U.S. Bankruptcy Court Rejects Safe Harbor Claims of Bahraini Entities Seeking Setoff Rights

Joseph Muschitiello

St. John’s University School of Law

American Bankruptcy Institute Law Review Staff


            In In re Arcapita B.S.C., a bankruptcy court in New York held that Tadhamon Capital B.S.C. (“Tadhamon”), a Bahraini corporation, and Bahrain Islamic Bank (“BisB”), an Islamic commercial bank, could not assert rights of setoff under Bahraini Law and that no safe harbor provisions in title 11 of the United States Code (the “Bankruptcy Code”) protected them from returning owed funds.[1] On March 29, 2012, Arcapita, an Islamic wholesale bank licensed by the Central Bank of Bahrain (“CBB”), filed a voluntary petition for relief under Chapter 11 of title 11 of the Bankruptcy Code).[2] Prior to Arcapita’s filing for bankruptcy, Arcapita transferred $30,000,000 to BisB[3] and $20,000,000 to Tadhamon to purchase Bahraini securities.[4] After the bankruptcy filing, Arcapita asked BisB and Tadhamon to return the funds as property of Arcapita’s bankruptcy estate pursuant to §542 of the Bankruptcy Code.[5] However, both refused to turn over the funds, arguing that they were “exercising a purported right to a setoff of the debts owing between themselves and Arcapita under Bahraini law.”[6] Arcapita then filed adversary proceedings against Tadhamon and BisB with U.S. Bankruptcy Court, S.D.N.Y. alleging claims for breach of contract and violation of the automatic stay.[7] The defendant requested dismissal of the complaint because (1) U.S. Bankruptcy Court lacked personal jurisdiction over them, (2) they properly exercised rights of setoff under Bahraini law, and (3) they were protected further by safe harbor provisions of the Bankruptcy Code.[8]

            The bankruptcy court denied the defendant’s request, finding that Bahraini law did not provide a right of setoff to either defendant.[9] The Court claims that mutuality did not exist because it ceased upon the filing of the bankruptcy estate, citing cases to show “[t]he character of a claim is not transformed from pre-petition to post-petition simply because it is . . . unmatured when the debtor’s petition is filed.”[10] Thus, because Tadhamon’s debt owed by Arcapita arose from transactions pre-petition, but their debt owed to Arcapita arose post-petition, they were treated as deals with separate entities, and mutuality was lacking.[11] While both defendants claimed that their respective setoffs were admissible under Bahraini Civil Code, the Court found that the setoffs are invalid because the provisions under the Bahraini Civil Code were superseded by the formal directions issued to the defendants by the CBB, ordering Tadhamon and BisB to comply with requests to return the funds to Arcapita.[12] The Court also found that, in violation of 11 U.S.C, §533, the record overwhelmingly showed that the debts incurred by both defendants were undertaken pre-petition, and specifically for the purpose of obtaining setoff rights against Arcapita.[13] As for the defendants four claims of alleged safe harbor protection against returning the funds, the court found no merit in (1) qualifying the transactions as “security contracts,” (2) qualifying the transactions as “forward contracts,” (3) qualifying the transactions as “swap agreements,” or (4) qualifying the purported setoffs as “contractual rights.”[14]

            In this instance, the New York bankruptcy court concluded that the withholding of investments by both Bahraini entities was not permissible under Bankruptcy Code or Bahraini law, nor were they valid under any provision of safe harbor.[15] While recognizing that issues of intent are “often unsuitable for summary judgment,” the Court held that it found little doubt the investments were made with the purpose of obtaining setoff rights.[16] This Court questioned the claims of safe harbor under the laws of foreign nations to contemplate intent, while upholding international comity in their unwillingness to “guess the wisdom” of the CBB’s actions.[17]

[1] See In re Arcapita Bank B.S.C., 62 B.R. 414, 423 (Bankr. S.D.N.Y. 2021).

[2] Id.

[3] Id. 427-428. $20 million of this payment was paid back, but BisB retained $10 million from the March 14, 2012 placement. Id.

[4] Id. 428. Arcapita was in debt to Tadhamon for roughly $18 million through prior investment agreements. Id at 426. Tadhamon returned some residual funds in December of 2012, in order to even out the debt that Arcapita had with them and the purported “Setoff” they claimed to have rights to. Id at 444.

[5] Id. at 429.

[6] Id. at 428.

[7] Id. at 430.

[8] Id. at 431

[9] Id. at 438.

[10] Id. at 437 (quoting Braniff Airways, Inc. v. Exxon Co., U.S.A., 814 F.2d 1030, 1036 (5th Cir. 1987)).

[11] Id.

[12] Id. at 439.

[13] Id. at 447. 11 U.S.C. §533 explains when a right of setoff is valid, and that setoff is disallowed when a creditor has incurred a debt “for the purpose of obtaining a right of setoff against the debtor.”

[14] See id. at 476.

[15] Id. at 481.

[16] Id. at 447 (explaining that “no fact finder could reasonably reach any other conclusion here given the record, particularly detailed evidence of parties’ thinking in contemporaneous emails and telephone conversations.”).

[17] Id. at 444–445.