Monday, February 11, 2008


Banker Lien And Right Of Set-Off*[1]

When a bank has a claim against a debtor and the debtor has a claim against the bank, the law generally permits the claims to be offset against one another. As a result, the party owing the larger sum makes a payment to the other party of the net amount due. Although this benefits both parties by simplifying matters, it especially can benefit a bank where its debtor is failing or in bankruptcy and may not have the funds to make any payment whatsoever. In this situation, at worst, the bank will only be out the net amount it might have to pay the debtor rather than the full amount it owes while it attempts to recover the amount it is owed.
In this project first chapter I deal lien and rights where I inscribe the meaning of lien and banker lien. For the lien significance I have give various sharpness of form the different text book. After that episode I reveal as the ‘lien compared with other surety’. Basically, I put in plain words the lien is match up with other surety. The third part of the project is defined the set-off. The various part of set-off is explained.

Chapter –I
Lien and Rights
A lien is the right of a creditor in possession of goods, securities or any other assets belonging to the debtor to retain them until the debt is repaid, provided that there is no contract express or implied, to the contrary. It is a right to retain possession of specific goods or securities or other movables of which the ownership vests in some other person and the possession can be retained till the owner discharges the debt or obligation to the possessor. It is a legal claim by one person on the property of another as security for payment of a debt. In Chalmers on Bills of Exchange, the meaning of the Banker’s Lien is stated: "A bankers’ lien on negotiable securities has been judicially defined as ‘an implied pledge’. A banker has, in the absence of agreement to the contrary, a lien on all bills received from a customer in the ordinary course of banking business in respect of any balance that may be due from such customer." It should be noted that the lien extends only to negotiable instruments which are remitted to the banker from the customer for the purpose of collection .When collection has been made the process may be used by the banker in reduction of the customer’s debit balance unless otherwise earmarked. “The Banker’s lien the learned author has stated that apart from any specific security, the banker can look to his general lien as a protection against loss on loan or overdraft or other credit facility. The general lien of bankers is part of law merchant and judicially recognized as such.” [2] "The lien is applicable to negotiable instruments which are remitted to the banker from the customer for collection. When the collection has been made, the proceeds may be used by the banker in reduction of the customer’s debit balance, unless otherwise earmarked." In Chitty on Contracts define as “A lien in its primary sense is a right for one person who is lawfully in possession of property belonging to someone else to keep possession of that property until the person in possession has been paid amounts due to him. Such a lien arises by operation of law and not by contract.”[3] This type of lien is described as a legal lien.
Chapter –II
Liens compared with other security
Legal lien and mortgage
A mortgage is a right founded on contract and is assignable. It will not depend on possession. In its correct sense a legal lien arises by operation of law and not by contract. It is a personal right depending entirely on possession of the goods and cannot be assigned. It will terminate once the holder of the lien loses possession. In the case of land, a deposit of title deeds with a lender will give the lender two sets of rights: (1) a legal lien over the deeds and (2) an equitable mortgage over the property. The equitable mortgage in practice gives more extensive rights than a lien and so the lien has not been relied on. There is still some doubt, however, as to whether the lien will survive if the equitable mortgage fails for lack of registration under the Companies Ordinance.
Liens and pledges
Liens and pledges are similar in that they are both based on possession of the property which is the subject of the security. However, a pledge arises from contract and is an assignable interest unlike a lien.

Liens and equitable charges
A charge is normally founded on contract whereas a lien will arise by operation of law or equity. Both an equitable lien and an equitable charge are equitable interests. An equitable charge is void if not registered. An equitable lien arising by operation of equity is not "created' by the owner of the property subject to the lien for the purposes of section 80 of the Companies Ordinance and so is not registerable.[4]

