to contempt proceedings that can result in fines, attorney fees, and imprisonment. Actual damages can also be awarded to persons injured by the violation. Punitive damages, costs, and attorney fees are also available in some cases.

As you can see, the consequences of wrongful setoff can be severe. You should, therefore, consider carefully whether you are authorized to set off before you do so.