What is a Deposit Control Account Agreement?
The purpose of a deposit control account agreement is to establish control over the funds in an account. A deposit control account agreement is an agreement between a business and a financial institution that opens and defines the relationship of the parties. A deposit control account agreement defines the nature and scope of the funds held, and the instructions as to the circumstances in which the financial institution may release the funds from the account and to whom . A deposit control account agreement may be entered into for the purpose of establishing control, in accordance with relevant UCC Article 9 rules, in relation to secured lending transactions involving deposit accounts or in other circumstances. A deposit control account agreement is an important part of any financial transaction that requires certainty in respect of the funds held in an account.
Key Elements of a Deposit Control Agreement
Deposit control accounts and similar arrangements (such as zero-balance accounts) are typically established by account control agreements. The principal components of these arrangements generally include (1) the rights and obligations of the parties to a deposit control agreement and (2) account control provisions governing such agreements. For purposes of this section, we will also address security agreements. In addition, we will briefly identify certain common banking practices that may affect the rights and obligations arising under these arrangements.
An agreement typically involves two types of parties: (1) those entitled to the deposit balance and (2) those obligated to provide instructions to the financial institution regarding how those deposits are to be held. The primary parties to a deposit control account agreement are those who (1) own an identified fund subject to the control of an account control agreement and (2) have certificate or endorsement hereunder, a right of withdrawal, or other authority to direct the disposition of the identified fund identified in the account control agreement. For instance, a deposit may be subject to the terms of an account control agreement if the identified fund is identified in the account control agreement and the owner of the deposit is a party to the agreement. Owners of deposits held in a bank (e.g., a company’s operating account) are common parties to an account control agreement.
In those cases when the identified fund is not owned by a party to the account control agreement, the agreement typically will identify a separate class of parties to the agreement, referred to as "directing parties." The directing parties of an account control agreement typically have the authority to give instructions to financial institutions on how to withdraw an identified fund from an account controlled by the account control agreement. These parties do not need to own the money subject to the account control agreement. Some account control agreements (and the law depending on the jurisdiction) permit a party to act as the directing party for the benefit of another person who does not have a right to act as a directing party. A common example of this scenario arises with respect to funds held in a trust account subject to an account control agreement where the trustee does not maintain an account at the bank holding the funds subject to the account control agreement for the trust.
Different Types of Deposit Control Agreements
Deposit Control Account Agreements come in a variety of flavors. You may hear the term "control agreement" or "Pledge Agreement", but in practice both types of agreements function in the same way. Both agreements direct the party holding the collateral to honor the terms of an agreement with the secured party over other claims, thus allowing the secured party to have over-riding control over the deposit account.
The two most common types of Deposit Control Account Agreements are: (1) Account Control Agreements that are negotiated "in the bank" with one bank (i.e., the depository bank where the funds rest); or (2) – if the parties need to create a highly perfected security interest – negotiating a multi-party "Pledge" document that spells out the terms of the security, and that is definitely NOT "in the bank".
The typical "Account Control Agreement" requires the parties to advise the custodial bank ("Bank") that (1) a security interest over a deposit account has been granted to the secured party (Client or Lender); and (2) Customer has no further instructions to the Bank after such notice and the Bank is directed to follow the instructions of the Lender. The Lender generally should require that the custodian provide periodic account statements directly to the Lender as to the balances in the account, and the balances must be swept regularly from the Bank to the Lender’s control account.
In contrast, a "Pledge" control agreement for a deposit control account is used when there are multiple parties involved. For example, a party may grant a security interest to multiple parties, or the parties cannot agree upon which party should have absolute control. The pledge document is then used to specify how the funds are held, and how the various parties must act to ensure control over their respective security. If one of the pledgors chooses not to serve as its own "bank" under the Pledge Agreement, the Pledge Agreement can specify that one party has to be the custodial bank, and that the custodial bank must send the account statements to all interested parties. A single party often can be designated by mutual consent as the custodial bank for all account statements.
These Agreements are often very complex, and also carry with them a great deal of liability to the Bank. The custodian could easily be liable to multiple parties, and he merely agreed that they would not allow anyone to have access to those funds without a separate written agreement. The Pledgor is generally much more vulnerable than if the security interest had been created exclusively "in the bank". Of course, the custodian has charging language to collect reasonable custodial fees, and the custodian generally can terminate the agreement upon a material default.
The custodian must be vigilant as to the status of the account, and to be aware of deposit accounts that have been levied by other parties, that have been attached, or that are subject to disputed claims. The custodian has to be extremely careful in making sweeps from the account, and in dealing with different demands from the various parties over disputed amounts.