General lien as banker lien
This entitles a person in possession of chattels to retain possession until all claims of the person in possession against the owner have been met. General liens have been recognized in favour of solicitors, bankers, factors, stockbrokers, insurance brokers and tailors, among others. Only the banker's lien will be considered here. The banker's lien has been an established right for nearly 200 years.[5] It is part of the law merchant and does not need to be pleaded or proved in court. There is also authority[6] for the proposition that a banker's lien is an implied pledge. As shown, a pledge consists of a right to retain possession of property as security coupled with a power of sale. In describing a banker's general lien as an implied pledge, the court was extending the powers conferred by a lien from a mere right of retention to include a power of sale.
The banker's lien will cover all chattels and securities coming into the possession of a bank in the ordinary course of its business as a banker, unless there is an agreement express or implied to the contrary. Thus if securities are deposited with a bank to be held in safe custody only, no lien can arise[7] But if they are deposited with instructions, for example, to collect interest, it would seem that a lien will arise. In Davis v Bowsher,[8] the securities were deposited with the bank as custodians only, so no lien arose. In the securities were deposited with instructions for the bank to act as bankers with respect to the securities and it was held that the bank had a lien over them. Similarly where securities have been deposited as security for specific indebtedness which is then repaid and the securities are left with the bank, they will only be subject to a lien in respect of other indebtedness owed by the same customer if there is no express agreement to the contrary in the original security document or by some other arrangement. The lien will cover all securities and is not limited to negotiable securities. Share certificates, deposit receipts and insurance policies have all been held to be covered by liens. A lien will not cover money in a bank account.[9] It is a misuse of language for a bank to claim a lien over its own indebtedness to its customer. The bank has a right to consolidate accounts or set-off the customer's indebtedness against the bank's indebtedness. In the Halesowen case[10], it was held that a cheque cleared by the bank ceased to be in the bank's possession. Any lien therefore terminated. The money collected from clearing the cheque physically became the bank's money although owed to the customer. It was not possible for the bank to have a lien on its own property.
As indicated, the banker's lien will cover the general balance actually owed by a customer, that is, all sums currently due and payable, whether on loan, overdraft or other credit facility.[11] It will not extend to contingent or future liabilities.[12]
Other aspects of legal liens
“A legal lien is a right of defence rather than a right of action. Even if the debt itself is barred under the Limitation Ordinance a lien may still be claimed. Only in special circumstances (see banker's liens, among others) will a lien confer a power of sale. It is first and foremost a right of retention. Unless there is authority from the owner, a lien will not pass with the transfer of possession.Possession is essential for a lien to be created and it must be rightfully obtained. Thus property which has been acquired by misrepresentation, mistake, fraud or by the wrongful act of a third person will not found a lien. As seen in the discussion of banker's liens, if possession is only obtained for a particular purpose a general lien may be excluded. There must also be continuous possession over the chattel the subject of the lien, so if the owner has free access to it at all times while in the possession of the person claiming the lien, there will be no lien.”
Effect occur in general lien
A general lien arises out of a series of transactions in the general course of business rather than a single specific transaction such as the repair of a piece of jeweleary or a computer. Attorneys, bankers, and Factors usually have general liens to ensure that his client will pay him for services already performed; an attorney may retain possession of the papers and personal property of his client that fall into his hands in his professional capacity. He also has a charging lien on any judgment he has obtained for his client for the value of his services. A banker may retain stocks, bonds, or other papers that come into his hands from his customer for any general balance owed by the customer. A factor or commission merchant may hold onto all goods entrusted to him for sale by the owner of the goods for any balance due. The merchant may sell the goods to satisfy his lien, but he must account to the owner for any excess realized from the sale. General liens occur less frequently than specific liens.

