If a lender has a UCC lien on your business, you have probably asked whether it can freeze your bank account. It’s a simple question, but the answer is one most people will wish they hadn’t asked. Filing a UCC lien, on its own, does not let a lender freeze your bank account. It’s a common mistake to believe otherwise. Since July 1, 2001, when revised Article 9 of the Uniform Commercial Code took effect, a business deposit account can be collateral in its own right, but a security interest in it is not perfected unless the lien holder can exercise ”control” over the account. There is a key distinction between a lien on file and control, and understanding it is crucial to knowing the answer to the simple question we posed above.
Control of a Deposit Account
Under the UCC, a secured party has control of a deposit account if:
- (1) the secured party is the bank with which the deposit account is maintained;
- (2) the debtor, secured party, and bank have agreed that the bank will comply with instructions originated by the secured party directing disposition of the funds in the deposit account without further consent by the debtor; or
- (3) the secured party becomes the bank’s customer with respect to the deposit account.
You might say that if the other guy’s got control, he can just take the bank account at any time!
Not quite. The strange part is that a lender has control even while the account remains open and not closed. The account isn’t frozen, in other words. In normal course of business, a lender has control over a bank account even though the company is using the account. You can keep paying bills and writing checks from the account, and the lender is still perfected. In effect, you can use the account until the lender says you cannot.
Two Claimants
Now say another creditor wins a judgment against you and serves a garnishment on your bank, which typically gives it a judicial lien. Now there are two claimants on the bank account: the lender with a perfected security interest in the account, and the judgment creditor with a judicial lien on the account. Who wins? This has been one of the thorniest problems in the UCC for a while. Ordinarily, the secured party with control gets priority over the creditor with a judicial lien. That means the creditor with the judicial lien can’t just swoop in and garnish the account without worrying about the lender that has control.
At least, that is the theory. Because there are differences in the law, different courts have taken different approaches to the problem of when a secured lender has to act on its security interest in the deposit account.
Courts in Illinois and Florida have taken what is sometimes called a ”use it or lose it” approach. In American Home Assurance Co. v. Weaver Aggregate Transport, the lender was also the borrower’s bank, and it did not declare a default until after the garnishment writ was served. The court said that didn’t give it priority, even though it had perfected a security interest in the account. In One CW, the court treated the lender’s choice to let the debtor keep using the account after a citation was served as a waiver of its prior right.
Other courts have rejected the “use it or lose it” approach. Courts in Nebraska, Michigan and Indiana decided that the lender had priority from the moment it had control, regardless of whether it was using the account. In Fifth Third Bank v. Peoples National Bank, the lender had kept honoring the debtor’s checks, and the appeals court still sided with it. It said the garnishing bank could not ignore Fifth Third’s rights, and Fifth Third had not waived or changed its interest in the funds. In those courts, for purposes of priority, a “use it or lose it” rule does not apply.
So what does all of this mean for you as a business owner? Unfortunately for you, you are not the main actor in the lender/judgment creditor dispute. You are, however, the focus of that dispute. Like most legal questions, the answer depends. In some jurisdictions, a lender with a perfected security interest in your bank account can stop the judgment creditor from getting the money. In other jurisdictions, the same secured party may lose priority to the judgment creditor. The issue is still open, and the rules are different in different places. A state’s own garnishment law may also affect the outcome. If you are dealing with a lender that has control over your bank account, make sure you understand what is going on with your bank account and when the lender is going to act on its control. You don’t want to wake up to find the account is blocked. Knowing the lay of the land is key, and that means knowing the law in your jurisdiction. We are not a law firm, so when a court fight is the right call, we refer owners to a vetted independent attorney.
The fight may look like it is only between creditors, but you are very much in the mix. A court could award the garnished funds to the judgment creditor, even if the lender had control. Because that is the money you pay your bills with, you could suffer substantial harm if the money is awarded to the judgment creditor. That is why you could well be on the side of the secured lender, hoping to hold off other unsecured creditors while you try to stay out of an insolvency proceeding. In System Soft Technologies v. Artemis Technologies, the lender and the business signed a forbearance agreement, and the lender agreed to allow the business to withdraw funds from the account to pay its bills. When another creditor garnished money owed to the business, the court came out on the side of the secured lender, and it did not make the lender enforce its security interest just to keep its priority.
If you are behind on a loan or an advance and a creditor is circling your bank account, talk to someone who can advise you and help you figure out a plan. If you have other unpaid debts, and a creditor brings in a garnishment, it is probably time to have a really serious talk with the secured lender. This is also where a business debt settlement company like ours steps in: our senior advisors negotiate with funders and lenders for less than the full balance owed.
So, can a UCC lien freeze your bank account? It can’t on its own, but it can put you in a tough position. If the lender is your bank, or if your business bank agrees that it will act on the secured lender’s instructions about the account, then the lender has control, and if someone else tries to garnish the account, the lender may have priority. The conflict between the secured lender and the garnishing judgment creditor can leave you in limbo, and what you do next, in effect, depends on the way the courts have handled similar conflicts in your state. Once a lender has control over your bank account, it can be a powerful position for it to take, even if it never actually taps the account. A first consultation with us is free and confidential, and if bankruptcy, such as Subchapter V, is the better path for your business, we will tell you so on the first call.
