Opinion ID: 465399
Heading Depth: 1
Heading Rank: 1

Heading: equitable exception to offset

Text: 5 The law of Texas has long recognized that a bank has the right to offset funds in a depositor's account against indebtedness owed by the depositor to the bank. Elizarraras v. Bank of El Paso, 631 F.2d 366, 371 (5th Cir.1980). Energetics brought this action claiming the equitable exception to the bank's right of offset. This equitable exception is also well established in Texas law. As adopted or recognized by the Texas Supreme Court in National Indemnity Co. v. Spring Bank State Branch, 162 Tex. 521, 348 S.W.2d 528 (Tex.1961), it provides that a bank cannot apply funds on deposit to the individual debt of the depositor when the funds belong to a third party and are held in trust for that third party by the depositor, if there has been no change in the bank's position to its detriment. Id. 348 S.W.2d at 529. The equitable exception is not limited to funds held pursuant to an express trust but applies to any funds held in a fiduciary capacity. South Central Livestock v. Security State Bank, 551 F.2d 1346, 1350 (5th Cir.1977), modified on other grounds and aff'd, 614 F.2d 1056 (1980). 6 Allied Bank argues that the equitable exception was erroneously applied to the facts of the present case because: (1) the bank had no knowledge that the funds belonged to Energetics; (2) Energetics did not own the funds; and (3) Energetics failed properly to trace the funds. We reject each of these contentions. 7 First, Allied Bank argues that the equitable exception to the bank's right of offset should not be applied because the bank had no knowledge that the funds were held in a fiduciary capacity at the time that it took the offset. The bank argues that the National Indemnity rule did not survive the adoption of the Uniform Commercial Code in Texas. 8 The adoption of the Uniform Commercial Code in Texas, however, did not abolish the National Indemnity rule. South Central Livestock, 551 F.2d at 1350. The common law on commercial transactions is still the law of Texas except in those instances where it has been displaced by the particular provisions of the Code. Tex.Bus. & Comm.Code Sec. 1.103 (Vernon 1968); see also First National Bank v. Lone Star Life Ins., 524 S.W.2d 525 (Tex.Civ.App.--Dallas 1975), ref. n.r.e., 529 S.W.2d 67 (1975). It is clear that Texas law does not consider the equitable exception as it applies to funds held in a deposit account to have been displaced by the Commercial Code. Continental National Bank v. Great American Management, 606 S.W.2d 346 (Tex.Civ.App.--Fort Worth 1980, writ ref'd n.r.e.); Pan American National Bank v. Holiday Wines, 580 S.W.2d 7 (Tex.Civ.App.--Houston 1979, writ ref'd n.r.e.); South Central Livestock, 551 F.2d at 1350. We conclude that the National Indemnity rule is still the applicable law in cases such as the one before us. 9 In the present case, the district judge found that Allied Bank was given notice four days after it took the offset that the funds belonged to Energetics. The bank did not return the funds. 6 Under the equitable exception doctrine the funds should have been returned to Energetics unless the bank could show that it had changed its position to its detriment. As stated in Continental National Bank v. Great American Management: 10 [F]urthermore even where innocently seized, the funds must be yielded up to the equitable owner when the entrustment fact is established unless he who is in possession can and does show that he has changed his position to his injury so that it would be inequitable to require him to yield up the funds. 11 606 S.W.2d at 348 (emphasis in original). 7 Allied Bank did not even attempt to make a showing of detrimental reliance. Thus, Allied Bank's contention that its lack of knowledge precluded the applicability of the equitable exception is without merit. 8 12 Second, the bank argues that Energetics did not establish that it was the owner of the funds in question. The district court found that the prepayment funds were held by Republic as a fiduciary for Energetics. Our review of factual findings of the district court is limited to review under the clearly erroneous standard. F.R.Civ.P. 52(a). 13 Appellant argues that Energetics did not own the funds because it took a tax deduction for them in 1981. Appellant cites tax regulations and tax court decisions stating that this deduction can only be taken once the funds have been parted with irretrievably. The tax characterization of the funds, however, is not the question for our review. We agree with the district court that the tax treatment is irrelevant because ... it has [nothing] to do with the ownership for the purposes of offset for [this] case. See Commissioner of Internal Revenue v. Tower, 327 U.S. 280, 287, 66 S.Ct. 532, 536, 90 L.Ed. 670 (1946) (Tax court deciding a tax question is not governed by how Michigan law might treat the same circumstances for purposes of state law.); see also Bagur v. Commissioner of Internal Revenue, 603 F.2d 491 (5th Cir.1979) (Tax law characterization is separate from state law characterization of same issue); Estate of Johnston v. United States, 586 F.Supp. 500 (D.C.Tex.1984). The only question before us is whether the funds were controlled by and belonged to Energetics under Texas law. 14 There was evidence that Energetics had complete control over the account and the money was not to be used by Republic except upon approval by Energetics. 9 There was testimony that Energetics could order withdrawal of funds from the account at any time including all of the funds in the account. There was also testimony that Energetics directed how the funds were to be used, that Republic had no voice in how they were used, and that Republic could not keep the funds for itself. The name on the account was Well Account-Energetics. Thus, there was ample evidence to support the district court's finding that the funds belonged to Energetics. Whether the tax deduction was properly taken by Energetics is not at issue before us. 10 15 Third, Allied urges that Energetics did not properly trace the funds that were in the Republic account. The district judge found that plaintiff has clearly traced these funds, and that the ideas of tracing of the accountant hired by defendants leave a great deal to be desired. We do not find this conclusion to be clearly erroneous. Mr. Webber, Energetics' accountant, traced the funds through the cashing of a Certificate of Deposit. In fact, the bank's own accountant admitted that, practically speaking, the funds had been traced. We find that the district court did not err, therefore, in applying to the facts of this case the equitable exception prohibiting offset.