I. Introduction
In Philippine banking practice, set-off (or compensation) is a powerful tool: if a depositor owes money to a bank, the bank may apply the depositor’s funds on deposit to pay that debt, often without need of prior consent or court action, provided certain legal and contractual conditions are met.
However, that right is not absolute. There are clear exceptions and limitations arising from:
- The Civil Code rules on compensation
- The nature of the deposit (ordinary vs. trust/special purpose)
- Contractual stipulations limiting set-off
- Statutes and public policy (e.g., labor laws, insolvency rules, public funds)
- The rights of third parties (e.g., garnishment, security interests)
This article discusses, in Philippine context, the general rule on bank set-off and then systematically examines the main exceptions.
Note: This is general legal information and not a substitute for tailored legal advice.
II. Legal Basis of the Bank’s Right of Set-Off
1. Civil Code on Compensation
The Civil Code provisions on compensation (Arts. 1278–1290) lay down when obligations are extinguished by the parties’ mutual debts. Legal compensation requires, in general:
- Each party is a principal debtor and a principal creditor of the other;
- Debts are in money or fungible things of the same kind and quality;
- Both debts are due and demandable;
- Both debts are liquidated and determinable;
- Neither debt is subject to retention, controversy, or third-party claims.
Banks rely on these principles, coupled with bank deposit law (the deposit is technically a simple loan of money to the bank), to justify set-off: the bank owes the depositor (for the deposit), and the depositor owes the bank (for a loan, overdraft, credit card, etc.).
2. Contractual Right of Set-Off
Modern bank account opening documents and loan agreements typically contain explicit set-off clauses, empowering the bank to:
- Consolidate the depositor’s accounts; and
- Apply any deposit (sometimes across different currencies or branches) to any debt the depositor owes, without prior notice.
Even so, these clauses cannot override mandatory law, public policy, or third-party rights. That is where the exceptions arise.
III. General Rule: When Banks May Set Off
Absent any exception:
- If a loan or credit facility is due and unpaid, and
- The debtor has deposits with the same bank,
the bank may set off:
- Applying the deposit to the outstanding debt;
- Often without prior notice, if contractually allowed;
- Provided the accounts are between the same parties in the same capacity, and no supervening legal bar exists.
The discussion below focuses on situations where this general rule is barred or severely restricted.
IV. Exceptions and Limitations to the Bank’s Right of Set-Off
A. Lack of Mutuality of Parties
Set-off requires mutuality: the same parties must be debtors and creditors of each other in the same capacity.
1. Joint Accounts vs. Individual Debts
A bank generally may not set off funds in a joint account against the individual debt of only one of the joint depositors, because:
- The bank’s debtor (on the deposit) is the joint account holders collectively;
- The creditor (on the loan) is only one person;
- Mutuality is missing as to the non-debtor co-depositor.
Exceptions might arise if:
- The joint account is expressly designated as “and/or”, and
- The joint depositors expressly consent (e.g., in the loan documents) that any of their joint deposits may secure the individual loan.
Without such clear consent, set-off is vulnerable to challenge by the non-debtor co-depositor.
2. Corporate vs. Personal Accounts
Banks may not generally set off:
- Corporate deposits against the personal debts of officers, shareholders, or directors, or
- Personal deposits of an officer against corporate loans,
because the legal personality is different. The corporation is a separate juridical person. Even if the officer is an authorized signatory or major shareholder, that alone does not make their personal account liable for corporate debt.
Conversely, personal deposits cannot be seized for debts that are strictly corporate obligations unless there is:
- A personal guarantee; or
- An express pledge/assignment of the personal deposit, or
- A situation justifying piercing the corporate veil (which requires a judicial process, not a unilateral bank act).
3. Different Capacities: Trust, Fiduciary, Representative Accounts
The bank’s right of set-off is limited when one of the obligations arises from a different capacity:
- Deposits held by a person “as trustee,” “as guardian,” “as executor/administrator,” or “in trust for (ITF)” a third party;
- Client funds deposited in “client account” by a lawyer, broker, or agent;
- Custodial or escrow accounts where the depositor merely holds funds for others.
The bank may not validly set off these funds against the personal debt of the trustee/agent, because:
- The true beneficial owner is the third party, not the trustee/agent;
- The trustee/agent, in their personal capacity, is distinct from their capacity as fiduciary.
Any attempt to set off fiduciary funds against a personal loan exposes the bank to liability for breach of trust and conversion.
