United States: Section 553 Of The Bankruptcy Code Preserves Rather Than Creates Setoff Rights

In Feltman v. Noor Staffing Grp., LLC (In re Corp. Res. Servs. Inc.), 564 B.R. 196 (Bankr. S.D.N.Y. 2017), the bankruptcy court considered whether section 553 of the Bankruptcy Code creates a right of setoff when no such right is available under applicable nonbankruptcy law. The court concluded that section 553 does not create an independent federal right of setoff, but merely preserves any such right that exists under applicable nonbankruptcy law. It ruled that, because New York law did not allow setoff of contingent claims, the defendants in an adversary proceeding could not assert a right of setoff for admittedly contingent claims as a defense.

Setoff

Section 553(a) of the Bankruptcy Code provides, subject to certain exceptions, that the Bankruptcy Code "does not affect any right of a creditor to offset a mutual debt owing by such creditor to the debtor that arose before the commencement of the case under this title against a claim of such creditor against the debtor that arose before the commencement of the case." Section 553 does not create setoff rights—it merely preserves certain setoff rights that otherwise would exist under contract or applicable nonbankruptcy law. See COLLIER ON BANKRUPTCY ¶ 553.04 (16th ed. 2017) (citing Citizens Bank of Maryland v. Strumpf, 516 U.S. 16 (1995)).

A "debt" is defined in section 101(12) of the Bankruptcy Code as a "liability on a claim." Section 101(5) defines "claim" to include a "right to payment, whether or not such right is reduced to judgment, liquidated, unliquidated, fixed, contingent, matured, unmatured, disputed, undisputed, legal, equitable, secured, or unsecured." Under bankruptcy case law, the term "contingent" means contingent as to liability. See Grady v. A.H. Robins Co. (In re A.H. Robins Co.), 839 F.2d 198 (4th Cir. 1988), cert. dismissed, 487 U.S. 1260 (1988).

Although the Bankruptcy Code does not define "mutual," debts are generally understood to be mutual when they are due to and from the same persons or entities in the same capacity. See COLLIER ON BANKRUPTCY ¶ 553.03[3] (16th ed. 2017).

Even though section 553 expressly refers to prepetition mutual debts and claims, many courts have held that mutual postpetition obligations may also be offset. See Zions First Nat'l Bank, N.A. v. Christiansen Bros., Inc. (In re Davidson Lumber Sales, Inc.), 66 F.3d 1560 (10th Cir. 1995); Palm Beach Cty. Bd. of Pub. Instruction v. Alfar Dairy, Inc. (In re Alfar Dairy, Inc.), 458 F.2d 1258 (5th Cir. 1972); Official Comm. of Unsecured Creditors of Quantum Foods, LLC v. Tyson Foods, Inc. (In re Quantum Foods, LLC), 554 B.R. 729 (Bankr. D. Del. 2016).

However, setoff is available in bankruptcy only "when the opposing obligations arise on the same side of the . . . bankruptcy petition date." Pa. State Employees' Ret. Sys. v. Thomas (In re Thomas), 529 B.R. 628, 637 n.2 (Bankr. W.D. Pa. 2015). Thus, prepetition obligations may not be set off against postpetition debts and vice versa. See In re Enright, 2015 BL 261143 (Bankr. D.N.J. Aug. 13, 2015); In re Passafiume, 242 B.R. 630 (Bankr. W.D. Ky. 1999).

A creditor is precluded by the automatic stay from exercising its setoff rights with respect to a prepetition claim without bankruptcy court approval. See 11 U.S.C. § 362(a)(7). Upon application by the creditor, however, the court will generally permit a setoff if the requirements under applicable law are met, except under circumstances where it would be inequitable to do so. See In re Ealy, 392 B.R. 408 (Bankr. E.D. Ark. 2008). By contrast, if there is a right of "recoupment" (i.e., where mutual obligations arise under the same contract), the exercise of the right does not require court authority, and the automatic stay does not apply. A creditor stayed from exercising a valid setoff right must be granted "adequate protection" (see 11 U.S.C. § 361) against any diminution in the value of its interest caused by the debtor's use of the creditor's property. Ealy, 392 B.R. at 414.

Under section 101(5)'s broad definition of "claim," contingent claims arguably would be eligible for setoff under section 553 if applicable nonbankruptcy law permitted setoff of such claims. The Feltman court addressed this issue.