Advantages of Deposit Control Agreements
The benefits of deposit control account agreements are numerous. Most of the advantages given to the lender in a CDA Agreement are designed to reduce the costs associated with funding a loan and to give the lender security in the event the borrower defaults under the credit facility. The key to using a CDA Agreement effectively is to calculate the benefits of the CDA Agreement as accurately and as early as possible. That will not only increase the chance that the borrower will agree to the CDA Agreement but will increase the chances significantly that the borrower will put more money into a cash collateral account than would otherwise occur on an unencumbered basis in order to obtain the benefits of the CDA Agreement.
Potential Risks and Pitfalls
Despite the many advantages offered by deposit control account agreements, they also present a number of challenges for lenders, including issues of enforceability, competing priorities and construction of the legal documents.
Many lenders have been able to amend their loan documentation to include deposit control accounts, thereby alleviating the problem of competing priorities. However, in many instances, the historical documentation provided that deposits will be swept into the loan account prior to satisfaction of any other obligations and, therefore , the new form of loan documentation to accommodate the deposit control account may be challenged and need to be revised. Failure to revise the loan documents to provide for the deposit control account or even an appropriate carve-out to address the priority of the deposit control account could result in a challenge by a subordinate creditor of the borrower upon a foreclosure of the security package. This could occur even if the unused portion of the loan was not fully advanced as at the date of the foreclosure.
Having a deposit control account in place and operational prior to enforcement of a default under the security package is key to the enforceability of the deposit control account. Otherwise, the court taking the action in respect of the security package may determine not to enforce a triggering event owing to a lack of any funding in the deposit control account at the time of enforcement by a lender.
In addition, the legal terminology used in deposit control account agreements needs to be exact so that any contractual agreements cannot be easily disputed by a subordinate creditor of the borrower upon enforcement or an enforcing judgment creditor of the borrower upon enforcement.
Legal Requirements and Compliance Issues
When entering into a DCA agreement, there are several statutory and regulatory considerations that should be explored. A DCA account is a type of deposit account created solely for purposes of escrow, and held at a bank or other type of financial institution. This is relevant for both parties to the DCA agreement. For a lender in a transaction involving a DCA account, consideration should be given to the conditions set forth in 12 U.S.C. § 29(a) and 12 C.F.R. § 337.1 concerning insurance of demand deposits. Specifically, the statute provides that federal depository institutions shall not pay interest on demand deposits, unless the demand deposit accounts are part of an "otherwise authorized temporary account at any federally insured depository institution which provides essential services for the preservation or disposition of criminal or terrorist property pending the resolution of a criminal forfeiture proceeding." 12 U.S.C. § 29(a). A federally insured depository institution includes national banks, federal savings associations, federal savings banks, federal credit unions and state depository institutions. 12 U.S.C. § 1813(e). In other words, subject to certain exceptions, a bank, savings association, savings bank, federal credit union or state depository institution may not pay interest on a DCA account held by the government. For this reason, a lender should consider the applicability of this statutory provision to a proposed arrangement. On the other hand, for a borrower in the transaction with the government, the property held in a DCA account may be exempt from levy in accordance with section 6334(a)(1) of Title 26 of the U.S. Code. A DCA account may therefore be withheld from levy under this provision if the DCA account is in a financial institution, except for the Bank of the Commonwealth of Northern Mariana Islands or any successor institution. 26 U.S.C. § 6334(a)(1). A DCA agreement is also not without its risks for the lender. For example, lenders will want to ensure that the DCA account is exclusively in the name of the government so that creditors of the DCA account holder do not have a claim to the funds. Moreover, if the lender sets up the DCA account in its name, a subsequently-hired investment adviser or trustee may challenge the legality of the arrangement – such as holding the DCA account in a name other than that of the government – and seek to remove the deposit control agreement or require that any party controlling the account comply with applicable laws and regulations. This consideration helps demonstrate the value of legal counsel when drafting and negotiating a DCA agreement or becoming a party to the agreement.
Drafting a Deposit Control Account Agreement
Drafting a Deposit Control Account Agreement starts by reviewing the form notes and security documents. A comprehensive opinion of the issuer of the Letter of Credit is required and should be read carefully to keep track of the issuer’s restrictions, limitations, requirements, and preferences. That goes for any issuer, not just issuers residing in New York.
Every day we see the same clauses and provisions repeated in each Deposit Control Account Agreement across the country, but unaware of local practices, those rules are then inadvertently woven into the Agreement as if they are universal. This presents a problem for customers when one issuer obligates the customer to meet an issuer centric preference by deviating from the norms. Where a customer is not familiar with Local Practice and Custom, it will be unable to recognize the practice which imposes a requirement or limitation that is not inherent to Letter of Credit transactions. Not all issuers care about the same things in the same way. Some issuers need 30 days’ notice to terminate an account, while others only need 10 days’ notice. Some issuers require that the account agreement be sent to them via certified mail, while others prefer e-mail. Again, unfamiliar with Local Practice and Custom, some issuers will attach their own set of terms and conditions to the Deposit Control Account Agreement. These terms and conditions will almost always deviate from the norms.
