Setoff
This practice note discusses the use of setoff by creditors as a mechanism to limit loss when a debtor has filed bankruptcy. In bankruptcy, setoff is governed by and subject to the limitations imposed by Section 553 of the Bankruptcy Code.
Section 553 of the Bankruptcy Code recognizes a creditor’s right to offset a pre-petition obligation it owes to the debtor against a pre-petition obligation the debtor owes to it. This setoff right, which permits the parties to cancel mutual debts, effectively shields a creditor from being obligated to pay its debt in full to a debtor and then needing to stand in line to collect only a pro-rata share of the debt owed by the debtor to that creditor. Thus, a creditor with a right to setoff receives priority over other creditors (after obtaining relief from the stay to exercise the setoff right).
Setoff is an important tool available to an otherwise unsecured creditor when it is faced with a bankruptcy filing. Therefore, it is important for creditors to understand precisely when the right of setoff exists under nonbankruptcy law, how to properly assert this right once a bankruptcy case is filed, and the limitations imposed by the Bankruptcy Code and the case law on the right to setoff, including the operation of the automatic stay. This practice note addresses how setoff rights are affected by a bankruptcy and elements to consider when seeking to enforce these rights as follows:
- Setoff Overview
- Setoff Requirements in Bankruptcy
- Treatment as a Secured Claim in Bankruptcy
- Setoff Exceptions
- The Automatic Stay
- Drafting Setoff Provisions in Contracts
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"Setoff," by Ira L. Herman was published on October 12, 2022, as a LexisNexis Practical Guidance® Practice Note. Reprinted with permission.