A deposit account control agreement (DACA) account is a specialized banking account used primarily in commercial lending and structured finance. This type of account is set up by a borrower, but it is controlled by the lender or a third-party agent. A DACA account gives the lender a certain degree of control over the borrower’s deposit account. This control serves as collateral for a loan and provides the lender with an assurance that it can recover its funds if the borrower defaults.

Below, we’ll walk through how DACA accounts work, what they’re used for, and their benefits and risks for both lenders and borrowers.

What’s in this article?

• What is a deposit account control agreement?
  
• How are DACA accounts used?
  
• How DACA accounts work
  
• What is a springing DACA?
  
• What is the UCC and how does it influence DACA accounts?
  
• Benefits of DACA accounts for lenders and borrowers
  
• Risks that come with DACA accounts
  

What is a deposit account control agreement?

A DACA is a tri-party legal contract between:

• The bank: This is where the borrower’s deposit account resides. The bank acts as the custodian of the funds and follows the instructions laid out in the DACA.

• The borrower: This is the bank’s customer. The borrower owns the deposit account and is seeking a loan. They agree to grant the lender certain rights over their account in exchange for the loan.

• The lender: This is the entity providing the loan to the borrower. The lender gains a “security interest” in the borrower’s deposit account through the DACA, ensuring a means to recoup its investment.

There are two primary types of control a lender can exert with a DACA:

• Active control: The lender has the authority to directly initiate withdrawals or transfers with the borrower’s account, even without the borrower’s consent. This typically occurs when the borrower defaults on their loan.

• Passive control: The lender can block the borrower from making certain transactions without the lender’s approval, but it cannot initiate transactions. This often acts as a preventive measure to safeguard the lender’s interests.

How are DACA accounts used?

DACA accounts are typically used in commercial lending rather than for personal loans. Among their key functions are:

• Perfecting a security interest: A DACA allows the lender to “perfect” its security interest in the borrower’s deposit account. This legal process establishes the lender’s priority claim on the account’s funds if the borrower becomes insolvent.

• Controlling disbursements and collections: Depending on the terms of the DACA, the lender might be able to control the flow of funds in and out of the borrower’s account. This can include disbursing loan proceeds directly into the account and sweeping funds from the account to repay the loan.

• Mitigating lender risk: With control over the deposit account, the lender reduces the risk of the borrower misusing the funds or being unable to repay the loan.

How DACA accounts work

DACA accounts work differently than other bank accounts. At the onset, the borrower, lender, and bank sign the DACA, which outlines the terms and conditions governing control over the deposit account. The borrower specifies the deposit account(s) subject to the DACA; this is often a business operating account where loan proceeds will be deposited and from which loan repayments will be made.

The DACA will stipulate whether the lender has active or passive control over the account. With a passive DACA—also known as a springing DACA—the borrower retains full control over the account unless an agreed-upon “trigger event,” such as a missed payment or bankruptcy filing, occurs; if it does, the lender takes control over the account.

With an active DACA, also known as a blocked account control agreement (BACA), the lender has complete control over the account from the outset. The borrower has limited or no access to the account’s funds, and the lender initiates all transactions on the account—including deposits of loan proceeds and withdrawals for loan repayments or other authorized purposes. Active DACAs provide the highest level of security for lenders.

What is a springing DACA?

Under a springing DACA, the borrower retains full control over the account’s day-to-day operations. They can deposit, withdraw, and transfer funds as needed and the DACA will define specific “trigger events” that activate the lender’s control. These events are typically linked to loan default scenarios such as breach of contract or bankruptcy filings. These events must be clearly defined in the DACA to avoid disputes.

If a trigger event occurs, the lender notifies the bank and the DACA “springs” into action. The bank then ceases to honor the borrower’s instructions and instead follows only the lender’s directives regarding the account. This can include transferring funds, restricting withdrawals, or other actions as per the DACA agreement. The lender can then use its newfound control to sweep funds from the account to repay the outstanding loan balance.

Springing DACAs provide borrowers with more operational flexibility and access to their funds as long as they do not trigger any of the conditions that would activate the secured party’s control. For lenders, they offer a safety mechanism that becomes active only when needed. Under normal operating conditions, this reduces the monitoring burden and potential for conflict. The main risk of springing DACAs is the potential for disputes about whether a triggering event has occurred, which can lead to legal complexities and operational disruptions.

Springing DACAs are often used in scenarios where the parties anticipate a generally smooth financial relationship but want a safety net in case the borrower’s situation deteriorates. It is a common tool that balances control and flexibility in larger commercial loans and structured finance environments.

What is the UCC and how does it influence DACA accounts?

The Uniform Commercial Code (UCC) is an expansive set of laws that governs commercial transactions in the United States. It’s designed to unify the law of sales and other commercial transactions across all 50 states by providing a consistent and predictable framework. The UCC is particularly influential in areas related to secured transactions, including those involving DACAs.