B. Funds Held in Trust or for a Specific Purpose
Even if the account is technically in the depositor’s name, banks must recognize when funds are earmarked for a specific, legally protected purpose. Common examples:
1. Escrow Accounts
Funds placed in escrow are subject to an escrow agreement and typically:
- Are held for the benefit of buyer/seller or parties to a transaction;
- Are only releasable upon fulfillment of certain conditions.
The bank, as escrow agent or depository, cannot unilaterally set off those funds to satisfy the personal debts of one party, because:
- The bank’s role is custodial, not as ordinary creditor of that party;
- The funds are impressed with a trust for a specific transaction.
2. Payroll Accounts and Statutory Employee Protection
Deposits that the bank knows are payroll funds (e.g., corporate account used solely for employee salaries) are treated as special-purpose funds:
- Applying them to the employer-debtor’s loans may prevent employees from being paid, conflicting with labor laws and public policy.
- Courts have treated such acts as improper and potentially actionable.
3. Public Funds and Government Accounts
Where the deposit consists of public funds (national agencies, LGUs, GOCCs):
- These are subject to budgetary and auditing laws;
- The bank is not free to divert those funds to pay off government debts to it unless in accordance with law and proper authorization.
Otherwise, bank set-off may be invalid against the State, whose funds must be disbursed only via lawful appropriation.
C. Absence of Due and Demandable Debt
Compensation requires both debts to be due and demandable.
Banks may not set off against deposits where:
- The customer’s loan is not yet due (no acceleration clause invoked);
- The obligation is subject to a suspensive condition (e.g., contingent liabilities, guarantees not yet called);
- There is an agreed moratorium or restructuring that defers maturity;
- The debt is still under dispute, such that its existence or amount is not yet determinate.
1. Contingent Liabilities and Guarantees
Examples:
- A depositor signs as a surety or guarantor for another’s loan;
- No default has occurred yet.
The bank may not pre-emptively set off the surety’s deposits:
- The surety’s liability becomes enforceable only upon the principal debtor’s default, demand, and satisfaction of contractual conditions.
- Before that, the debt is not yet due and compensation is improper.
2. Disputed and Unliquidated Claims
If:
- The amount owed is unliquidated (still subject to accounting or litigation), or
- The very existence of the debt is contested in good faith,
banks risk liability if they treat such contested amounts as automatically liquidated and due for set-off without notice or judicial determination.
D. Contractual Prohibitions or Limitations
Just as contracts can grant a right of set-off, they can also restrict or waive it.
1. “No Set-Off” Clauses
Certain agreements expressly state that:
- The bank waives its right of set-off in respect of particular accounts; or
- Funds in a specific account (e.g., escrow account, performance security deposit) may not be encumbered or offset without written consent.
Where such clauses exist and are valid:
- The bank is contractually barred from applying set-off;
- Breach exposes it to damages and reversal of the offset.
2. Third-Party Security Agreements
If a deposit is pledged or assigned to a third-party creditor, or serves as cash collateral in another transaction, the bank must honor prior liens or assignments:
- If the bank attempts set-off in disregard of such undertakings, its act may be void as against the secured creditor or beneficiary.
E. Supervening Rights of Third Parties
Even if all elements for compensation exist, third-party rights may intervene and block set-off.
1. Garnishment and Attachment
Once a writ of garnishment or attachment is served on the bank as garnishee:
- The bank becomes a custodian of the funds for the court’s benefit;
- The deposit effectively becomes in custodia legis (in the custody of the law).
From that point:
- The bank may not set off the garnished funds against the depositor’s debts without court authorization;
- Doing so may constitute contempt of court and render the bank liable to the judgment creditor.
The priority of the judicial lien limits the bank’s otherwise available contractual right.
2. Perfected Security Interests and Assignments
Where:
- The depositor has assigned the deposit to a creditor, or
- The deposit secures a debt by virtue of a perfected security interest (e.g., under special lending structures),
the bank’s unilateral set-off may not override the rights of that secured creditor who acquired a prior or superior claim, depending on the sequence of events and the governing law.
F. Statutory and Public Policy-Based Exemptions
Philippine law exempts certain funds from execution or garnishment, and by analogy or express rule, limits or prohibits bank set-off against them.
1. Retirement, Social Security, and Similar Benefits
Various laws provide that:
- Retirement benefits, pensions, and similar benefits (from SSS, GSIS, private retirement plans) are generally exempt from execution, garnishment, or attachment, subject to specific exceptions.
When such benefits are deposited in a bank, the legal question is whether they retain their exempt character. Philippine jurisprudence tends to protect these funds if they can be identified or traced as retirement/pension benefits, especially if they’re in accounts clearly designated for that purpose.
