“Control” Your Destiny: Perfecting a Security Interest in Deposit Accounts

March 2017

When it comes to collateral for a loan, cash is king. All other forms of collateral require liquidation, which entails time, expense, and uncertainty for the lender. To perfect a security interest in a deposit account, the lender must establish "control" over that account. This article discusses the means to obtain that control and the key terms that should be included in a control agreement.

The Uniform Commercial Code (UCC) defines a deposit account as a demand, time, savings, passbook, or similar account maintained with a bank. This excludes investment property or accounts that are represented by an instrument. Unlike with most types of collateral, filing a UCC-1 financing statement does not perfect a lien on a deposit account. A lender can perfect a lien on a borrower's deposit account only by obtaining "control" over the account, which requires one of the following arrangements: (1) the borrower maintains its deposit account directly with the lender; (2) the lender becomes the actual owner of the borrower's deposit accounts with the borrower's depository banks; or (3) the parties obtain a deposit account control agreement (DACA) with the borrower's depository bank. Alternative (3) is often the only viable option. This would be in addition to the security agreement by which the borrower pledges its cash deposit accounts to the lender as security for the loan.

During its due diligence process, the lender should request information regarding the depository banks where the borrower's deposit accounts are held, the purpose of each account, and the amount of cash the borrower keeps in each account.

The lender should obtain a DACA from each third-party depository bank with which the borrower maintains any deposit accounts that have been designated as collateral. A depository bank that signs a DACA agrees to comply with the lender's instructions regarding the borrower's deposited cash, without further action by or consent of the borrower. Such an agreement gives the lender "control" of the deposit account. Many banks have form DACAs that the parties can use as a starting point for negotiations.

In a "blocked" control agreement, the DACA provides that the borrower will have no access to the funds in the deposit account(s) and that the lender will have complete control over the funds. In most cases, however, the DACA provides that the borrower can freely access the deposit account(s) until the depository bank receives a notice of exclusive control from the lender. Generally, such a notice can be given by the lender only if the borrower is in default under the underlying loan. Such an arrangement is commonly referred to as a "springing" control agreement because the lender's control of the account springs into effect only upon the occurrence of certain defined events. Once such notice is given, the depository bank will stop complying with instructions from the borrower regarding the deposit account(s) and will begin complying with, and only with, the instructions of the lender. Either variety of control–blocked or springing–is sufficient for purposes of control and perfection under the UCC.

With a springing DACA, the lender would prefer that when the depository bank receives the notice of exclusive control and the lender's instructions, the depository bank will immediately carry them out. However, the depository bank will often require a few days of administrative time between its receipt of such a notification and its implementation of the lender's instructions. Typically, a springing DACA will also include, as an exhibit, a form of notice that the lender must use when notifying the depository bank of an event requiring action under the DACA.

From the lender's perspective, the DACA should also contain the following provisions:

  • acknowledgment by the depository bank that the DACA is intended to evidence the lender's "control" as defined in the UCC;
  • representation by the depository bank that the accounts in question are "depository accounts" as defined in the UCC;
  • agreement by the depository bank that it will not change the name or account number of the depository account(s) without the written consent of the lender;
  • agreement by the depository bank and the borrower to notify the lender prior to closing any deposit account(s) and to give the lender an opportunity to enter into a new DACA with respect to any deposit account(s) into which the borrower might move the cash collateral;
  • agreement by the depository bank and the borrower not to permit the deposit account to become subject to any other control agreement or lien while the DACA is in place; and
  • agreement by the depository bank to subordinate any lien that it has on the deposit account and to waive its right of set-off against the deposit account, except to the extent of deposits credited to the account that are returned unpaid and ordinary service fees charged by the depository bank.

The lender should consider separately requiring the borrower to maintain a minimum balance in the deposit account(s) under the lender's control, and limiting the borrower's ability to open other deposit accounts that are not subject to the lender's control. The lender should also monitor the balances in the borrower's deposit accounts. In a springing control arrangement, a borrower in distress could withdraw funds from the deposit account before the lender is able to deliver its notice of springing control to the depository bank.

Although depository banks use different forms of DACA, they are fairly standardized and rarely the subject of much negotiation or discussion. Accordingly, they are a simple and effective way – and often the only way – to obtain a perfected security interest in a deposit account.