UCC and secured transactions

Article 9 of the UCC, which addresses secured transactions, provides a wide range of guidelines for using personal property as collateral for loans. This part of the UCC covers:

• Creation of a security interest, or how creditors can establish a legal claim on assets offered as collateral

• Perfection of the security interest, or how creditors can make their security interest enforceable against third parties

• Prioritization of interests, or how conflicts over collateral are resolved between creditors

Influence of UCC on DACA accounts

Article 9 of the UCC stipulates that a secured party can achieve “control” over a deposit account, which is necessary to perfect a security interest in the account. Here’s how this influences the DACA.

• Perfection by control: The UCC allows for the perfection of a security interest in a deposit account primarily through control. This can be achieved by the bank agreeing in a DACA to follow the directions of the secured party without further consent from the depositor.

• Priority of interest: Under the UCC, a secured party with control over a deposit account generally has priority over other creditors who might have claims against the deposit account but do not have control.

How the UCC affects DACA operations

• Legal framework: The UCC provides the legal definitions and framework that dictate how control must be established and maintained. This includes what constitutes control, how notifications must be handled, and how control affects the rights of depositors and third parties.

• Standardization and predictability: The UCC provides a uniform approach to handling DACA accounts that’s consistent across state lines. This standardization helps reduce legal uncertainty and variability from one state to another.

• Dispute resolution and enforcement: UCC provisions guide courts and other dispute resolution bodies in interpreting DACA agreements and the actions taken under them.

Benefits of DACA accounts for lenders and borrowers

While DACA accounts allow lenders to retain varying degrees of control, they can benefit both lenders and borrowers. DACAs create a transparent structure where both parties understand the risks and have clear expectations about their roles, which can decrease the likelihood of conflicts and facilitate smoother financial relationships. Both lenders and borrowers also benefit from the UCC’s regulatory framework, which ensures that their agreement is in line with legal standards and makes the enforcement and dispute resolution processes easier for all involved.

Let’s take a closer look at the benefits for each group.

Benefits for lenders

• Perfected security interest: A DACA allows lenders to establish a perfected security interest in the borrower’s deposit account. This gives them priority over other creditors in the case of borrower insolvency.

• Control over cash flow: DACAs provide lenders with a degree of control over the borrower’s cash flow. This control can ensure that funds are available for loan repayment, and it can prevent the borrower from diverting funds for other purposes.

• Default remedy: In the event of default, lenders can readily access and apply the funds in the controlled account to offset the outstanding loan balance. This option avoids lengthy and costly collection efforts.

• Lower fraud risk: DACAs can help reduce the risk of fraudulent activity. The lender’s control over the account can deter the borrower from engaging in unauthorized transactions or diverting funds.

• Versatility: DACAs can be customized to fit different lending scenarios and risk profiles. Lenders can choose between active and passive control, and they can define trigger events that suit their specific needs.

Benefits for borrowers

• Access to credit: Borrowers who might not have substantial physical assets or real estate to pledge as collateral can still qualify for loans by offering their deposit account as security through a DACA.

• Improved loan terms: Lenders might offer borrowers lower interest rates, longer repayment periods, or other favorable terms given the added security provided by a DACA.

• Control of business operations: Springing DACAs allow borrowers to maintain full control over their account and continue their business operations without interruption until a trigger event occurs.

• Demonstration of financial responsibility: Agreeing to a DACA showcases the borrower’s willingness to cooperate with the lender and fulfill their financial obligations. This can be beneficial in building a positive credit history.

• Simplified collateralization process: Using a deposit account as collateral through a DACA is often less cumbersome than pledging physical assets. This can lead to faster loan approvals and disbursements.

Risks that come with DACA accounts

Like most forms of lending, DACA accounts do involve some risk for each party. Here are some potential issues to consider before signing a DACA.

Risks for lenders

• Administrative burden: Managing DACA accounts can involve additional administrative tasks for lenders, such as monitoring account activity, processing transactions, and communicating with the bank and borrower.

• Potential disputes: Disagreements can arise between the lender’s and borrower’s interpretations of DACA terms or from the lender exercising control. These disagreements can potentially lead to legal disputes.

• Reputational risk: Overly aggressive DACA control enforcement or the perception of treating borrowers unfairly could negatively impact a lender’s reputation.

• Legal and compliance risks: Lenders must make sure they adhere to all applicable laws and regulations governing DACAs, including the UCC and consumer protection statutes.

• Limited control (in passive DACAs): With springing DACAs, lenders have no control over the account until a trigger event occurs. This can leave them more vulnerable to potentially losing funds before control shifts.

Risks for borrowers

• Restricted account access: Especially in the case of active DACAs, these agreements limit the borrower’s control over their own funds. This can impact their ability to manage cash flow and conduct business.

• Unexpected account freezes: In the event of a trigger event, the lender might freeze the account. This can disrupt the borrower’s business operations and cause financial hardship.

• Potential for abuse of control: While not common, there’s a risk that lenders could misuse their control over the account, financially harming the borrower.

• Negative impact on credit: If a lender exercises its control under a DACA due to default, it can negatively impact the borrower’s credit score and ability to borrow in the future.

• Fees and charges: Borrowers might be subject to additional fees or charges imposed by the bank for administering the DACA and processing lender-initiated transactions.