50 JULY / AUGUST 2023 LENDING / CREDIT Picture this. A bank makes a loan to a borrower, and the bank’s collateral includes a security interest in the borrower’s deposit account maintained at the bank. All necessary loan paperwork is executed and filed, and the loan officer sleeps well knowing the funds in the borrower’s deposit account will go a long way toward satisfying the outstanding loan balance. Fast forward. The borrower pays as promised for a few months. Then, the bank receives garnishment paperwork from a judgment creditor of the borrower. The paperwork identifies the bank as a garnishee defendant and instructs the bank to freeze the funds in the borrower’s deposit account so the same may be used to satisfy the judgment. Not only that, but the paperwork indicates if the bank does not act as instructed, it may be liable for the payment of the judgment. Now, the loan officer is losing sleep over what she thought was a problem-free loan. The loan officer should rest easy. As long as the bank responds appropriately to the garnishment paperwork, the bank’s security interest in the deposit account will defeat any interest asserted by the judgment creditor. Why is that the case? First, consider the bank’s interest. Under the Uniform Commercial Code, security interests in deposit accounts may be perfected only by “control.”1 One way a bank can obtain control of a deposit account is by ensuring the deposit account is maintained at the bank.2 Such perfection by control exists even if the depositor has the right to make withdrawals from the account, and even if a loan default must occur before the bank can seize funds from the account.3 A security interest held by a bank having control of a deposit account has priority over an interest held by a party that does not have control.4 Next, consider the interest of the judgment creditor seeking garnishment. Through garnishment the judgment creditor is trying to reach funds of its judgment debtor in the hands of the bank in order for those funds to be applied to satisfy the judgment.5 It is well settled under Indiana law that a judgment creditor acquires an equitable lien on funds owed by a third party to the judgment debtor from the time the third party receives service of process in the garnishment proceeding.6 Accordingly, a third party garnishee may be liable for paying out funds in a manner inconsistent with the judgment creditor’s lien.7 In the aforementioned hypothetical, the interests of the bank and judgment creditor are in direct conflict. If the bank must pay out funds from the deposit account, its prior perfected security interest is nullified. On the contrary, if the bank can use its perfected security interest as a shield to garnishment, the judgment creditor will be out of luck. So, who wins? This question was answered in Fifth Third Bank v. Peoples National Bank, 929 N.E.2d 210 (Ind. Ct. App. 2010). There, the trial court had ordered the bank to turn over deposited funds to the judgment creditor, ignoring the bank’s prior perfected deposit account security interest.8 The bank appealed, arguing that its security interest trumped the judgment creditor’s equitable lien.9 The Court of Appeals agreed with the bank, finding that “[a] garnishing creditor has no greater rights in the judgment debtor’s assets than does the judgment debtor.”10 Since the judgment debtor’s rights were subject to the bank’s security interest, so too was any lien obtained by the judgment creditor.11 As such, the bank had a right to “set off” any amounts owed to it with funds in the deposit account, even after receiving the judgment creditor’s garnishment paperwork.12 Despite this favorable precedent, banks must be David J. Jurkiewicz Partner Bose McKinney & Evans LLP DJurkiewicz @BoseLaw.com Bose, McKinney & Evans LLP is an associate member of the Indiana Bankers Association. Don’t Sleep on Your Rights Deposit account security interest will overcome a garnishment order if the bank takes appropriate action Timothy E. DeLaney Partner Bose McKinney & Evans LLP TDeLaney @BoseLaw.com
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