Offset Rights (the Right to Setoff) in Bankruptcy

Setoff involves the right of a creditor to offset pre-petition credits against pre-petition debts. The Bankruptcy Code makes it clear that unsecured trade creditors do not have an absolute right of offset. For example, the right to offset a debit against a credit is affected by the timing of those obligations.   The right of setoff may also subject to the automatic stay provisions of the U.S. bankruptcy code.  This means that a creditor cannot offset pre-petition debts owed by the debtor against post-petition credits - at least not without approval from the bankruptcy court.   Approval is unlikely because such approval would violate many of the fundamental concepts of the bankruptcy code.

Upon learning of a bankruptcy filing, a creditor should consult with bankruptcy counsel before attempting a set-off. A setoff has an effect similar to that of receipt of a payment received during the 90 day lookback period.  The Bankruptcy Code permits a debtor in possession or trustee to attempt to recover any amount by which a bank or other creditor improved its collateral position through setoff or other means in the 90 days preceding the bankruptcy filing. 

Setoff and preferential transfers

Once the right of setoff has been established, the Bankruptcy Code provision permitting the avoidance of preferences bestows secured status upon a creditor for the amount of its setoff, so payments to a secured creditor are not considered to be preferential since the creditor does not receive more than it would receive in a liquidation.

See also Preferences

Edited by Michael C. Dennis.  Mr. Dennis is a consultant and can be reached by e-mail at mcdennis13@yahoo.com