Springing Deposit Account Control Agreements Explained
What Is a Deposit Account Control Agreement
A deposit account control agreement, oftentimes referred to as a "DACA" or "DAC," is an agreement between a borrower that maintains a deposit account with a bank and the bank (the "Bank"). Through a DAC, a lender can either perfect its security interest or obtain control in connection with a secured lending transaction. In other words, a DACA is a way for a secured lender to perfect its interest in a deposit account maintained by the borrower. Bank control of a deposit account will give the lender (referred to as the "Secured Party") a perfected security interest in the collateral.
A deposit account control agreement is a contract between the borrower, the Secured Party and the Bank that creates a lien on cash deposited in a deposit account (e.g., checking, savings, etc.), which is created as a result of a loan or credit facilities to a particular business entity or individual for business purposes. In order to defeat prior competing liens, particularly a lender’s lien on deposit accounts of which it does not have control, the lender often finds it necessary to establish a control arrangement to provide that it has a first-priority, perfected security interest in the deposit account . For purposes of perfection priority, creation of a lien on deposit accounts is treated differently from other types of collateral by state law. The UCC lists three methods of perfecting such a security interest in deposit accounts: (i) by the Secured Party being a bank with which the deposit account is maintained; (ii) by control under § 9-104 of the UCC; or (iii) by "control agreement," (i.e., a deposit account control agreement).
A DAC should fall within the category of a control agreement with two or more banks, which control agreement constitutes a perfected security interest under the requirements of § 9-104(b). A DACA designed to cover those accounts that are not "transferred" to the Secured Party (i.e., limited to accounts where the Secured Party is not the bank maintaining the account) will require the use of a three-party traditional deposit account control agreement, such as the one used by Wells Fargo, Bank of America and JPMorgan Chase (a model of which is provided below).
Defining a Springing DACA
A springing deposit account control agreement (DACA) is an agreement created to secure direct or indirect rights to a deposit relationship, even if it has not been opened yet. A DACA that is not springing allows for rights to a deposit relationship, but only after it is opened. A springing DACA has the same rights as a regular DACA, but it springs into effect immediately and does not provide for notice on opening. In Texas, for instance, a regulatory notice is typically required within five days of opening.
This means that if a new account is opened at the depository bank, it is covered and automatically within the control of the lender. The obligations of the borrower and the bank are usually defined by the DACA. For instance, the borrower will be required to maintain certain balances in the account, pay fees on the account, and so forth. After the granting of notice by the bank, the depository bank will be required to comply with the rights given up by the borrower. Lenders like springing DACAs because they immediately become effective, and provide them with basically the same rights as a regular DACA. They don’t really give the bank anything extra.
When there is a transaction where there is a high likelihood that an account will be opened, but no prior correspondence with the actual opening, the lender should ask for a springing DACA. This is because the DACA is used to obtain possession and control of funds deposited in an account at a bank or other financial institution. If an account is opened after a springing DACA is signed, but without any notice or acknowledgement from the transferor or bank, then it is difficult if not impossible to the recover the funds from the bank.
Essential Elements of a Springing DACA
The basic framework of a springing DACA will typically mirror that of a typical DACA; however, the intricacies of the agreement can be tailored to fit specific borrower and/or lender needs. The standard elements of a springing DACA include:
Debtor Termination Rights. A springing DACA should detail the circumstances in which the debtor will be permitted to terminate its rights under the agreement. For instance, a DACA will likely provide that upon the emergence of an event of default requiring a change in authority over debtor funds, the debtor will not be permitted to terminate its rights on the DACA without the express written consent of the secured party.
Transition Period for Secured Party. A springing DACA should also provide for a transition period so that the secured party has time to transition authority of the accounts into its name or to a third-party agent selected by the secured party.
Authorized Agent. The springing DACA should allow both the debtor and bank to appoint an authorized agent to exercise powers in the name of the secured party during the transition period. Both parties should be required to notify the bank upon the appointment of such authorized agent.
Activation. In order for the DACA to "spring" into effect, an enumerated event must occur. For example, such an event might include the transfer of all or substantially all of the assets of the debtor, or the failure of the debtor to make a payment to the secured party when it becomes due. A springing DACA might also include enumerated events that would not automatically "spring" the DACA into effect, but would rather give the secured party the right to exercise control over all or a subset of the accounts.
