While filing a UCC-1 financing statement is the primary tool to perfect for most forms of collateral under the UCC, there are a number of exceptions.

On December 31, 2024, the U.S. District Court for the Western District of Pennsylvania found that a depository bank materially breached a deposit account control agreement (DACA).[1] This Alert summarizes the District Court’s finding and also provides key takeaways in light of the holding for practitioners (secured creditors, depository banks, borrowers, secured parties, etc.) when dealing with DACAs. Before summarizing the holding and discussing major takeaways, this Alert also provides readers with a brief overview of the use and purpose of DACAs in secured lending transactions.

What Is a DACA?

In almost all secured financing transactions, a lender will want to ensure that it has a perfected security interest in the debtor’s deposit accounts (among other applicable collateral). The Uniform Commercial Code (UCC) characterizes collateral in certain ways, and that characterization dictates how a secured party can obtain a perfected security interest in such collateral. Under the UCC § 9-102(a)(29), a deposit account is defined as a “a demand, time, savings, passbook, or similar account maintained with a bank.” Put simply, a “deposit account” under the UCC is the actual account that a debtor maintains with a bank.

While the terms are often used interchangeably, “deposit accounts” differ from “accounts” under the UCC: The latter is “a right to payment of a monetary obligation,”[2] essentially accounts receivables. A debtor’s accounts receivables are often one of the primary collateral sources for a secured lender, but practically speaking, a perfected security interest in “accounts” does a secured creditor no good unless the secured creditor is also perfected in the deposit accounts that actually hold the funds therein.

So how does a secured party perfect its security interest in deposit accounts? While filing a UCC-1 financing statement is the primary tool to perfect for most forms of collateral under the UCC, there are a number of exceptions. One of those exceptions is with deposit accounts, which can only be perfected by virtue of the secured party taking “control” of the deposit account.[3] In transactions where the secured lender is not also acting as the debtor’s depository bank, a secured lender takes “control” of a debtor’s deposit account by entering into a DACA.[4] A DACA is a tri-party agreement among (i) the debtor/account holder, (ii) the secured party and (iii) the depository bank maintaining the deposit account. Pursuant to the DACA, the depository bank agrees to comply with the secured party’s instructions regarding disposition of funds in the deposit account.[5] By executing a DACA, the secured party is perfected in the applicable deposit account.

Studio Enterprise LLC v. SSB Bancorp, Inc.

In Studio Enter. LLC v. SSB Bancorp, Inc.,[6] the defendant and depository bank, SSB Bancorp Inc., entered into a DACA with the plaintiff and secured party, Studio Enterprise LLC. In September of 2023, after a default in respect of the underlying debt, Studio Enterprise foreclosed on the debtor’s deposit accounts maintained at SSB (including the funds maintained therein) and “also sent a Notice of Exclusive Control” to the depository bank pursuant to the terms of the DACA.[7] Thereafter, the depository bank made line of credit withdrawals from the deposit account, which Studio contended violated the terms of the DACA. Studio then brought suit alleging, among other things, breach of contract.[8]

The primary issue before the court was the impact of the secured party’s foreclosure on its security interest in the deposit accounts. The depository bank defended itself arguing that the foreclosure by the secured party discharged the security interest and therefore the related DACA as well. As a result, per SSB’s argument, it was no longer under any obligation to comply with the DACA, including the notice of exclusive control, thereby allowing it to make the line of credit withdrawals.[9] Studio countered with two arguments: (i) that the foreclosure did not extinguish its security interest in the deposit account (and the accounts maintained therein) and (ii) that any statutory discharge of the security interest as a result of the foreclosure would “not relieve SSB from abiding by the material terms of the DACA.”[10]

Relying on a 2016 ruling from the U.S. Court of Appeals for the Eighth Circuit that “foreclosure does not discharge a security interest for the purpose of enforcing that interest,”[11] (emphasis added) the court found that Studio maintained its status as a secured party (notwithstanding the foreclosure).[12] Moreover, in terms of the DACA itself, the court noted that the “central purpose [of the DACA] was to govern the parties’ control over the Accounts following a default by the Debtors and create an enforcement mechanism.”[13] The court cited the depository bank’s own actions (i.e., “requesting Studio’s permission to make the LOC Draws post-September Foreclosure”) as evidence of the depository bank’s understanding of the that purpose.[14] As a result, the court ultimately held in favor of the plaintiff-secured party with respect to the breach of contract claim (i.e., that the depository bank was in material breach of the DACA).[15]

Key Takeaways

The SSB Bancorp case highlights the importance of DACAs in commercial transactions and the potential pitfalls if parties are not aligned and do not fully understand their obligations. Both secured lenders and depository banks, along with their counsel, should pay close attention to termination language in DACAs, including when and how long a lender’s instructions regarding the disposition of funds should stay in effect. Historically, a very commonly negotiated item in a DACA has been when a secured lender’s instructions to a depository bank take effect. Now, though, in light of the court’s holding here, parties are likely to pay closer attention to how long those instructions remain in effect and how long the DACA remains in effect has well.

For More Information

If you have any questions about this Alert, please contact Jonathan M. Petrakis, Joel N. Ephross, Max W. Fargotstein, any of the attorneys in our Banking and Finance Industry Group or the attorney in the firm with whom you are regularly in contact.

Notes

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.