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Suppose you took a loan and have to to pay it off uniformly. You made more money than you initially thought when you took the loan and have yet to pay 50 000 $ off, but have 20 000 $ credit on an account of the same bank when the bank defaults.

If it is decided that every creditor of the bank gets 20% of what the bank actually owes them, do you still owe 50 000 $ to the bank / the other creditors and get 4 000 $ of the insolvency estate, or do you only owe 30 000 $?

If the question is not answerable in the context of a bank defaulting because they'd be backed (I just remembered that in the EU, all banks need to be backed for the monetary value I stated above anyways, so maybe assume values bigger than 100 000 €.) or are virtually guaranteed to be bought up by a different bank, assume it to be some regular company defaulting with a different company having contracts with each other. For example: Company A is obligated to ship 10 000 parts per month to company B for which company B paid a year ahead, but company B also received some other goods which (by contract) they only have to pay for 2 months after receiving them.

I live in Germany, so my I'm mainly interested in how it is handled in Germany, but I think it's very similar throughout the EU. So if you know the answer in the context of a different EU country, that's also fine. Furthermore, I'm interested in the situation in the US, because ... come on, it's the US.

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    Most likely scenario is another bank will buy up the assets (including your loan), so you'd owe the full amount to a different bank. Not certain if the credit would get applied, either in part or in full.
    – D Stanley
    Aug 23, 2017 at 20:20
  • @DStanley Then it'd be nice to know what happens in that scenario and what happens if no one buys up the assets. For example, if no other bank is interested or we're not talking about a bank but about some other kind of business which failed.
    – UTF-8
    Aug 23, 2017 at 20:27
  • Is it safe to assume you're asking about the US? Either way, this question has no universal answer since there is a lot of regulatory nuance between types of loans, types of depository accounts, and the structure of the actual bank affected.
    – quid
    Aug 23, 2017 at 20:29
  • @quid I would be content with an answer explaining an example scenario. I updated the answer in response to the comments, btw.
    – UTF-8
    Aug 23, 2017 at 22:47
  • For the EU, you're looking at the Bank Recovery and Resolution Directive (BRRD) . It's indeed a unified policy these days.
    – MSalters
    Aug 25, 2017 at 8:36

1 Answer 1

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If they are different entities, you lose

If you owe the money to A, and B owes you money and goes bankrupt, that has no effect whatsoever on your loan from A. Obviously.

Your best bet -- while you still owe and are owed by the same company -- is either get them to agree to apply your credit to your debt (reducing it to $30,000) -- or rush to the courthouse and ask a judge to order this done. You want to do this well before the bankruptcy is filed; too close and someone could object to you having been paid preferentially or "out of turn" -- and claw back the money, meaning you now owe it to the bankruptcy trustee.

Your debt to them is, from their perspective, an asset. It is an asset with a cash value (based on the probability of people in that portfolio paying). It can be sold to gain some immediate cash instead of more cash over a time period. This is routine in the debt world.

Before or during the throes of bankruptcy, and depending on what the reorganization plan is, the bank is quite likely to sell your debt to someone else to raise cash - typically a distress sale for a fraction of its principal value (e.g. 20% or $10,000). That goes into the pool of money to pay creditors such as yourself, and if you're lucky, you'll get some of it. So good on you, you got $2000 back from the bank and now you owe someone else $50,000.

I'm assuming they owe you $20,000 for IT services or because you put a new roof on their branch, or something like that.

This doesn't apply to money on deposit at a first-world bank

If it's money on deposit at the bank, then two things are true: First, pre-bankruptcy, you can trivially command the bank to dump the entire $20,000 into paying down the debt. Instantly: done, and irreversible. The bankruptcy trustee can't claw that back because it was never the bank's money, it was yours.

Second, any civilized country has deposit insurance, which they typically implement by helping another bank buy out your bank, and continue to honor your deposits, so this is seamless and hands-off for you. Your old checks continue to work, your branch just changes their sign. This deposit insurance has limits, which is only a problem for the very rich (who are dumb enough to put over the limit in one bank).

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    A note on "over the limit in one bank". In the UK (and, I think, the EU) the limit (£85k in the UK; €100k in EU) applies to the combination of all accounts within the same authorised institution. So, for instance, Halifax is part of the Bank of Scotland group: if you had £50,000 in accounts with both banks, only £85,000 of your £100,000 would be covered. See this Bank of England page for details.
    – TripeHound
    Aug 24, 2017 at 9:13
  • Why can you command the bank to use the 20 000 $ for paying off your debt? I heard you can't always pay off your debt as fast as you make money to do so because the bank would earn less interest than if you paid it off over many years, so they added something to the contract which limits your ability to pay the debt off.
    – UTF-8
    Aug 24, 2017 at 12:06
  • @UTF-8 You've heard that? How deeply have you gone into this? In my experience you can always pay off a debt at any schedule you please. What you say is true on some loans, but it is only early-payment fees - annoying, but still cheaper than interest. If you want to know what that's about, ask... In some cases you must pay a loan early - borrow to buy 3 boats, 1 sinks, you must pay 33% of the loan right now.
    – Harper - Reinstate Monica
    Aug 24, 2017 at 17:00
  • @Harper I have done exactly zero research about this. My math teacher told this to the class about 8 years ago and it still sounds realistic to me. I might ask another question if I don't find answers via Google.
    – UTF-8
    Aug 24, 2017 at 20:05
  • @UTF-8 unfortunately human minds can be very, very tricky in the area of money. People's beliefs about money tend to be wired pretty deep. I try not to really challenge people's beliefs, but "sounds realistic to me" can be a confirmation bias, a feedback loop that reinforces potentially wrong beliefs. Or as Mark Twain said, "What you don't know isn't what gets ya... it's what you know that just ain't so!"
    – Harper - Reinstate Monica
    Aug 25, 2017 at 0:42

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