Feltman

In February 2015, Noor Associates, Inc., and Noor Staffing Group, LLC (collectively, "Noor") purchased substantially all of the assets of Corporate Resource Services, Inc. ("CRS") under a purchase agreement governed by New York law. 

On July 23, 2015, CRS and certain affiliates filed for chapter 11 protection in the Southern District of New York. The bankruptcy filings occurred shortly after Noor discovered that CRS or its affiliates failed to remit more than $100 million in employee withholding taxes to the IRS and state taxing authorities. It was unclear at the time of the filing whether Noor, as the purchaser of CRS's assets and its successor, might be liable for the unpaid taxes. The taxing authorities had not asserted any claim against Noor as of the petition date. 

In March 2016, a chapter 11 trustee appointed in the case commenced an adversary proceeding against Noor, alleging, among other things, that Noor breached the sale agreement. The trustee also sought to avoid the sale as a constructive fraudulent transfer under section 548 of the Bankruptcy Code because, allegedly, the value of CRS's assets substantially exceeded the sale price and CRS was insolvent at the time of the transaction.

In its answer and a proof of claim filed in December 2016, Noor asserted, among other things, that it had a right to set off contingent liabilities to taxing authorities or CRS customers in the amount of approximately $8.4 million against any liability to the trustee in the avoidance and breach of contract litigation. As noted, no claims for those liabilities had been asserted against Noor. 

The trustee moved to strike the setoff defense and to disallow the proof of claim to the extent it asserted a right to set off contingent claims.

The Bankruptcy Court's Ruling

The bankruptcy court ruled in favor of the trustee.

The court explained that "in order to establish a right to setoff under section 553, a creditor must first demonstrate a preexisting right of setoff under nonbankruptcy or state law." It rejected Noor's argument that the Bankruptcy Code creates a federal right of setoff. According to the court, the U.S. Supreme Court's ruling in Strumpf "definitively resolved that the Bankruptcy Code does not create a right of setoff," but merely "preserves a right to setoff created by state law or federal nonbankruptcy law." As a consequence, the bankruptcy court in Feltman noted, pre-Strumpf rulings cited by Noor to the contrary were inapposite or no longer good law, and a post-Strumpf decision relied on by Noor—In re Comm'n Dynamics, Inc., 382 B.R. 219 (Bankr. D. Del. 2008)—was distinguishable.

In Comm'n Dynamics, the court held that, for purposes of section 553, a contract rejection damages claim under section 365(g) is a prepetition claim that qualifies for setoff. In so holding, the court identified an ambiguity in section 553, in that it does not identify the sources of a setoff right, but speaks only of not "affect[ing]" such a right. Thus, the court reasoned, section 553 should not prevent setoff of a claim arising under another section of the Bankruptcy Code—in that case, section 365(g). The Feltman court, however, did not view the existence of this ambiguity as support for the proposition that there is a federal right of setoff. 

Nor did the Feltman court agree with the argument that a federal right of setoff exists because section 101(5) broadly defines "claim" to include contingent claims. According to the court, reading sections 101(5) and 553 together as creating a federal right of setoff, when no such right exists under applicable nonbankruptcy law, would result in elevating contingent "unsecured claims to secured status to the disadvantage of all other unsecured creditors, a result contrary to the Code's policy promoting a distribution to unsecured creditors in pari passu."

The Feltman court explained that section 151 of the New York Debtor and Creditor Law, which codifies equitable and common law setoff rights, provides that a debtor has the right "to set off and apply against any indebtedness, whether matured or unmatured," any amount owing from the debtor to the creditor. However, the provision does not permit setoff of contingent claims. 

Without any setoff right under state law, the court ruled, Noor could not use its contingent claim to offset liability to the trustee under section 553. 

Outlook

Feltman reinforces the settled proposition that section 553 preserves setoff rights under applicable nonbankruptcy law but does not create such rights. This principle of preservation, but not creation of rights for creditors, is reflected in other provisions of the Bankruptcy Code. For example, section 546(c) of the Bankruptcy Code, which addresses a creditor's right to reclamation of goods supplied to a debtor prepetition, does not create a new "federal right of reclamation," nor does it create a comprehensive federal scheme for reclamation, but rather, preserves a seller's reclamation rights under applicable nonbankruptcy law. In re Dana Corp., 367 B.R. 409 (Bankr. S.D.N.Y. 2007).

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.

To print this article, all you need is to be registered on Mondaq.com.