Right of Set –off
The right of set off is also known as the right of combination of accounts .A bank has a right to set off a debt owing to a customer against a debt due from him. "A legal set-off is “where there are mutual debts between the plaintiff and defendant, or if either party sue or be sued as executor or administrator one debt may be set against the other "[13] A set off must be in the form of a cross- claim for a liquidated amount and can be pleaded only in respect of a liquidated claim. Both the claim and the set -off must be mutual debts, due form and to the same parties, under the same right. A claim by a person in a representative capacity cannot be set –off against a personal claim. Thus, if A claims Rs.500 as the balance due to him form his banker, while as trustee of B, A owes to the banker Rs.300, no set-off against a debt, which was due to the customer form his banker, during the former’s life-time, whether the accounts are with one or more offices of the banker, it does not materially affect the position in any way. In the case Firm Jaikishen Dass Jinda Ram v. Central Bank of India Ltd.[14] “two partnership firms with the same set off partners had two separate accounts with the Bank. The Court held that the bank was entitled to appropriate the monies belonging to a firm for payment of an overdraft of another firm. Because although two separate firms are involved they are not two separate legal entities and cannot be ‘distinguished from the members who compose them. Mutual demands existed between the bank on the one hand and the persons constituting firm on the other. Nor it could be said that these demands did not exist between the parties in the same right.” Further in the matter A.S.R. St. Veerapa Chettiar v. J.V. Pirie (Official Liquidators- Traancore National and Quilon Bank Ltd.)[15] the claim of setting off an amount due by the bank to the plaintiff and his mother, payable to either or survivor, in respect of a fixed deposit against an amount due to the bank by the plaintiff on overdraft account was allowed, on the ground that the fixed deposit amount absolutely belonged to the plaintiffs.
2. When set off right not available
In case of joint account, the bank cannot set-off a debt due form A alone against join debt nor can A set- off such a debt against a separate debt due form his to the bank[16], and also held that the bankers have not a right to combine one or more accounts of the same customer. But a banker cannot combine a customer’s personal account with a joint account of the customer and another person.[17] In the matter of Official Liquidator, Hanuman Bank Ltd. V. Chota Nagpur Banking Association Ltd.[18]a banker’s right of set-off cannot be exercised after the money in his hands been validly assigned or in any case after he shas been notified of the fact of an assignment. Rule of set -off in bankruptcy does not rest on the same principle as the right to set-off between solvent parties.[19] It is open to the parties to contract out of their rights of set-off. If the company has surrendered this right, it would not then be entitled to raise a defence on that basis.[20]
Banker’s Right of Set Off
Where the same partners were running two partnerships firms and maintaining two accounts in a bank in two different names, and remitting branch where the two accounts were partnership firms was refused and the same was returned to the remitting branch where the two accounts were maintained, the bank receipt of the remitting credited the proceeds to the account of the other firm. It was held in Firm Jaikishen Dass Jinda Ram v. Central Bank of India Ltd.[21] that the bank is competent to adjust the balance of the accounts of the two firms where the constituents of partnership firms are the same. The court argued that the partnership is not distinct legal entities.

4. Relationship between Lien and Set-Off
In the matter of Radha Raman Choudhary v. Chota Nagpur Banking Association Ltd.[22] the banker’s right of lien can attach to the money so long as it is earmarked. Where it has ceased to be such a separate earmarked sum, the bank has not the right of set off. There is a distinction between a banker’s lien and the bank’s right to set-off. A lien is confined to securities and property in bank’s custody. Set-off is in relation to money and may arise from a contract or from mercantile usage or by operation of law. “Of more universal interest is the treatment of the general banker-customer relationship, and it is here that the work begins to disappoint. The description of the banker's lien is particularly confusing. The lien is defined as a charge on property, whereas it is a mere right of detention. The "lien' on money is put into the same category as a lien on documents, when it is clear that a lien in the true sense is not exercisable in relation to intangibles and that the so-called lien on money is a right to withhold payment, typically as the result of exercise of a right to combine accounts, a point picked up a few pages later. The treatment of set-off is inadequate. No distinction is drawn between contractual set-off, set-off in equity and set-off in bankruptcy, and there is no discussion whether cross-border or cross-currency set-off will be recognized by the courts. Remarkably, while two chapters occupying 40 pages are devoted to the insolvency of the bank (which one assumes is happily infrequent), the relatively common case of the customer's insolvency do not, apparently, rate a mention except in the context of a fraudulent preference. In the discussion on the bank's duty of confidence it would have been helpful to know whether the editor considers that the common banking practice of furnishing status reports about a customer to other banks without the customer's prior knowledge or consent is not an infringement of that duty.”[23]Bankers cherish their rights of setoff. Applying a customer's deposit balance is often the most efficient and least expensive step in collecting a loan that is in default. A banker's first reaction, upon hearing that a borrower is headed for bankruptcy, is usually to check the borrower's deposit balance. If the loan is in default or can be accelerated, the banker may be inclined to offset the deposit without further deliberation, because to delay is to run the risk that the balance may be depleted or that a bankruptcy petition will be filed before the setoff can be accomplished. While those risks are real, the banker should nevertheless pause to consider the matter. The risk of depletion is susceptible to some control. The bank can monitor the deposit account and delay the setoff until it must decide whether to pay or dishonor checks.[24] Even when a decision to pay or dishonor must be made, the bank can weigh the amount of presented checks against the total deposit balance and consider whether, in view of the bankruptcy issues discussed in this article, the bank should pay the checks in order to preserve a more valuable opportunity.”[25]

