Several Supreme Court Decisions consistently ruled that a pledge of deposit is not really a pledge and does not offer the pledgee bank a priority right on the deposit over other creditors of the pledging debtor the way a pledge does. Nor is a deposit book a right represented by an instrument, and therefore it cannot be pledged.
It follows from this judicial interpretation that a judgment creditor of the pledging debtor in a regular civil case or the official receiver, representing creditors in general, in a bankruptcy case against the pledging debtor will always have a better case than the pledgee bank when these creditors contest against each other over who will have the right to get paid from the pledged deposit.
For a pledge, as defined by the Civil and Commercial Code (CCC), the pledgor delivers a moveable property it owns to the pledgee as security against a loan. One crucial feature of a pledge under the CCC is that at all times while the pledged property continues as security, its ownership remains with the pledgor.
For a pledge of deposit, however, the ownership in the deposit ceases to belong to the pledgor under the CCC and passes on to the pledgee upon being delivered to the pledgee’s possession. In place of the pledgor’s ownership rises the pledgee’s ownership in the pledged deposit, with the pledgee’s obligation to refund the same amount with interest to the pledgor.
The high court’s decisions also invariably held that the pledgor’s right to receive back the deposit cannot be pledged, but can be restricted as loan security and forfeited upon default.
Pledge of Deposit Is Set-Off Agreement
Whatever name of the agreement you call: Pledge of Deposit Agreement, Cash Collateral Agreement, or Set-Off Agreement, a pledge of deposit is in fact an extended form of set-offs noted in the CCC, perfectly legal and valid, enforceable against the pledging debtor.
Under the agreement, the pledging debtor agrees that it cannot withdraw the deposit until all the loan debt is fully satisfied and that the pledgee bank can deduct from the pledged deposit any amount of principal, interest and fees related to the loan the deposit secures upon the pledgee bank notifying the pledging debtor of the happening of an event of default.
Such an event of default includes the pledging debtor failing to repay the loan when due, a civil lawsuit of significance being filed against the debtor, and a bankruptcy claim being lodged over the debtor’s insolvency.
The typical pledge of deposit agreement is a set-off in technical term because when an enforcement of the agreement is exercised by the pledgee bank the amount of the deposit the pledgee bank owes the pledging debtor is set off by the pledgee bank against the amount of the loan the pledging debtor owes the pledgee bank in reverse.
Other Creditors Prevail Over Pledgee Bank
A pledge of deposit is perfectly valid and enforceable as against the pledging debtor—alright—but it may not stand up to other judgment creditors and the official receiver.
If a judgment creditor learns of the existence of the pledged deposit, it has the right to request the court to issue a freeze order to the pledgee bank, instructing it to deliver the deposit to the execution officer, who will distribute the deposit to the judgment creditor in satisfaction of the judgment debt.
Upon receiving the court’s freeze order, the pledgee bank must freeze all activities hostile to the well-being of the deposit, hold the deposit for the benefit of the judgment creditor and deliver it to the execution officer within the time frame stipulated in that order. The pledgee bank must obey the court order and cannot deduct, set off or exercise any of its right under the pledge of deposit agreement.
If the pledgee bank disagrees with the court order, it can appeal against the order but must first put up security with the court amounting to the same amount as the pledged deposit in contest. In most cases, the pledgee bank will likely lose the appeal and is compelled to deliver the deposit to the execution officer for payment of the pledging debtor’s debt owed to the judgment creditor.
Ignoring Court Order Not a Good Idea
Efforts by the pledgee bank to disobey the court order without a proper appeal creates the bank’s liability under the Civil Procedure Code (CPC), which converts the pledgee bank unfavorably into a judgment debtor itself.
As a deemed judgment debtor in violation of the court’s freeze order, the pledgee bank would be exposed to a possibility of the execution officer asking the court to issue a writ of execution to the pledgee bank directly as a new judgment debtor, in addition to the pledging debtor.
By the writ of execution, the execution officer is empowered to seize any tangible moveable properties and immoveable properties from the pledgee bank and attach any of its rights of claims against third parties (such as its loan rights against any debtors or its cash deposits with other banks) to satisfy the amount of the pledged deposit, which the pledgee bank is now officially owed to the judgment creditor as a new direct judgment debtor, by the operation of the CPC.
Both the CPC and the CCC will also grant the judgment creditor a right to claim damages on the grounds of wrongful act against the pledgee bank who ignores the freeze order of the court and delays compliance without filing a proper appeal, causing damage to the judgment creditor, potentially including a loss of interest in the amount of debt that would otherwise have been paid.
The official receiver, acting on behalf of creditors at large, in a bankruptcy case against the pledging debtor would enjoy an advantage similar to the judgment creditor over the pledgee bank.
Deposit-Taking Bank as Third Party
There are cases where the deposit-taking bank is not a pledgee bank, but is a bank who takes a deposit from the pledging debtor and issues the debtor a deposit book; the debtor then pledges the deposit book with the pledgee bank.
In other cases, an agent bank acts on behalf of a syndicate of lending banks as the syndicate’s agent in taking a pledge of deposit as security on a loan disbursed by the bank syndicate.
The principles of a judgment creditor and the official receiver prevailing over the pledgee bank apply to the third-party deposit taking bank as well.
The difference is that with a third-party deposit taking bank, there need be a tri-partite pledge of deposit agreement between the deposit taker, the pledging debtor and the pledgee bank(s) to give a full force to the pledge of deposit against the pledging debtor, although at a defect against the judgment creditor and the official receiver.
Right of Pledging Debtor
Contests between the pledgee bank and the judgment creditor or the official receiver concern the creditor side, out of control of the pledging debtor.
The pledging debtor can improve its position by getting vigilant early at the beginning and not taking a pledge of deposit agreement for granted at the time when it is required to make the agreement as a condition of a loan in the first place.
Care should be given to the question of whether or not the pledge is a particular fund for a pledge of deposit to secure a certain credit for a specific project or simply a general letter of setoff as a standing order from the pledging debtor, without a specific pledge of deposit, to allow the lending bank to deduct any deposit in any bank account of the debtor against any indebtedness the pledging owes the lending bank any time the bank wants.
If the former is the case, the pledging debtor should carefully negotiate the terms of the pledge of deposit to clarify the circumstances in which the deposit can be deducted and set off against the loan debt. The more difficult the circumstances the better.
In any case, the debtor should avoid the latter case of a standing order of a general letter of setoff in the bank’s standard form whereby a particular indebtedness that the letter of setoff secures is not known, a fund for a pledge of deposit is not set up, and the lending bank is given a universal power to set off and deduct any deposit of the debtor against any debt it owes the bank with no limits, causing the debtor to lose all its leverage and even to forget that it once signed that damning letter of setoff.
Wirot Poonsuwan is Senior Counsel and Head of Special Projects at Bangkok law firm Blumenthal Richter & Sumet and can be contacted at email@example.com.