Click to Login as an existing user or Register so you can print this article.

Authors
Mark G. Douglas
Similar Articles
Relevancy Powered by MondaqAI
 
In association with
Related Topics
 
Similar Articles
Relevancy Powered by MondaqAI
Related Articles
 
Related Video
Up-coming Events Search
Tools
Print
Font Size:
Translation
Channels
Mondaq on Twitter
 
Register for Access and our Free Biweekly Alert for
This service is completely free. Access 250,000 archived articles from 100+ countries and get a personalised email twice a week covering developments (and yes, our lawyers like to think you’ve read our Disclaimer).
 
Email Address
Company Name
Password
Confirm Password
Position
Mondaq Topics -- Select your Interests
 Accounting
 Anti-trust
 Commercial
 Compliance
 Consumer
 Criminal
 Employment
 Energy
 Environment
 Family
 Finance
 Government
 Healthcare
 Immigration
 Insolvency
 Insurance
 International
 IP
 Law Performance
 Law Practice
 Litigation
 Media & IT
 Privacy
 Real Estate
 Strategy
 Tax
 Technology
 Transport
 Wealth Mgt
Regions
Africa
Asia
Asia Pacific
Australasia
Canada
Caribbean
Europe
European Union
Latin America
Middle East
U.K.
United States
Worldwide Updates
Registration (you must scroll down to set your data preferences)

Mondaq Ltd requires you to register and provide information that personally identifies you, including your content preferences, for three primary purposes (full details of Mondaq’s use of your personal data can be found in our Privacy and Cookies Notice):

  • To allow you to personalize the Mondaq websites you are visiting to show content ("Content") relevant to your interests.
  • To enable features such as password reminder, news alerts, email a colleague, and linking from Mondaq (and its affiliate sites) to your website.
  • To produce demographic feedback for our content providers ("Contributors") who contribute Content for free for your use.

Mondaq hopes that our registered users will support us in maintaining our free to view business model by consenting to our use of your personal data as described below.

Mondaq has a "free to view" business model. Our services are paid for by Contributors in exchange for Mondaq providing them with access to information about who accesses their content. Once personal data is transferred to our Contributors they become a data controller of this personal data. They use it to measure the response that their articles are receiving, as a form of market research. They may also use it to provide Mondaq users with information about their products and services.

Details of each Contributor to which your personal data will be transferred is clearly stated within the Content that you access. For full details of how this Contributor will use your personal data, you should review the Contributor’s own Privacy Notice.

Please indicate your preference below:

Yes, I am happy to support Mondaq in maintaining its free to view business model by agreeing to allow Mondaq to share my personal data with Contributors whose Content I access
No, I do not want Mondaq to share my personal data with Contributors

Also please let us know whether you are happy to receive communications promoting products and services offered by Mondaq:

Yes, I am happy to received promotional communications from Mondaq
No, please do not send me promotional communications from Mondaq
Terms & Conditions

Mondaq.com (the Website) is owned and managed by Mondaq Ltd (Mondaq). Mondaq grants you a non-exclusive, revocable licence to access the Website and associated services, such as the Mondaq News Alerts (Services), subject to and in consideration of your compliance with the following terms and conditions of use (Terms). Your use of the Website and/or Services constitutes your agreement to the Terms. Mondaq may terminate your use of the Website and Services if you are in breach of these Terms or if Mondaq decides to terminate the licence granted hereunder for any reason whatsoever.

Use of www.mondaq.com

To Use Mondaq.com you must be: eighteen (18) years old or over; legally capable of entering into binding contracts; and not in any way prohibited by the applicable law to enter into these Terms in the jurisdiction which you are currently located.

You may use the Website as an unregistered user, however, you are required to register as a user if you wish to read the full text of the Content or to receive the Services.

You may not modify, publish, transmit, transfer or sell, reproduce, create derivative works from, distribute, perform, link, display, or in any way exploit any of the Content, in whole or in part, except as expressly permitted in these Terms or with the prior written consent of Mondaq. You may not use electronic or other means to extract details or information from the Content. Nor shall you extract information about users or Contributors in order to offer them any services or products.