A banker cannot rely on his banker’s lien over property which was his customer’s property when it first come into the banker’s hands, but which the banker knows to have been subsequently assigned by the customer to a third party to the full extent of the customer’s beneficial internets therein, if the purpose of relying on the lien of reimburse the banker in the respect of advances made by him to the customer after notice of the assignment .Banks often rely on setoff to limit their risk to failing debtors.

Gupta, S.N., Banking Law in Practice and Theory, 4th edn., Universal Law Publishing Co., Delhi
Gupta, S.N., Supreme Court on Banking Law, 4th edn., Universal Law Publishing CO., Delhi.
Hapgood Mark, Paget’s Law of Banking, Indian Reprint, Lexisnexis Butterworths, Delhi, 2004.
Holden J. Millnes, The law and practices of Banking, Vol. 1, Universal law Publishing Co., Delhi, 1998.
Simon Deane “Principal types of security including pelages and liens”, J.I.B.L.1994
Jack B. Justice “Setoff Against A Depositor Facing Bankruptcy: A Question Of Timing” 110 Banking L.J. 310.

[1] *Edvin Gardia final year student of Hidayatullah National Law University Raipur Chhattisgarh.
[2] Peget’s Laws of Banking ,8th Edn. at page 498.
[3] Simon Deane “Principal types of security including pelages and liens”, J.I.B.L.1994, 9(2), 52-57.

[4] Capital Finance Co. Ltd v Stokes [1986] 1 All ER 573.
[5] Davis v Bowsher (1794) 5 Term Rep. 488.
[6] Brandao v Barnett (1846) C1. & Fin. 787 at 806.
[7] Ibid.
[8] Supra5.
[9] National Westminster Bank v Halesowen [1972] AC 785 at 802 and 810.
[10] Ibid.
[11] Re European Bank (1872) 8 Ch. App. 41.
[12] Bower v Foreign and Colonial Gas Co. Ltd (1874) 22 WR 740.
[13] S.13 Insolvent Debtors Relied Act 1728.
[14] AIR 1960 Punj. 1.
[15] AIR 1946 Mad. 436.
[16] Nath Bank Ltd.( In liquidation) v. Sisir Kumar Sarkar, (1954) 24 Comp. Case 306 (Cal).
[17] Radha Raman Choudhray v. Chota Nagpur Banking Association Ltd.,(1945) 15 Comp. Case 4.
[18] 26 Comp. Casse 81.
[19] I.S.& C. Maxhado v. Official Liquidator, Travancore National and Quilon Bank Ltd.,( 1994) 11 Com. Case 221.
[20] Hong Kong and Shanghai Bkg. Corpn. v. Kloecker & Co. 1989 BCLC 776 QBD.
[21] AIR 1960 Punj. 1.
[22] (1945) 15 Comp.Cas.4(Pat).
[23] J.I.B.L.1987, 2(3), 198-199.
[24] Pittsburgh Nat'l Bank v. United States, 657 F.2d 36 (3d Cir. 1981), United States v. Citizens and S. Nat'l Bank, 538 F.2d 1101 (5th Cir. 1976).
[25] Jack B. Justice “Setoff Against A Depositor Facing Bankruptcy: A Question Of Timing” 110 Banking L.J. 310.

1 comment:

omni sham said...

Customer A has a loan account with Bank A. Customer A defaults on loan account with Bank A. Customer A opens a deposit account with Bank B. Bank A sells defaulted loan account to Bank B. Bank B claims set off against Customer A’s deposit account to settle the default loan account. Discuss.