Magazine article The Journal of Lending & Credit Risk Management

A Promise Not to Exercise Setoff Rights Creates a $1 Million Problem for the Lender

Magazine article The Journal of Lending & Credit Risk Management

A Promise Not to Exercise Setoff Rights Creates a $1 Million Problem for the Lender

Article excerpt

What does a harried loan officer do when faced with a troubled loan while his bank is in the midst of merger negotiations? In re Colonial Realty Co. (Hirsch v. Union Trust Company), 229 B.R. 567 (Bkrtcy. D. Conn. 1999) provides an answer as well as a valuable lesson.

Colonial, a nationwide syndicator of real estate limited partnerships, established a $4 million unsecured line of credit with Union in June 1989. It drew down the entire line and was in financial difficulty by December 1989, having defaulted on loans procured from other lenders. A $2 million payment was due in March 1990 and the entire line was due in April 1990.

One of Union's officers met with an officer of Colonial in January 1990. Colonial agreed to make the $2 million payment in March 1990 and Union agreed to relend the $2 million a few days later. However, because Colonial could not repay the $4 million line in April 1990, it asked for an extension. The extension was granted, conditioned on Colonial making a $1 million deposit into a money market account at Union. But according to Colonial's officer (who ended up in a federal prison), the $1 million deposit was based on a promise by Union's officer that, in case of default, Union would not set off against these funds.

When April 1990 rolled around, Colonial could not repay the $4 million line. Union placed an "administrative freeze" on the $1 million deposit. A meeting was held in May 1990 at which Colonial's officer objected to the freeze and Union's officer denied that he promised to waive Union's right of setoff. In July 1990, a new revolving credit agreement was signed. Union was granted a security interest in a $1 million certificate of deposit Colonial purchased with the proceeds of the money market account. Union took possession of the CD.

Colonial was forced into bankruptcy on September 14, 1990; Union cashed the CD and set off the proceeds against the unpaid loan. …

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