In your use of the Website and/or Services you shall: comply with all applicable laws, regulations, directives and legislations which apply to your Use of the Website and/or Services in whatever country you are physically located including without limitation any and all consumer law, export control laws and regulations; provide to us true, correct and accurate information and promptly inform us in the event that any information that you have provided to us changes or becomes inaccurate; notify Mondaq immediately of any circumstances where you have reason to believe that any Intellectual Property Rights or any other rights of any third party may have been infringed; co-operate with reasonable security or other checks or requests for information made by Mondaq from time to time; and at all times be fully liable for the breach of any of these Terms by a third party using your login details to access the Website and/or Services

however, you shall not: do anything likely to impair, interfere with or damage or cause harm or distress to any persons, or the network; do anything that will infringe any Intellectual Property Rights or other rights of Mondaq or any third party; or use the Website, Services and/or Content otherwise than in accordance with these Terms; use any trade marks or service marks of Mondaq or the Contributors, or do anything which may be seen to take unfair advantage of the reputation and goodwill of Mondaq or the Contributors, or the Website, Services and/or Content.

Mondaq reserves the right, in its sole discretion, to take any action that it deems necessary and appropriate in the event it considers that there is a breach or threatened breach of the Terms.

Mondaq’s Rights and Obligations

Unless otherwise expressly set out to the contrary, nothing in these Terms shall serve to transfer from Mondaq to you, any Intellectual Property Rights owned by and/or licensed to Mondaq and all rights, title and interest in and to such Intellectual Property Rights will remain exclusively with Mondaq and/or its licensors.

Mondaq shall use its reasonable endeavours to make the Website and Services available to you at all times, but we cannot guarantee an uninterrupted and fault free service.

Mondaq reserves the right to make changes to the services and/or the Website or part thereof, from time to time, and we may add, remove, modify and/or vary any elements of features and functionalities of the Website or the services.

Mondaq also reserves the right from time to time to monitor your Use of the Website and/or services.

Disclaimer

The Content is general information only. It is not intended to constitute legal advice or seek to be the complete and comprehensive statement of the law, nor is it intended to address your specific requirements or provide advice on which reliance should be placed. Mondaq and/or its Contributors and other suppliers make no representations about the suitability of the information contained in the Content for any purpose. All Content provided "as is" without warranty of any kind. Mondaq and/or its Contributors and other suppliers hereby exclude and disclaim all representations, warranties or guarantees with regard to the Content, including all implied warranties and conditions of merchantability, fitness for a particular purpose, title and non-infringement. To the maximum extent permitted by law, Mondaq expressly excludes all representations, warranties, obligations, and liabilities arising out of or in connection with all Content. In no event shall Mondaq and/or its respective suppliers be liable for any special, indirect or consequential damages or any damages whatsoever resulting from loss of use, data or profits, whether in an action of contract, negligence or other tortious action, arising out of or in connection with the use of the Content or performance of Mondaq’s Services.

General

Mondaq may alter or amend these Terms by amending them on the Website. By continuing to Use the Services and/or the Website after such amendment, you will be deemed to have accepted any amendment to these Terms.

These Terms shall be governed by and construed in accordance with the laws of England and Wales and you irrevocably submit to the exclusive jurisdiction of the courts of England and Wales to settle any dispute which may arise out of or in connection with these Terms. If you live outside the United Kingdom, English law shall apply only to the extent that English law shall not deprive you of any legal protection accorded in accordance with the law of the place where you are habitually resident ("Local Law"). In the event English law deprives you of any legal protection which is accorded to you under Local Law, then these terms shall be governed by Local Law and any dispute or claim arising out of or in connection with these Terms shall be subject to the non-exclusive jurisdiction of the courts where you are habitually resident.

You may print and keep a copy of these Terms, which form the entire agreement between you and Mondaq and supersede any other communications or advertising in respect of the Service and/or the Website.

No delay in exercising or non-exercise by you and/or Mondaq of any of its rights under or in connection with these Terms shall operate as a waiver or release of each of your or Mondaq’s right. Rather, any such waiver or release must be specifically granted in writing signed by the party granting it.

If any part of these Terms is held unenforceable, that part shall be enforced to the maximum extent permissible so as to give effect to the intent of the parties, and the Terms shall continue in full force and effect.

Mondaq shall not incur any liability to you on account of any loss or damage resulting from any delay or failure to perform all or any part of these Terms if such delay or failure is caused, in whole or in part, by events, occurrences, or causes beyond the control of Mondaq. Such events, occurrences or causes will include, without limitation, acts of God, strikes, lockouts, server and network failure, riots, acts of war, earthquakes, fire and explosions.

By clicking Register you state you have read and agree to our Terms and Conditions