No. 88-528

INTHE SUPREME COURTOF THE STATEOFMONTANA
1989

VICTOR WERLHOFAVIATION INSURANCE, Plaintiffand Respondent,-vsRONALDGARLICK,d/b/aGARLICK HELICOPTERS, Defendant.

### -vsFARMERS STATE BANK, a Montana Banking corp., Garnishee-Appellant.

APPEAL FROM: District Court of the Fourth Judicial District, Inand for the County of Ravalli, The Honorable JackL. Green, Judgepresiding.

COUNSEL OF RECORD: ForAppellant: JeffreyH. Langton, Hamilton,Montana

For Respondent:
CharlesJ. Tornabene; Patterson, Marsillo, Tornabene and Schuyler, Missoula,Montana

ForAmicus Curiae: George T. Bennett,Montana BankersAssoc., Helena, Montana

Filed: SubmittedonBriefs: Jan. 

### 12, 1989 ~~~id~d: April 6, 1989

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# -Mr. Justice John C. Sheehy delivered the Opinion of the Court.

The principal issue in this case is whether a bank, otherwise lawfully entitled to a setoff, may exercise its right of setoff against a depositor's account at the same moment it is presented with a writ of execution which seeks to levy on the same depositor'saccount. We uphold the right of the Rank to the setoff. A second issue iswhether a bank may set off a matured debt against a depositor's account when the debt is secured by collateral. Again, we hold that the Rank's right of setoff in this case is not barred by the presence of collateral. A third issue is whether S 30-4-303,MCA,modifies the Bank's right of setoff. We hold that 30-A-403 has no application in this case. FarmersState Rank appeals froman order of the District Court, Fourth Judicial District, Ravalli County,which held that the Bank holds property of a depositor to which a judgment creditor of the depositor Victor Werlhof Aviation Insurance, had a right. The order forbade the Bank to transfer or otherwise dispose

### of thedepositor's monies until the judgment creditor, Victor Werlhof Aviation Insurance, could commence and prosecute to judgment an action against the Bank for recovery of the monies which the District Court held were wrongfully set off by the Bank. The order is in the nature of an injunctionand is thus appealableunder Rule 

### 1,M.R.App.P. We reverse the District Court and vacate the prohibitive order. There isno dispute as to the evidentiarv facts. Victor Werlhof Aviation Insurance first obtained a judgment againstGarlick Aviation on April 11, 1996 in Missoula County District Court for $10,391.46. The judgmentwas abstracted toRavalliCountyDistrictCourt onMay 19, 1986. That court issued a writ of execution on June 4, 1986 directed to appellant Farmers State Rank of Victor, Montana, against Garlick's account in the Bank. Garlick owed monies on a delinquent note to the Bank at the time of the execution of the first writ. The return of service of the June 4 execution indicated that Garlick's account held $3,276.97, but the Bank claimed a setoff against the monies for a delinquent note of $80,000.00 which Garlick had executed to the Bank in 1982. On January 15, 1988, on behalf of Victor Werlhof Aviation Insurance, a second writ of executionwas issuedby the court. This writ was presented by the sheriff to the Rank in the samemanner as the firstwrit. At the time the Bank received the writ, Garlick owed the Bank a monthly payment of $2,895.10 which was due as of January 1, 1988. The overdue payment was amonthly obligation in satisfaction of a debt underlying a contract for deed which had been assigned to the Bank in a separatebankruptcy by a party not involved in these proceedings. The Bank, when the judgment creditor's writ was presented, set off Garlick's checking account balance toward the January 1, 1988 overdue installment. Victor Werlhof Aviation Insurance then sought suppl.emental proceedings in aid of execution against the Rank. The District Court held against the Bank and it appealed to this Court. 

### 1. May 

### -- the Bank claim set off against a depositor's 

### -- - account 

### - at 

### - the moment it is presented with a writ of 

### - - ---- execution tobe leviedupon the account? 

### -- --- The basis of a bank" right to set off its depositor's accounts against matured debts owed 

### by the depositor to thehank was recently discussed by this Court in Bottrell, Reeve and Northern Line Layers, Inc. 

### v. American Bank (f/k/a Western StateBank), JimReaton and Marty ~errig(NO. 87-209, Decided April 5, 1989). There we said, citing Spratt v. Security Bank of Buffalo, Wyo. (Wyo. 1982), 654 ~.2d 130,

We next reach appellant's claim that the bank's set-off should fail for lack of mutuality between appellee and Gail Fanning. Before going further, weneed to discuss abank's right to setoff against the general deposits in its possession. Thebank's right of set-off to secure the payment of its depositor's indebtedness 

### is a part of the law merchant and well established in commercial transactions. (Citing authority.) For a bank to establisha right to setoff,three conditions must be met: "the fund to be setoff must be the property of the debtor, the fundmust be deposited without restrictions,and the existing indebtedness must be due and owing." (Citingauthority.) The bank's right to setoff does not arise until the time the depositor's indebtedness to the bank has matured. (Citing authority. Addressing appellant's point, for set-off to be permissible, there must be mutuality of obligation between the debtor and his creditor, as well as between the debt and the fund on deposit. (Citing authority.

