United States: Prepetition Setoff Not An 'Improvement In Position' Under Bankruptcy Code

In a recent decision out of the U.S. Bankruptcy Court for the Western District of Virginia, a court analyzed the effect of a setoff effectuated between two governmental units in the 90 days prior to the filing of a husband and wife's bankruptcy case. In Hurt v. U.S. Department of Housing and Urban Development (In re Hurt), 579 B.R. 765 (Bankr. W.D. Va. 2017), the court addressed competing motions for summary judgment filed by the debtors, on the one hand, and the U.S. Department of Housing and Urban Development (HUD), on the other hand, in an adversary proceeding instituted by the debtors seeking to avoid a prepetition setoff of the debtors' tax refund on account of a debt owing to HUD. In ruling in favor of HUD, the court found that a pre-petition setoff is not avoidable as a preference under Section 547 of the Bankruptcy Code, and HUD did not "improve its position" vis-à-vis the debtors within the scope of Section 553(b) of the Bankruptcy Code, and therefore the setoff was appropriate and not avoidable by the debtors.

Facts and Arguments of the Parties

Before filing for bankruptcy protection, Adam Hurt obtained a loan from HUD, a U.S. government agency, in the principal amount of $38,463. This loan ultimately fell into arrears, and HUD sent the Hurts a notice of intent to collect by treasury offset. Pursuant to this notice, HUD alerted the Hurts of HUD's intention to seek to offset any amounts owed to the Hurts by the treasury (another U.S. government agency).

The Hurts filed for bankruptcy protection in March 2017, but before doing so, they filed their 2016 income tax return. The Internal Revenue Service (IRS), which is a part of the Treasury Department, determined that the Hurts had overpaid their 2016 income taxes, and were owed a refund on account thereof in the amount of $5,267. As of January 2017, the Hurts owed $19,653.38 to HUD on account of their loan. On Feb. 23, 2017, in advance of the date on which the Hurts filed their bankruptcy petition, the treasury processed the offset request from HUD and turned over to HUD the full amount of the Hurts' 2016 tax refund to satisfy a portion of the Hurts' indebtedness to HUD.

In their bankruptcy petition and schedules, the Hurts listed their 2016 tax refund as exempt. In order to recover the 2016 tax refund, the Hurts filed an adversary proceeding against HUD under 11 U.S.C. Section 547(b), seeking avoidance of the setoff between the treasury and HUD. The Hurts then filed a motion for summary judgment on their claims, and HUD cross-moved for summary judgment, asserting that the setoff was not recoverable by the debtors under Section 547 Bankruptcy Code, and further that the setoff was not recoverable under 11 U.S.C. Section 553, which is the Bankruptcy Code section governing setoffs.

The Court's Analysis

The court first addressed whether the Hurts could recover the amount of their 2016 tax refund from HUD as an avoidable preference under Section 547 of the Bankruptcy Code. In analyzing this issue, the court noted that in order to avoid and recover a preferential payment, Section 547(b) of the Bankruptcy Code requires that the amount to be avoided be a "prepetition 'transfer' of an interest of the debtor in property." The court took note of the fact that the Bankruptcy Code specifically defines the term "transfer" and, in a recent revision to the Bankruptcy Code, Congress removed the term "setoff" from this definition. The court cited the legislative history with respect to this change, which provided that "inclusion of 'setoff' is deleted. The effect is that a 'setoff' is not subject to being set aside as a preferential 'transfer' but will be subject to special rules." Accordingly, the court found clear instruction from the Bankruptcy Code that the setoff between HUD and Treasury was not a preferential "transfer" that could be avoidable under Section 547 of the code.

Although the Hurts did not raise the argument in their complaint, HUD asserted in its cross-motion for summary judgment that the Hurts could not recover the setoff between HUD and the treasury under Bankruptcy Code Section 553, which is the specific provision in the Bankruptcy Code governing setoff. It is important to note that Section 553 does not create a right of setoff, but rather recognizes that such a right exists; additionally, Section 553 limits the exercise of a party's setoff rights to certain circumstances. As relevant here, Section 553(b) provides that a pre-bankruptcy setoff may be recovered by a debtor's estate where the creditor improved its position with respect to any insufficiency between the mutual debts between the parties within the 90 days prior to the bankruptcy filing. For purposes of this section, "insufficiency" is defined in Section 553(b)(2) as the "amount, if any, by which a claim against the debtor exceeds a mutual debt owing to the debtor by a holder of such claim."

