Mutuality is Still a Requirement when Creditor Attempts to Exercise a Setoff

By: Michael J. Keane
St. John's Law Student
American Bankruptcy Institute Law Review Staff 

Recently, the In re Lehman Brothers Holdings Inc.[1] bankruptcy court held that a creditor may only exercise a “setoff” against a debt owed to a debtor when “mutuality” exists between that debt and the obligation running to the creditor from the debtor.[2] In the case, Swedbank attempted to setoff indebtedness owed by Lehman against the amount that Lehman had deposited in a Swedbank general deposit account.[3] The court held that 11 U.S.C. §§ 560[4] and 561’s[5] safe harbor exceptions to the automatic stay for swap agreements did not abrogate 11 U.S.C. § 553(a)’s “mutuality” requirement.[6] Thus, the court disallowed the setoff.

As a general matter, section 553 does not create the right to a setoff. Rather, the section merely recognizes and preserves setoff rights that exist under other applicable law.[7] To be eligible for a setoff under section 553, a creditor must meet three requirements.[8] One requirement is that “the debtor’s claim against the creditor and the debt owed the creditor must be mutual.”[9] Mutuality exists when “the debts and credits are in the same right and are between the same parties, standing in the same capacity.”[10] In Lehman, it was never disputed that the funds frozen in the general deposit account lacked mutuality with the debt owed to Swedbank.[11] However, Swedbank argued that the safe harbor provisions of section 560[12] and section 561[13] overrode the concept of mutuality found in section 553(a).[14]

The court declined to read these safe harbor exceptions into section 553(a).[15] Bankruptcy Code sections 560 and 561 do not address the requirement of mutuality.[16] Instead, those exceptions permit the exercise of a contractual right to offset in connection with swap agreements.[17] In its analysis, the court examined the language of the statutes. Sections 560 and 561 both contain the language that swap agreements “shall not be stayed . . . by operation of any provisions of this title.”[18] That language is different from the commonly used statutory language “notwithstanding any other provision of the law,” which has an established meaning of superseding all other law.[19] Accordingly, sections 560 and 561 do not supersede section 553(a). Moreover, the court used congressional intent to support its interpretation. The court reasoned that the “mutuality” requirement of Section 553(a) is so well established that had Congress intended to eliminate it, Congress would have done so directly and with clarity.[20]

The Lehman Brothers court used the plain language of the Code and the long history of “mutuality” to reach its decision. The case confirmed the “mutuality” requirement when dealing with a “setoff” and section 553 of the Code, even in the context of protected derivative transactions. Since the swap safe harbor provisions do not even discuss the concept of “mutuality,” they do not override that requirement of section 553. While this represents a significant exception to the protection provided to derivative transactions, it furthers bankruptcy policy. One of the fundamental goals of bankruptcy is to prevent particular creditors from acquiring a larger share of the estate than other similarly positioned creditors. The Lehman Bothers holdingadvances this goal by requiring a creditor to establish “mutuality” before it can utilize setoff under section 553.