### 1 Debts to he used as set-offs must be due to and from the same persons in the same capacity. (Citingauthority.) The rightof setoff is not limited exclusively tobanks. Such right exists between any mutual debtors and creditors where the debts have matured and the parties mutually are debtors and creditors of and to each other. Thus,because setoff is a common law right, it exists independently of statutes, unless, of course, statutes affecting setoff have been enacted. Thebanker's right to setoff is the common law equitable right of the bank to apply the general deposits of a depositor against the matured debts of the depositor. Theright grows out of the contractual debtor-creditor relationship created between the depositor and the bank at the time the account is opened, Security State Bank of Comanche, Okl. 

### v. V. FJ. 

### R. Johnston & Co. (1951), 204 Okla. 160, 228 P.2d 169; and it rests on the principle that it would be inequitable to permit the debtor-depositor to carry an open account that induces the bank to extend credit, and then allow the debtor to apply the funds to other purposes because he had not expressly agreed to apply them to the debt. Melson v. Rank of New Mexico (N.M. 19581, 332 P.2d 472; SouthwestNatflBank v. Evans (1923),94Okla. 185, 221 

### P. 53. It is a general rule that when a depositor is indebted to a bank, and the debts are mutual--that is, between the same parties and in the same right--the bank may apply the deposit, or such portion thereof as may he necessary, to apayment of the debt due itby the depositor, provided there is no express agreement to the contrary and the deposit is not specifical.ly applicable to some other particularpurpose. Security State Bank ofMelrose,Minn. 17. First NatflBank of Ismay (1927), 78 Mont. 389, 254 P. 41.7. For a hank to establish the right to setoff, the fund to he setoff mustbe owed by the Bank to the debtor,the fundmust be deposited without restrictions, and the existing indebtedness must be due and owing. Federal. Deposit Ins. Corp. v. Pioneer State Bank (1977),155N.J. Super 381, 382, 281A.2d 958. As to the writ of execution levied against the Bank on June 4, 1986, the District Court held that though the Rank

was not entitled to a setoff, since Victor Werlhof did nothing further about it, Victor was barred b~7laches from recovery as to the proceeds of the firstwrit of execution. T7ictorWerlhofhasnot cross-appealed on thisholding, and sowe do not concern ourselveswith the result in the District Court as to the levy of the firstexecutionwrit. As to the second writ of execution, it is undisputed that Garlick was delinquent under the contract for deed in not making the monthly payment of $2,895.10 due the Bank on January 1, 1988. On January 21, 1988,when presented by the sheriff with the secondwrit of execution, theBank claimeda setoff of $1,697.41 from Garlick's checking account against the delinquent indebtedness. Victor Werlhof contends that since the Bank had taken no action to set off the account before the writ was presented, the checking account was subject to the writ from the moment of its issuance on January 15, 1988,and thus preceded any rightof the Bank to setoff. The Rank, on the other hand, contends that its setoffoccurredwhen themonthly paymentwas not made--at the moment the debtmatured in otherwords. Neither contention is correct. The Bank acquired a rightto setoffwhen Garlick'spavment became delinquent, but the Bank must take positive steps to accomplish the setoff. As to a would-he executing judgment creditor,the setoff is accomplished.when the Bank takespositive steps to claim its right,by entering evidence of the setoff in its own records, and then possibly giving otherwritten notice of its action. United States v. Citizens and Southern National Bank (5th Cir. 1976), 538 F.2d 1101, 1107, cert. denied 430 U.S. 945

(1977); Studley v. Boylston Bank (1913), 229 U.S. 523, 33 S.Ct. 806, 57 L.Ed. 1313. Here the Bank recorded the setoff in its records on the date thewrit waspresented,executed a response to the sheriff claiming setoff,and later furnished an affidavit stating the facts OF its claim of setoff. By those actions, the Bank accomplished its setoff. Thenature of the claim of a judgment creditor againsta third party holding property of the judgment debtorprovidesa further reason whv the writ of execution does not take precedence over the right of setoff. A judgment creditor seeking attachment or execution of a judgment debtor's property in the possession 

