By: Paul Clancy
St. John’s Law Student
American Bankruptcy Institute Law Review Staff
Recently, the United States Bankruptcy Court for the District of Delaware held that the Bankruptcy Code does not permit triangular setoff of debts, notwithstanding pre-petition contracts among parties that contemplate such an exchange.[1] In In re Semcrude, L.P., Chevron Products Company (“Chevron”), the creditor, had entered into separate petroleum-related contracts with three affiliated debtors: Semcrude, L.P., SemFuel, L.P., and SemStream, L.P.[2] Each contract expressly allowed the parties to setoff debts related to the contract or to any other contract between the parties and their affiliates.[3] At the time of the debtors’ bankruptcy filings, Chevron owed a debt to Semcrude, L.P., and was owed a debt from each of SemFuel, L.P. and SemStream, L.P.[4] Chevron moved for relief from the automatic stay to effect a triangular setoff of the debts among itself and the debtors, arguing that the terms of the contracts permitted such a setoff.[5] The court denied Chevron’s motion and held that, regardless of the contract language at issue, section 553 plainly does not allow triangular setoff.[6] The court determined that the contract arrangement did not satisfy the section 553 requirement that debts be mutual in order to be setoff, and that no exception existed that would allow parties to contract around the mutuality requirement.[7]
As a general matter, section 553 preserves a creditor’s prepetition right to a setoff of mutual debts with the debtor. [8] While the Bankruptcy Code does not define mutuality,[9] the In re Semcrude court noted that authorities have understood debts to be mutual only where the debts exist between the same parties in the same capacity.[10] Pursuant to this understanding of mutuality, triangular setoffs have not been permitted under section 553 because triangular setoffs, by their nature, do not contemplate debts due to and from the same parties.[11]
While the In re Semcrude court discussed an exception to the mutuality requirement that applies when parties have contracted for triangular setoffs in prepetition agreements,[12] the court observed that the chain of authorities recognizing this contract exception traces back to Inland Steel Co. v. Berger Steel Co. (In re Berger Steel).[13] However, In re Berger Steel recognized this contract exception as applying in cases decided under state law or common law of receivership, not under the Bankruptcy Act of 1898 or the Bankruptcy Code. Furthermore, In re Berger Steel did not itself rule on whether the contract exception applied in bankruptcy.[14] The In re Semcrude court concluded that In re Berger Steel did not create a contract exception for triangular setoff, and neither did subsequent bankruptcy cases that relied on In re Berger Steel in dicta.[15]
Having rejected the creation of a contract exception in bankruptcy through case law, the court in In re Semcrude then expressly rejected the argument that the Bankruptcy Code permits triangular setoffs via a prepetition contract exception.[16] The court concluded that, contrary to Chevron’s assertion, “[a]bsent a clear indication from the text of the [Bankruptcy] Code that such an exception exists,” it would be “improper to recognize one.”[17]
The holding in In re Semcrude is important because it expressly addressed and discarded a persistent strand of bankruptcy authority recognizing the existence of a contract exception to the mutuality requirement for setoff. After In re Semcrude, parties should be wary of relying on this purported exception in arguing that a prepetition agreement allowing triangular setoff will extend into bankruptcy, particularly because the court pointedly noted the absence of any direct authority permitting such an arrangement in cases decided under the Code.
[1] See In re Semcrude, L.P., 399 B.R. 388, 398 (Bankr. D. Del. 2009).
[2] See id. at 391.
[3] See id.
[4] See id. at 392.
[5] See id.
[6] See id. at 392–93.
[7] See id. at 396–98.
[8] See 11 U.S.C. § 553 (2006) (describing permissible conditions for setoff); 5 Collier On Bankruptcy ¶ 553.01[1], at 553-7 (Alan N. Resnick et al. eds., 15th ed. rev. 2009) (“In general, section 553(a) recognizes and preserves rights of setoff where four conditions exist: (1) The creditor holds a ‘claim’ against the debtor that arose before the commencement of the case; (2) The creditor owes a ‘debt’ to the debtor that also arose before the commencement of the case; (3) The claim and debt are ‘mutual’; and (4) The claim and debt are each valid and enforceable.”).
[9] See 5 Collier on Bankruptcy ¶ 553.03[3], at 553-28 (Alan N. Resnick et al. eds., 15th ed. rev. 2009); 4 Norton Bankruptcy Law and Practice § 73:5, at 73-32 (William L. Norton, Jr. ed., 3d ed. 2009).
[10] See In re Semcrude, 399 B.R. at 393 (“[T]he authorities are also clear that debts are considered ‘mutual’ only when ‘they are due to and from the same persons in the same capacity.’” (quoting Westinghouse Credit Corp. v. D’Urso, 278 F.3d. 138, 149 (2d Cir. 2002))); 5 Collier on Bankruptcy ¶ 553.03[3][b], at 553-29 (Alan N. Resnick et al. eds., 15th ed. rev. 2009) (“[W]hereas A and B may offset their mutual obligations, A may not offset an obligation that it owes to B against a debt that B owes to C.”); 4 Norton Bankruptcy Law and Practice § 73:5, at 73-32 (William L. Norton, Jr. ed., 3d ed. 2009) (“The creditor must show that each party owes something to the other in the same right and capacity.”).
[11] See In re Semcrude, 399 B.R. at 397 (discussing requisite indebtedness for mutuality under section 553); see 5 Collier on Bankruptcy ¶ 553.03[3][b], at 553-29 (Alan N. Resnick et al. eds., 15th ed. rev. 2009).
[12] See In re Semcrude, 399 B.R. at 394-96 (discussing bankruptcy cases recognizing contract exception); 5 Collier on Bankruptcy ¶ 553.03[3][b], at 553-31 (Alan N. Resnick et al. eds., 15th ed. rev. 2009).
[13] 327 F.2d 401 (7thCir. 1964); see In re Semcrude, 399 B.R. at 394–96 (tracing discussion of contract exception in bankruptcy case law to Inland Steel Co. v. Berger Steel Co. (In re Berger Steel)).
[14] See Inland Steel Co. v. Berger Steel Co. (In re Berger Steel), 327 F.2d at 405–06 (citing cases decided under state law or common law of receivership then distinguishing them factually).
[15] See In re Semcrude, 399 B.R. at 395–96 (distinguishing cases that cited In re Berger Steel).
[16] See id. at 399.
[17] See id.
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