By: Charles D. Dunbar and Mark A. Mangano
For at least the next several months, you will be funding Payroll Protection Program (PPP) loans for your customers. At the same time, you may be dealing with loan defaults. You will attempt to accommodate your financially stressed borrowers. But, you will continue to have the obligation to make sound credit risk decisions to preserve the bank’s ability to recoup its principal and interest from customers in default.
The right to set-off a borrower’s debt obligations against the borrower’s deposits with the bank is a powerful tool. There are normally a limited number of significant risks that suggest caution in exercising this right. However, there are additional risks in the time of PPP.
Currently, there are no specific prohibitions against exercising a right of set-off against an account containing funds from PPP loans. But taking funds from a PPP loan may increase reputation and lender liability risks.
The unique feature of PPP loans is the potential for forgiveness of the debt. Forgiveness is dependent on proof that the recipient of the PPP funds used the funds for very specific purposes in a very specific time-frame. If the PPP borrower is unable to apply for forgiveness because the funds were used to offset a defaulted debt, the borrower may claim that the bank created a harm.
It is not clear that PPP borrowers would be successful in bringing claims for damage caused by the bank’s legal set-off. However, if the borrower’s business fails or finds itself with significantly increased debt because of failure to qualify for forgiveness, it is conceivable that such borrowers will bring civil actions to recover alleged losses.
Our recommendations are to:
- Consider updating your collection policies and procedures to ensure that you assess whether the funds in question can be traced to PPP funds, before exercising the set-off right.
- Ask your customer to set up a separate deposit account to manage the PPP loan proceeds.
The PPP is a unique program. Be aware that standard collection procedures in the time of PPP may trigger increased risks.