### of a third party stands in the shoes of the judgment debtor as far as the rights of the third party are concerned. Thus, it is stated in General Electric Credit Corporation 17. Tarr (W.D. Pa. 19781, 457 F.Supp. 935, 938: The service of attachment execution has the effect of an equitable assignment of the thing attached. It puts the garnishee in the relation to the attaching creditor which he had sustained to his former creditor. He may make the same defense to the attachment by evidence of set off or of other equities that he might have made if sued by his original creditor.
Here the Rank could have asserted its right of setoff against any claim of Garlick to his checking account at the time of the presentation of the writ of execution. The judgment creditor, Victor Werlhof Aviation Insurance,had no greater right against the Bank thandid Garlick at that time. Therefore,thewrit did not takeprecedence over the right of setoff. We hold the setoff here could be asserted by the Rank at the time it was presented with the executionwrit. 2. Was the Bank's right of setoff affected the 

### -- - contract for deed for realproperty which secured Garlick

## 's ----- 

### - debt to theBank? 

### ---- Stated another way, we are asked to decide if the Bank must first exhaust it.s collateral before it can exercise setoff to recover a matured debt secured by the collateral. In Montana, the "one-action rule" applying to notes secured by mortgages on real property, S 71-1-222,MCA, does not apply to contracts fordeed. Glacier Campground 

### v. Wild Rivers, Inc. (1978),182Mont. 389, 597P.2d 689,698.The Rank's position as a creditor of Garlick appears to result from some "creative financing" prevalent in the early 1980's. The Bank held a first securityposition on the real property to secure two promissory notes totalling $392,560.00. The owner of the realproperty entered into a contract for deed with Garlick as buyer to deliver clear title uponpavment by installments of $400,000.00. Later the

owner became bankrupt, and the bankruptcy court segregated the contract for deed and assigned it to the Bank, with Garlick to keep up the payments and thus retire the promissorynotes. Under the assignment,Bank has first claim to Garlick's payments, and it was the payment due January 1, 1988 thatGarlickhad notmade. Under the contract fordeed, if Garlick remained in breach of the contract for more than 30 days after notice, the Rank could accelerate the debt and "takeallmeans to enforce and collect the same." Nothing in the law, however,requires theBank under these circumstances to wait until the contract for deed was cancelled before it had a right of setoff on the contract debt. Garlick'

### s January 

### 1, 1988 payment was overdue, the debt had matured, and the Rank was not limited to or constrained by the contract terms. It could pursue any legalmeans to coll.ect its debt, or any part of the debt that had matured. J. M. Hamilton Co. 

### v. Battson (1935),99Mont. 583, 44 P.2d 1064. We hold under these circumstances that the Bank could resort to setoff even though other remedies lay open under the contract fordeed. 3. Does § 30-4-303,MCA affect Bank's right of setoff? 

### -- - Prominent among the conclusions of law adopted by the District Court was itsdetermination thatS 30-4-303,MCA "in the light of the facts" gave the writ of executionpriority over the setoff rights of theBank. Section 30-4-303,MCA, provides:(1) Any knowledge, notice or stop order received 

### by, legal process served upon or set-offexercised by a payor bank, whether or not effective under other rules of law to terminate,suspend ormodify 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 thebank to act thereon expires or the setoff is exercised after the bank has done any of the following:

(a) accepted or certified the item; (b) paid the item in cash; (c) settled for the itemwithout reservinga right to revoke the settlement and without having such right under statute, clearinghouse rule or agreement;

(d) completed the process of posting the item to the indicated account of thedrawer,maker or other person to be charged therewith or otherwise has evidenced by examination of such indicated account and by action its decision to pay the item; or

(el become accountable for the amount of the item under subsection (1)(d) of 30-4-213 and 30-4-302 dealing with the payor hank's responsibility for late returnof items. (2) Subject to the provisions of subsection (1) items may be accepted,paid, certified or charged to the indicated account of its customer in any order convenientto thebank.

Itneed onlybe said that the foregoing statutedoes not apply to the circumstances of this case. If we regard the writ of execution as an "item" (likelynot), the Bank in no wise recognized the writ nor acted upon it so as to indicate

a reversal of its action to accompl.ish a setoff. If the District Court felt that acceptance by the Bank of deposits from Garlick after the first attempted lev17 of a writ ofexecution gave the Bank notice of the outstanding judgment against Garlick, still, as discussed above, the Rank had not lost its right to accomplish the second setoff as against a judgment creditor. We hold that S 30-4-303, MCA, is not applicable to the circumstancesof this case. Finally, we find no merit in two other contentions raised by Victor Werlhof on this appeal. We hold, as stated above, that the Rank's imputed knowledge of the outstanding judgment against Garlick did not affect the Rank's right of setoff in this case. We also hold that under the circumstances here, the Rank did not act against public policy in frustrating the attempted levies of execution, since it acted legally in accomplishing setoff. The judgment and order of the District Court is reversed, and the prohibi.tionagainst the Bank transferring or disposing of the funds sought to be executed upon is vacated.

We Co cur: 

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