The Hurts argued that Section 553 required the avoidance of the setoff because at the beginning of the 90 day period, HUD was owed $19,653.38, but as of the date that the Hurts filed their bankruptcy petition, HUD's position had improved, as it was owed only $14,386.38—the difference between the two amounts being the Hurts' 2016 tax refund. This analysis, however, failed to address the "insufficiency" concept in Section 553.

Contrary to the Hurts' argument, the court found that there was no "insufficiency" between the Hurts and the government on Dec. 3, 2016—the beginning of the 90-day period—because the Hurts' 2016 tax refund did not become a debt owed to the Hurts by the government until Dec. 31, 2016, the last day of the tax year at issue. Accordingly, at the outset of the 90-day statutory period, there was no insufficiency between mutual debts, because there were no mutual debts between the Hurts and the government at all at that time. Rather, on Dec. 3, 2016, the Hurts simply owed the government $19,653.38 on account of the HUD loan, and the government owed nothing to the Hurts.

During the 90-day period, however, a mutual debt did arise when the Hurts became entitled to their 2016 tax refund. The creation of an insufficiency in mutual debts during the 90-day period prior to a debtor's petition date does not impact the right to setoff under Section 553. Rather, if a mutual debt arises during the 90-day period, there would only be an improper improvement in the creditor's position if the insufficiency were less on the petition date than it was on the date that such insufficiency arose.

In completing the analysis required by Section 553, the court determined that on Dec. 31, 2016, an insufficiency of $14,386.38 arose. This insufficiency was the difference between what the Hurts owed HUD ($19,653.38), and what the treasury owed the Hurts as of that date ($5,267.00). Because the government's claim against the Hurts as of the petition date was the same amount as the insufficiency that arose during the 90-day period ($14,386.38), the court concluded that the government had not improved its position with respect to the Hurts during the 90-day period, that the setoff was therefore not recoverable by the Hurts in the bankruptcy case.


The rule of setoff, as explained by the Hurt court, does not appear to articulate much more than the fact that a creditor may avail itself of the right to set off up to the amount of the debt owed to it during the ninety days prior to a debtor's bankruptcy case. In drafting Section 553 and removing "setoff" from the type of transaction that can be avoided as a preference under Section 547, Congress manifested its intent to allow setoffs within 90 days before a bankruptcy filing. However, the result of Congress' drafting might, in some instances, create a problem for creditors with setoff rights. For example, if the Hurts had made a payment to HUD in the amount of $5,000 after Dec. 31, 2016, thereby reducing the insufficiency that was created on that date, and HUD later effectuated its setoff with the treasury, HUD's insufficiency on the petition date would have been $5,000 less than it was on the date that the insufficiency arose. This would allow the Hurts to recover the $5,000 payment under Section 553, apparently regardless of whether HUD had a valid defense to the preferential transfer, such as the provision of new value under Section 547(c)(4) of the Bankruptcy Code, or that the payment was made in the ordinary course of business under Section 547(c)(2). As such, creditors with setoff rights might find themselves in a worse position than other creditors if the insufficiency is diminished (i.e., if they receive some form of payment) before they exercise setoff rights. As a general rule, therefore, creditors with setoff rights would be well advised to exercise those rights as soon as possible in order to avoid the hypothetical scenario described above.

This article originally appeared in The Legal Intelligencer.

Disclaimer: This Alert has been prepared and published for informational purposes only and is not offered, nor should be construed, as legal advice. For more information, please see the firm's full disclaimer.

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.

In association with
Related Topics
Related Articles
Related Video
Up-coming Events Search
Font Size:
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
Confirm Password
Mondaq Topics -- Select your Interests
 Law Performance
 Law Practice
 Media & IT
 Real Estate
 Wealth Mgt
Asia Pacific
European Union
Latin America
Middle East
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.


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.


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