Ferguson Enterprises, Inc. v. Main Supply, Inc.

• Decision Date: 19 February 1993
• Docket Number: No. 92-CA-0884-MR,92-CA-0884-MR
• Citation: 868 S.W.2d 98
• Parties: 23 UCC Rep.Serv.2d 1197 FERGUSON ENTERPRISES, INC., Appellant, v. MAIN SUPPLY, INC., and Bank of Danville, Appellees.
• Court: Kentucky Court of Appeals

Page 98

868 S.W.2d 98

23 UCC Rep.Serv.2d 1197

FERGUSON ENTERPRISES, INC., Appellant, v. MAIN SUPPLY, INC., and Bank of Danville, Appellees.

No. 92-CA-0884-MR.

Court of Appeals of Kentucky.

Feb. 19, 1993.

Rehearing Denied April 30, 1993.

Discretionary Review Denied

by Supreme Court Feb. 16, 1994.

Bernard F. Lovely, Richard A. Whitaker, Vimont & Wills, Lexington, for appellant.

E. David Marshall, Lexington, for appellee/Main Supply, Inc.

James William Barnett, Danville, for appellee/Bank of Danville.

Before HOWERTON, JOHNSON and MILLER, JJ.

MILLER, Judge:

Ferguson Enterprises, Inc. (Ferguson), brings this appeal from an order of the Boyle Circuit Court entered March 16, 1992. We reverse and remand.

On July 5, 1991, Ferguson obtained a judgment against appellee Main Supply, Inc. (Main Supply), in the amount of $34,631.18. To enforce this judgment, an Order of Garnishment was served upon appellee Bank of Danville (bank) on July 24, 1991. Kentucky Revised Statute (KRS) 425.501 et seq. On August 7, 1991, the bank submitted to the Boyle Circuit Court an affidavit and answer indicating there were no funds available for the garnishment lien's attachment. Through additional correspondence, it was discovered on July 24, 1991 (the date the Order of Garnishment was received by the bank), that Main Supply's account showed a balance of $13,206.87. Notwithstanding this balance, the bank indicated that it deemed a loan to Main Supply as being in default, thus entitling it to the account balance by reason of a security interest lien or setoff. Thereafter, Ferguson filed a motion in the Boyle Circuit Court for an order compelling payment of funds by garnishee. On March 16, 1992, the circuit court denied Ferguson's motion. This appeal follows.

This case presents a simple question as to what requirements a bank must meet in order to effectuate a setoff from a depositor's account. Under Kentucky law, the relationship of a bank and a depositor is that of debtor and creditor. See Dorman v. Adams, 247 Ky. 678, 57 S.W.2d 534 (1933). The bank is the debtor; the depositor is the creditor. A depositor's funds become a part of the bank's assets. See Scoggan v. Dillon, Ky., 252 S.W.2d 35 (1952). When a depositor becomes indebted to a bank and defaults on the indebtedness, it is a well-established rule of law that the bank may exercise a right of setoff to enforce collection of indebtedness owed to it by a depositor. See American Bank & Trust Co. v. Shouse & Burrus, Ky.App., 648 S.W.2d 540 (1983). Many authorities refer to the bank's right as that of a lien upon the deposit account, but, strictly speaking, such is erroneous. A bank cannot possibly have a lien upon its own assets. 10 Am.Jur.2d Banks Sec. 666 et seq. (1963). It is logical, therefore, that the Uniform Commercial Code (U.C.C.) Sec. 9-104(i), (l ), codified in this Commonwealth as Kentucky Revised Statute (KRS) 355.9-104(9), (12), excludes setoffs and transfers of an interest in deposit accounts from secured transactions.

In view of the foregoing, if the bank's interest in Main Supply's account is to be adjudged superior to that of Ferguson's garnishment lien, it must emanate from the right of setoff and not from any notion relating to a security interest lien. Therefore, in order to settle this controversy between the bank and Ferguson, we must determine whether the bank's right to setoff or the garnishment lien has priority as to Main Supply's account. In this regard, the Uniform Commercial Code is helpful. Although, as aforesaid, it does not give the bank a security interest in a depositor's account, it does address the issue of priority in regard to setoffs and competing claims to a bank account. U.C.C. 4-303 (codified as KRS 355.4-303) provides, in relevant part, as follows:

(1) Any knowledge, notice or stop-order received by, legal process served upon or setoff exercised by a payor bank, whether or not effective under other rules of law to terminate, suspend or modify the bank's right or duty to pay an item or to charge its customer's account for the item, comes too late to so terminate, suspend or modify such right or duty if the knowledge, notice, stop-order or legal process is received or served and a reasonable time for the bank to act thereon expires or the setoff is exercised after the bank has done any of the following:

(a) accepted or certified the item[.]

It is plain that under this statute a bank cannot charge a customer's account with a setoff after accepting a garnishment thereon--the same being a legal process. Following U.C.C. 4-303(1)(a), in order to determine whose interest is superior, it must be initially determined who was first in time: the bank's acceptance of the garnishment lien or the exercise of the right to setoff. It is undisputed that the garnishment was received by the bank and simultaneously attached Main Supply's account on July 24, 1991. It may be that at this time the Main Supply loan was delinquent or even in default. This, however, is immaterial. Priority is not predicated upon either delinquency in loan payment or default, but rather upon the effectuation of a setoff. The issue before us is to determine factually and legally when the bank's setoff occurred. The exact steps necessary to effectuate a setoff present a case of first impression in Kentucky.

In Baker v. National City Bank of Cleveland, 511 F.2d 1016 (6th Cir.1975), the Court, applying Ohio law, recognized the uniqueness of this issue and held that affirmative steps must be taken to effect an intended setoff. The Court stated that "the act of setoff is not complete until three steps have been taken: (1) the decision to exercise the right, (2) some action which accomplishes the setoff and (3) some record which evidences that the right of...