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United States

In the early 1980s, Riggs National Bank of Washington DC made loans to several wholly-owned entities of Peru. These loans were renewed in 1983 under the restructuring of Peru's external debt.

The restructured loans were guaranteed by the government of Peru. In addition, the Banco de la Nación (one of the borrowers) promised to secure the US$6 million loan with a US$2 million deposit with Riggs. The deposit was in fact made by Peru's Central Bank, Banco Central de Reserva del Peru (BCR), which was not one of the borrowers.

Several years later, BCR attempted to withdraw the deposit from Riggs. Riggs demanded repayment of the loan and when repayment did not occur, executed a set-off by applying the BCR deposit to the obligations owed under the loan and the guarantee.

BCR brought suit in a federal court in Washington DC requesting the recovery of its deposit on the grounds that the set-off was improper. In a decision handed down in December 1994, but only reported recently, the federal court has sustained Riggs' set-off and dismissed BCR's suit (Banco Central de Reserva del Peru v Riggs National Bank, 919 F Supp 13, DDC 1994). The court's decision in this case has significant implications for the law of set-off.

In most states, common law governs the right of set-off (other than a bankruptcy situation where the federal bankruptcy code applies). In general, a bank may set off deposits against the indebtedness of a depositor where:

  • the debt to the bank has matured; and
  • there is mutuality between the debtor and the creditor and between the debt and the deposit.

BCR argued before the court that there was no mutuality in this case because it was not one of the borrowers on the loan and was not indebted to Riggs.

The court rejected this argument because it viewed the borrowers, BCR and the guarantor as one and the same legal entity, ie the government of Peru. The court did not investigate the degree of control of the borrowers and BCR by the government. Rather, it held that to treat the borrowers and BCR as separate legal entities (and thereby deny Riggs a right of set-off) would work fraud or injustice. In its opinion the court stated: "The government of Peru chose to complete its transaction through BCR. BCR cannot now disassociate itself from the Republic of Peru, circumventing the entire purpose of the deposit and guarantee. This would work injustice on Riggs."

BCR also contended that as the central bank of Peru it was protected from set-off by US banks under the US Foreign Sovereign Immunities Act. Section 1611(b) of the act does provide immunity to central banks with respect to attachment of and execution against their property in the US. However, the court held that the right of set-off was not covered by this section: "Attachment and execution are fundamentally different from set-off. The former are legal remedies to legal wrongs, whereas the latter is a remedy that rests in equity."

Finally, BCR argued that, under Peruvian law, it is not permitted to use its funds to secure the debt of other parties such as the borrowers. Therefore, as a matter of Peruvian law, the deposit was illegal. The court would not give the Peruvian law extraterritorial effect in this case because to do so would be inconsistent with the law and policy of the US, ie the right of set-off.

This case expands the concept of mutuality under the law of set-off to include entities under common ownership with the debtor where denial of the right to set-off would work fraud or injustice on the creditor. However, creditors such as banks would not be wise to rely on the holding in this or similar cases. Instead, they would be well advised to contractually provide for the right of set-off in deposit arrangements with parties other than the debtor.

Robert S Rendell

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