Pros and Cons of Springing DACAs
Springing Deposit Account Control Agreements ("DACAs") can offer advantages to both lenders and borrowers, but they have certain drawbacks for each party. From the lender’s perspective, a springing DACA is generally far less costly and time consuming to implement than setting up a DACA from the outset. A lender is also able to avoid the time and effort needed to implement a DACA early in a credit relationship, only to later discover that a DACA is not really necessary. For borrowers, springing DACAs can be a "dial down" trigger that permits them to retain greater liquidity in their accounts without having to keep margin or cash to secure a DACA.
However, these advantages can be offset by the costs associated with documents and instructions that must be provided to a borrower or financial institution in a short period of time, which can be difficult under time constraints to avoid a default. It is possible that a lender might have a hard time operating a loan policy that allows it to implement a springing DACA after it has determined that a default has occurred or is likely to occur. For example, a bank’s loan policy might require that a loan stop being classified as a pass loan and become nonaccrual due to a reporting trigger event – essentially a DACA that is used as collateral in the calculation of the bank’s capital ratio – within a certain number of days after the trigger event, thus placing a DACA on deposit accounts that are classified by the bank as nonpass and therefore not eligible for accrual interest income. While a DACA could theoretically go into default by the bank holding a DACA on a nonpass account, this can seem like a contradictory position to a borrower. As a practical matter, and consistent with normal loan administration, a bank will want to avoid accruing interest on deposits that it determines should be classified as nonpass.
Borrowers should also consider that, once the DACA is in place, there may be additional documentation efforts required to amend the deposit account control language to identify Andover Bank’s interest. A change to a bank control agreement is not going to be a cheap or quick process.
Legal and Compliance Considerations
Like any other contract, springing DACA’s should not be entered into lightly. Consideration should be given to the important role that such an agreement plays and the potential liabilities for both sides under different circumstances. Lenders should strongly consider their remedies if a springing DACA is not followed. For example, if a springing DACA’s would have triggered a Default Rate of Interest then the Lender’s delay in responding to the triggers could have resulted in the imposition of the Default Rate of Interest on late payments or other events of default, but if the Lender does not respond to the Trigger Events then it might be argued it has waived its right to impose the Default Rate of Interest.
To mitigate those potential issues, and to make life easier for itself and later lawyers , a Lender should consider adding a clause which says something to the effect that the failure of the Lender to respond to a DACA Trigger Event shall not constitute a waiver of any Trigger Event, and may not be used against the Lender in any proceeding involving any of the agreements secured by the DACA. In such cases where the failure of the Lender to follow the strict wording of the DACA results in an outcome unintentional or unfavorable to the Lender, the "unscrambling" of the eggs by arguing there was no waiver on the part of the Lender or that such a waiver adversely impacted the security of the DCA will be avoided. This is particularly important to the parties who are relying on there being no adverse impact to the intended security in the DACA. If a Springing DACA is called under circumstances where the trigger event did not actually occur, the lender may find itself having to scramble to find a way to avoid being sued if it triggers the DACA.
Practical Implications and Scenarios
A springing DACA can be used, for example, in a chain of restaurants where the bank has a lien on the accounts receivable of one restaurant. The bank may want a springing DACA to be in place, so if that restaurant defaults on a loan from the bank, the bank can protect the collateral by freezing all of the accounts of that restaurant. Whatever cash is received in those accounts cannot be moved or spent unless the bank approves. This allows the borrower to remain in business for the benefit of the bank, while assuring that the bank has control of all cash that otherwise might be used to pay unsecured debts.
Another application is as a temporary freeze of all accounts in a chain of dealerships or repair shops, where the lender has a lien on the parts, tools and equipment of one location of the chain. The bank wants to secure payment on its loan to one location, but also may need the chain’s entire cash flow in order to do so. This allows the bank to maximize its recovery while also allowing the dealer or repair shop to continue to operate.
Emerging Trends in Deposit Account Control Agreements
Looking ahead, it seems likely that as the use of technology in banking and electronic finance continues to grow, the use of deposit account control agreements will similarly increase. With greater digital financial transactions, greater use of electronic payments and more reliance by end-users on deposits constituted by digital assets, the use of controls under deposit account control agreements — whether under the UCC or pursuant to a contractual agreement outside of the UCC — is likely to develop. Security interests in deposit accounts may also grow if some jurisdictions opt into UCC Article 9 reforms related to control by putting a financial asset into a deposit account . Even without such statutory change, a court judgment against a debtor may be more readily attached to a deposit account as more deposits become asset-backed (as opposed to being backed by a debtor’s general creditworthiness) or as more financial institutions elect to follow the UCC rules for deposit accounts under the doctrine of lex loci solutionis, which holds that, for purposes of UCC Article 4A, the bank account is located at the financial institution’s headquarters and all instructions are given there.