Local Practice and Custom isn’t as elusive or such a mystery after you review what the issuer expects out of a transaction. In my experience, once you have reviewed the working conditions imposed upon the customer, a few basic terms and conditions are standard. And those terms and conditions will be expected and are found in virtually all Deposit Control Account Agreements. They are:
This is not a complete list of everything that must be read, but once you’ve visited and reviewed the provisions of the form notes, security documents, and other instructions issued by the issuer, we are ready to break down how to draft a Deposit Control Account Agreement. When drafting the Deposit Control Account Agreement, there are a few basics that need to be taken into consideration. While the norms are the basic defaults – this is not an all exclusive layout. There are some issuers who prefer stronger terms and conditions. Absent some form of restrictive or use limitations, the norms are sufficient for all issuers. There are several ways to draft the Deposit Control Account. A template with spaces for specific identifying information is used by most borrowers. The general provisions are standard and include the following: Issuer, Applicant, Customer, Cash Collateral, Guaranty and Guarantor, Credit Agreement, Credit Documents, Payment Office, and Stated Amount. More simply put, these are all the parties and how they relate to each other.
For example, a Deposit Control Account Agreement will identify the Issuer as "THE BANK." Below that, they may identify themselves separately as "THE BANK . . ." so that it is clear that – even though they are the issuer – they do not believe any of the terms, conditions, and requirements listed below are applicable to them. They focus solely on the actions and obligations of the Applicant. The Applicant would be identified as "APPLICANT." It is very important to make sure that the definition of Applicant includes all parties who sign the security documents, including personal guarantors.
Almost all letters of credit are subject to the UCP, but there are some letters of credit which are not subject to the UCP. A few examples of letters of credit not subject to the UCP are an environmental letter of credit, a farm letter of credit, a government and municipal bond letter of credit, and a commercial paper letter of credit. For those types of letters of credit, the UCP must be replaced with the set of rules which govern that particular type of letter of credit.
Practical Examples of Usage
Dial Fire Protection, Inc. (DFP), a fire protection systems contractor based in Houston, Texas, used a deposit control account agreement in tandem with a master client service agreement to construct a state-of-the-art hotel-kitchen fire-extinguishing system in Houston. The project, valued at nearly $400,000, would last approximately 12 months. DFP required that its client, LVH Lakeside Towers, LLC, deposit just over $350,000 into a non-interest-bearing deposit control account for the use of paying suppliers for labor and materials supplied on the project. After a third of the work was complete, causing the account balance to decrease to less than $250,000, LVH Lakeside was required to replenish the account to at least $250,000. One DFP executive indicated that he had never had issues with a deposit control account, and this one was no different. While DFP was able to use the money on the project, DFP had the assurance that the funds would be available if required.
Amec Foster Wheeler, a global engineering company with a Houston office specializing in the oil and gas sector, was working on several oil and gas pipeline construction projects from mid-2017 to early-2018. While many of its projects used master client service agreements, Amec also used deposit control account agreements to fund some of its projects, allowing a client to deposit project-funded cash at the beginning of the project. Amec, like many large construction companies, did not want or have the expertise to be holding large portions of its clients’ cash. Excluding the first two months of the projects when there were no funds deposited, Amec’s deposit control accounts kept an average of $1 million in cash for five pipeline construction projects and at various points had held as much as $3 million. This is likely a result of the size of Amec’s clients and the anticipated size of their projects.
Hunt Building Company , Ltd. (Hunt) is a national development and construction firm with a focus on multi-family construction and renovation. Based in El Paso, Texas, Hunt specializes in the construction of affordable housing and military family projects, and typically has a dozen dual-family projects at any time, as well as large multifamily projects like an $8 million congress-allocated soldier-oriented housing facility and a $90 million triple-team barracks complex for Fort Bliss. Like DFP, Hunt negotiated a deposit control account agreement when using a master client service agreement in a long-running relationship with a U.S. Army project manager in Fort Worth. A construction loan had been obtained for the project’s funds, and putting an initial $1million and later another $500,000 cash into the account ensured that the project could meet its payment deadlines to subcontractors and suppliers. Hunt’s manager praised the arrangement, noting that there were never any issues with the procedures and that subcontractors appreciated the process as they were not always paid promptly if a developer was waiting for funds.
A New York-based general contractor appeared to like the guarantee of payment that came with the use of a deposit control account agreement and a master client service agreement. The contractor used the two types of agreements for a $4.2 million single family home project and a $4.35 million home-renovation project. The two agreements provided the added benefit of allowing suppliers to be paid with a debit card that had funds drawn automatically from the account. In acknowledging that it would have had trouble funding the two projects without use of the accounts, the contractor explained that the arrangement had helped it tremendously.