Accordingly, a bank’s set-off against such specially protected benefits may be:
- Challenged as contrary to statute and public policy; and
- Reversed, with possible liability for damages.
2. Labor Law Policies: Wages and Separation Pay
While wages and separation pay can lose their distinct character once mixed with other funds, strong public policy protects:
- Workers’ wages
- Separation pay and similar benefits
Banks that are aware that deposits represent unpaid wages or separation benefits and still apply set-off may face arguments that they are undermining labor protections. Courts and regulators often view such conduct unfavorably.
3. Financial Rehabilitation and Insolvency
Under the Financial Rehabilitation and Insolvency Act (FRIA) and related rules:
When a court issues a stay order in a rehabilitation/insolvency case, most actions to enforce claims against the debtor are suspended.
Set-off attempted after the commencement date may be treated as a prohibited enforcement action unless:
- Legal compensation had already automatically taken effect before the commencement, or
- The rehabilitation court expressly authorizes the set-off.
Thus, in corporate rehabilitation:
- Banks may be barred from unilaterally setting off deposits against loans after the stay order, if mutual debts had not yet reached the point of legal compensation.
G. Regulatory and Ethical Constraints
Banks are heavily regulated. Even when civil law might allow set-off in principle, regulatory or governance considerations can discourage or prohibit it in specific contexts:
- Bangko Sentral ng Pilipinas (BSP) circulars and prudential regulations emphasizing fair dealing and risk management
- Know-Your-Customer (KYC) and anti-money laundering considerations, especially where the funds’ origins or ownership are unclear
- Internal policies restricting set-off where it may cause severe reputational or customer-relations issues
These do not always create judicial “exceptions,” but they function as practical limits that responsible banks must observe.
V. Consequences of Wrongful or Improper Set-Off
When a bank applies set-off despite the presence of an exception or legal bar, it can face:
Contractual and Civil Liability
- Obligation to restore the funds wrongfully applied
- Actual damages (lost opportunities, penalty interest suffered by the depositor)
- Possible moral and exemplary damages if bad faith or malice is shown
Regulatory Consequences
- Sanctions, fines, or directives from the BSP or other regulators
- Adverse findings in audits or examinations
Reputational Harm
- Loss of client trust
- Litigation publicity, adverse judicial pronouncements
Personal Liability of Officers
- In egregious cases, bank officers who knowingly effect illegal set-offs may incur administrative or even criminal liability, particularly where court orders (e.g., garnishments) are ignored or public/misappropriated funds are involved.
VI. Practical Guidance for Banks and Depositors
For Banks
- Check mutuality carefully: same parties, same capacities.
- Identify special-purpose or fiduciary accounts and clearly tag them in the system.
- Review contracts for any “no set-off” or restrictive clauses.
- Verify maturity and liquidity of the debt before set-off.
- Screen for third-party claims: garnishments, security interests, escrow agreements.
- Document the basis for any set-off decision to defend it if challenged.
For Depositors / Borrowers
Understand that set-off is a real risk if you maintain deposits in a bank where you also have loans or credit facilities.
If you want certain funds to be protected, consider:
- Keeping trust, payroll, or client funds clearly segregated and documented as such;
- Ensuring escrow or special-purpose arrangements are formalized in writing;
- Negotiating explicit limitations on set-off in loan or deposit agreements where feasible.
If confronted with a questionable set-off:
- Demand a written explanation;
- Gather account statements, contracts, and any documents showing special purpose or third-party rights;
- Seek legal advice promptly to evaluate remedies.
VII. Conclusion
In Philippine law, the bank’s right of set-off is a recognized and powerful remedy, grounded in the Civil Code and heavily used in practice. Yet, it is bounded by:
- The requirements of legal compensation (mutuality, due and demandable, liquidated debts);
- The nature of the deposit (ordinary vs. fiduciary or special-purpose funds);
- Contractual limitations voluntarily assumed by the bank;
- The rights of third parties and court processes; and
- Statutory protections for certain classes of funds and beneficiaries.
Understanding the exceptions and limitations to bank set-off is crucial for:
- Banks, to avoid unlawful or imprudent application of deposits; and
- Depositors, to protect funds that should not be used to pay debts without due process.
In complex or high-stakes situations—such as corporate rehabilitation, public funds, large escrow transactions, or deposits intertwined with labor/retirement benefits—parties should obtain specialized legal advice to ensure that any attempted set-off (or opposition to it) aligns with Philippine law and jurisprudence.